U.S. Treasury Bond Market Jolted by Panic Mode Quantitative Easing

By: Levente_Mady

The bond market was jolted up by the “surprise” (not entirely for the readers of this column) announcement that the Fed will be buying not only additional boatloads of Mortgage Backed Securities and Agency bonds, but also up to $300 Billion Treasury paper during the next 6 months in order to keep a lid on interest rates for the foreseeable future. As previously discussed, the Fed has already taken the Fed Funds Rate down to zero, so they are “all in” on that front. Now they opened a new kettle of fish by joining the Bank of England and the Bank of Japan in what is called Quantitative Easing – i.e. purchasing Treasury bonds in the Fed's case.

I did not feel that this was a big surprise, because of the way Chairman – I Can Walk On Water – Bernanke has approached this crisis thus far – i.e. shoot first and ask questions later, or when in doubt err on the side of doing too much. Before I move on, I believe that is very important that we pay way more attention to what central banks are doing as opposed to what they are saying. We have Bernanke, Carney and various others talking out of the side of their mouths telling us that (not just any, but) a strong recovery is just around the corner, while they continue to press panic button after panic button by having eased aggressively and now embarking on quantitative easing as a next step of their liquidity pumping activities. These guys are in panic mode and certainly acting like they can't see the light at the end of the tunnel. They have tried a number of drastic measures, and nothing has worked thus far, so they continue to act like they have an unlimited arsenal to save the world. Admitting defeat is not an option. Re-inflating the credit bubble that has burst is the only way to glory. There is too much debt out there, but reducing it is not an option. Let's give that drunken sailor another bottle of rum. The big question mark is how many more bottles does it take before we kill the sailor?

I must admit that while I was expecting the FOMC to announce Treasury note purchases in some shape or form, I was surprised at the sudden tremendous move in the Treasury market. The Long bond futures had their largest daily range on record – just a tad over 9 points. The market has given back close to 4 points from the highs. Volume on the futures was only slightly higher than average. The market reaction leads me to believe that this was a very sharp jolt but not anywhere a knockout punch for the bears. While I feel much more confident that the line in the sand has been drawn for massive support for the bond market (Long live the Bernanke Put!), I don't expect that the highs from the turn of the year will be challenged any time soon.

NOTEWORTHY: The economic data was mixed again last week. The week started with a disappointing Empire State Manufacturing survey that dropped 4 points to -38, followed by weak Capacity Utilization – down 1 point to 70.9% - and Industrial Production – a decline of another 1.4%. Building Permits and Housing Starts showed strong gains in February – they were up 3 and 22% respectively, albeit from extremely depressed levels. The inflation data was a snick higher than expected, with core CPI and PPI both rising 0.2% last month. The US Current Account Deficit is imploding in step with the Trade Deficit – it fell close to $50 Billion in the last Quarter of 2008, to a 5 year low of $132 Billion. Wee kly Jobless Claims drifted down 12k to 646k. Leading Economic Indicators fell 0.4% in February and the previous month's increase was revised down from +0.4 to 0.1%. This forward looking indicator does not forecast an imminent recovery yet.

The Philadelphia Fed Manufacturing survey moved up 6 points to a still dismal -35. The Canadian economic data was better than expected but far from good. Retail Sales increased 1.9% in January after a 5.2% decline in December. The year over year figure stands at -5.8%. Canadian CPI jumped 0.7% overall and 0.5% on the core measure. However, the annual inflation measure stands at 1.4% on the headline and 1.9% on the core. This is a good news – bad news story depending on how you care to view it. It is good news from a non-deflationary perspective, but bad news that in spite of a severe economic slowdown, inflation remains sticky. Inflation is definitely a lagging indicator, so I suspect that these data series will be under pressure going forward. Next week's schedule will be highlighted more housing data as well as Durable Goods orders, the final Q4 GDP data, Personal Income and Spending and the Michigan Consumer Sentiment survey.

INFLUENCES: Trader sentiment surveys remained stuck in neutral territory. The Commitment of Traders reports showed that Commercial traders were net long 368k 10 year Treasury Note futures equivalents – a decrease of 25k from a week ago. This is supportive for bonds. Seasonal influences are negative. The technical picture is damaged as the market managed to stabilize. 124 remains the line in the sand for support on the bond future. This key support managed to hold so far, and I expect it to hold for a while.

RATES: The US Long Bond future traded up 3 points to 129-07, while the yield on the US 10-year note decreased 24 basis points to 2.65%. The Canadian 10 year yield decreased 12 basis points to 2.75%. The US yield curve was flatter as the difference between the 2 year and 10 year Treasury yield decreased 16 basis points to 193.

BOTTOM LINE: Bond yields dropped lower, while the yield curve was flatter last week. The fundamental backdrop remains weak, which is supportive for bonds. Trader sentiment is neutral; Commitment of Traders positions are supportive and seasonal influences are negative. My bond market view is neutral.

By Levente Mady
lmady@mfglobal.com
www.mfglobal.ca

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