U.S. Treasury Bond Market Breaks Out of Trading Range

By: Levente_Mady

The bond market finally broke out of its 5 month trading range with some conviction.  The long bond future actually traded as high as 124½ before settling back to 122 even at the close on Friday.  While the fundamental data mostly exceeded expectations, the focus was on the jumpy, weak and nervous stock market which provided Treasuries with their traditional safe haven bid along with gold and the US Dollar.

The Reserve Bank of Australia increased its rate by 25 basis points, but it did not seem to matter much as the Australian Dollar sold off in tandem with most other currencies (including the C$) versus that chipper US buck. 
I continue pointing out the on-going problems in the financial sector as the FDIC continues to slide down on an increasingly slippery hole.  Well, the mortgagors of last resort are not doing any better!  As the Fed winds down its mortgage buying program, the agencies are intent on losing billions and billions to support a hopeless cause.  Freddie Mac just asked for another $10.6 Billion from the Treasury after losing a bazillion dollars last quarter.

NOTEWORTHY:  The economic calendar was mostly better than expected last week.   Personal income increased 0.3% while Personal Spending jumped 0.6% causing the Savings Rate to drop again from a recent high of 6%+ to a current 2.7% in March.  This was at least partially reflected in the Consumer Credit data rising $2.0 Billion during that same period.  I read all this (MIS)-information about deleveraging and consumers becoming increasingly conservative.  Look at the numbers: they speak much louder than words in the media.  Consumers are back to their old ways of spending beyond their means as long as they can find a way to borrow more, they are chomping at the bit to do it.  Whether it is government transfers, “free” (as in zero% interest rate) consumer loans, defaulting on their mortgages to free up cash-flow, or any other means available, the consumer is just not giving up its old free spending ways until all doors to credit will be shut.  Just like Greece or any other sovereign that is borrowing themselves into oblivion.  The question remains about the sustainability of this process.   

Meanwhile the ISM indexes are telling the story of further expansion in the near term.  The Manufacturing survey rose a point to a strong 60.4, while the Services survey was unchanged at a solid 55.4%.  Auto Sales faded somewhat to 11.2 million annualized units.  Weekly Initial Jobless Claims dropped marginally from 451k to 444k – in line with expectations - last week.  The monthly Employment report was stronger than expected in spite of the headline Unemployment Rate jumping to 9.9% - its highest level in 2010.  Although Household employment (the figure that is used to calculate the Unemployment Rate) increased by over 500k, the fact that the Unemployment Rate still increased 0.2 attests to the fact that there is tremendous slack in the labour pool.  Payrolls increased 290k – about 100k more than expectations.  Not only that, but previous months’ data was revised up a total of 121k.  In Canada, the Employment Report was incredibly strong as 109k new jobs were created in April, far surpassing even the most bullish of bullish forecasts.  The Canadian Unemployment Rate dropped from 8.2 to 8.1%.  This week’s economic schedule will be highlighted by the Trade Balance, Retail Sales, Consumer Confidence, Capacity Utilization and Industrial Production reports.

INFLUENCES:  Trader sentiment surveys we follow moved in the bullish direction.  On a scale of 0-10, the surveys are close to 6.0, which is moving in the right direction for the bulls but it is far from overbought to help the bears.  The Commitment of Traders report showed that Commercial traders were net long 430k 10 year Treasury Note futures equivalents – an increase of 21k on the week.  This metric is still supportive as the smart money is buying into the break-out in bond prices.  Seasonal influences are diminishingly negative through May.  The technical picture is positive as the bond futures convincingly broke through the upside of the recent 114 -120 trading range.  It is time to drop the neutral view and get our pom-poms out to cheer the bond bulls again.  Last week’s comment suggested that bonds may settle back unless the stock market blowed up real good!  Well, I would say stocks blowed up pretty good and bonds did rally accordingly.  With the heavy supply schedule and an oversold stock market, the test of the 120-00 breakout point may provide an outstanding buying opportunity.  Next resistance level is at 124 to 124.5 on the bond futures and nothing but daylight if we get through that.

RATES:  The US Long Bond future was up another 3 points to 122-00, while the yield on the US 10-year note decreased 24 basis points to 3.42% last week.  The Canadian 10 year yield decreased 15 basis points to 3.50%.  The Canada-US 10 year spread continues to move in the US market’s favour.  The US 10 year yield is now 8 basis points lower than the Canadian 10 Year yield as the Treasury yield dropped 9 points more than its Canadian counterpart.  The US yield curve was 9 basis points flatter with the difference between the 2 year and 10 year Treasury yield now at 260.  The tail is wagging the dog as moves in the long bond are dictating the shape of the yield curve.

BOTTOM LINE:  Bond yields were lower across most maturities last week, while the yield curve tilted slightly flatter.  The fundamental backdrop remains supportive.  Trader sentiment is moving in the positive direction; support provided by the Commitment of Traders data is positive while seasonal influences are somewhat negative.  Based on this and the positive technical set up, we will be looking to buy into weakness during the rest of May.  Add to a bullish bias and earn the carry!

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

The data and comments provided above are for information purposes only and must not be construed as an indication or guarantee of any kind of what the future performance of the concerned markets will be. While the information in this publication cannot be guaranteed, it was obtained from sources believed to be reliable.  Futures and Forex trading involves a substantial risk of loss and is not suitable for all investors.  Please carefully consider your financial condition prior to making any investments.

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