Flat U.S. Treasury Bond Market

By: Levente_Mady

The bond market was flat and choppy again last week as bonds held their ground even as equities continued to rally.  A little less than a month ago we reported that bonds became 2.5 standard deviations expensive to stocks.  That is no longer the case as that relationship is closer to neutral now due mostly to the rally in the stock market.  The fundamental news remains quite supportive, as most of the data points to non-existent inflation and a slowdown in economic activity.

The US Federal Reserve Bank has its next policy meeting scheduled for next Tuesday and Wednesday.  It is quite clear that the Fed will continue to stick with its Zero Interest Rate Policy (or ZIRP for short).  Although some Central Banks such as the Bank of Canada and the Bank of New Zealand have recently hiked their short term benchmark rates, I think it is safe to say that the major central banks – the US Fed, the European Central Bank, the Bank of England and the Bank of Japan – plan to stay with their ultra low interest rate policies for the foreseeable future.  Just the other week, the Bank of Japan approved a new lending program to pump liquidity and aid growth, which is considered to be a substitute for further easing (which they can’t do as they are already at Zero).  While there are a few members of the Fed Open Market Committee that would like to see rates increased, as long as “Helicopter” Ben Bernanke is the Chairman, the Fed will continue to lean toward lower rates in order to avoid perceived policy mistakes from the 1930s.  As per the commentary below, the latest economic data proves that the world economy is losing momentum as the effects of ZIRP are fading away.  While the Fed Funds rate will be kept unchanged, it will be interesting to see if the Fed will downgrade its outlook for the economy in the news release that normally follows its policy meeting.

NOTEWORTHY:  The economic calendar was unequivocally pointing to diminishing (if any) inflationary pressures last week.  Manufacturing Surveys both in New York State and especially in the Philadelphia region are pointing at a loss of growth momentum in the sector going forward.  Housing Starts are just confirming that the end of the housing purchase tax credits are indeed having the negative effect that some of the other data such as cratering mortgage applications (in spite of record low mortgage rates) and the decline in the NAHB survey were hinting at.  Housing Starts fell over 10% in May from a downwardly revised 659k in April to 593k.  Building Permits were below that figure at 574k, forecasting further weakness for Starts ahead.  Industrial Production increased 1.2% while Capacity Utilization was up 1 point to a still slack 74.7% in May.  Both PPI and CPI declined on the headline figures again in May.  PPI was off 0.3% while CPI retreated 0.2% last month.  The core figures showed marginal increases but the annual core CPI (the single most influential driver of long term rates) is now below 1% and still trending down.  Weekly Initial Jobless Claims increased from 460k to 472k last week.  This was quite disappointing as the past few weeks were indicating that the latest trend maybe toward the wrong side of 450k.  The Conference Board’s Leading Indicators increased 0.4% in May.  In Canada, the schedule was light.  On the economic release front May Existing Home Sales took a similar dive to US Housing Starts by tanking close to 10%.  On the policy front, Bank of Canada Chief Carney introduced a new level of caution and balance in his latest presentation in PEI last week.  It looks like the 75 basis point tightening expectation that has been built into the Canadian short term interest rate market may be overly ambitious at this point.  This week’s economic schedule will be highlighted by more housing data in the form of Existing and New Home Sales as well as Durable Goods Orders and the final revision of the Q1 GDP data.

INFLUENCES:  Trader sentiment surveys we follow pulled back somewhat.  On a scale of 0-10, the surveys dipped back under 6.5, which is flirting with overbought territory.  The Commitment of Traders report showed that Commercial traders were net long 245k 10 year Treasury Note futures equivalents – which is down 74k on the week.  This metric is neutral.  Seasonal influences are slightly positive at this juncture.  The technical picture is positive as the bond futures continue to hold up well.  It continues to look like a new 120 to 125 trading range is holding heading into futures option expiry this coming week.

RATES:  The US Long Bond future was down a quarter to 123-30, while the yield on the US 10-year note decreased 1 basis point to 3.23% last week.  The Canadian 10 year yield decreased 8 basis points to 3.32%.  The Canada-US 10 year spread moved in the Canadian market’s favour.  The US 10 year yield is trading 9 bps lower than the Canadian 10 Year yield as the Treasury yield underperformed by 7 basis points relative to its Canadian counterpart.  The US yield curve was 1 basis point steeper with the difference between the 2 year and 10 year Treasury yield now at 251.  The yield curve was ultra steep when 2s-10s were trading near 300.  Now it remains only very, very steep.

BOTTOM LINE:  Bond yields were practically unchanged across the board last week, while the yield curve tilted marginally steeper.  The fundamental backdrop looks increasingly supportive.  Trader sentiment is less positive this week; support provided by the Commitment of Traders data has evaporated while seasonal influences are slightly positive.  Based on this and the neutral technical set up, we are going to retain our neutral market position with a slight positive bias due to carry considerations.

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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