Treasury Bonds Trade Lower on Increasing Supply

By: Levente_Mady

The bond market traded down again last week, as the main driver appears to be the supply side of the equation. As expected, setting up for the Quarterly Treasury refunding kept a lid on the market even as the economic landscape continues to deteriorate. Traders will have to deal with $32Billion 3 Year Notes on Tuesday, $21Billion 10 Year paper on Wednesday and $14Billion 30 Year Bonds on Thursday. The key is normally in the second leg of these 3 day auctions, so if the 10 Year tranche is well distributed, that could provide a bit of relief for this market that has seen nothing but trouble during the first 5 weeks of 2009.

Obviously supply is front page news and I had several clients/readers ask who will buy all the Trillions of Treasury bonds and bills that will be issued in the very near future (starting with over $100Billion next week)? First of all, even if foreign Central Banks slow their purchases, I don't think they will stop entirely. Second, as long as the financial and economic turmoil continues (I expect it will quite a while longer) Treasury securities will retain their safe haven aspect and will be purchased by large market participants for that reason. And even if there will be too much supply for the market in the form of failed auctions (where not enough bids will be submitted to buy all the Treasury securities offered for sale) – the US Federal Reserve has already indicated that they are prepared to step in as buyers of last resort. So stay tuned, it should be an interesting week coming up in the bond market.

On the Central Bank front, last week it was the Royal Bank of Australia 's turn to slash another 100 basis points to 3.25% on their policy rate. They were joined in the party by the Bank of England cutting their benchmark rate 50 basis points to a new all time low of 1%, while the European Central Bank decided to hold rates at 2%. We expect Central Banks to continue in easing mode for the foreseeable future.

NOTEWORTHY: The economic calendar was hopeless again last week. Personal Income was down 0.2%, Personal Spending declined 1%, Construction Spending fell 1.4%, while Auto Sales were beyond pathetic in January. The ISM surveys actually improved somewhat on both the Manufacturing and Services fronts, but they both continue to forecast declining activity in their respective areas with well below 50 (neutral) readings. Wee kly Jobless Claims popped another 35k to 626k – another fresh multi-decade high. Factory Orders dropped 3.9% in December after an upwardly revised 6.5% drop during the month of November. The monthly Employment report was actually a lot worse than the headline numbers indicate. Officially, Non-Farm Payrolls declined a worse than expected 598k, with downward revisions of 66k to the previous months' data.

The official Unemployment Rate climbed from 7.2 to 7.6%. The “unofficial” Unemployment Rate in the USA is now at 13.9% and rapidly rising. Consumer Credit declined $6.6 Billion in December after an $11Billion collapse the previous month. The Canadian jobs data was actually way worse than the US report. The Canadian economy shed 129k jobs with Ontario (-71k) and British Columbia (-35k) leading the way down. The Unemployment Rate jumped from 6.6 to 7.2% in Canada . These numbers are also seasonally adjusted as the report showed strange characteristics such as job gains in the melting financial sector. I could spend a lot more time slicing and dicing these numbers but the bottom line is that the employment scene is deteriorating at an increasing pace in both countries. Next week's schedule will be highlighted by the Trade Balance and Retail Sales reports.

INFLUENCES: Sentiment surveys continue to fall gradually and they are back to neutral as of last week. This is a slight negative as long as the momentum is down. The Commitment of Traders reports showed that Commercial traders were net long 342k 10 year Treasury Note futures equivalents – a decline of 60k from a week ago. This is remains supportive for bonds. One item I would still like to see in order to turn wildly bearish: the COT data to show commercials switching from a large long to a short position on the Long Bond contract. It is just not happening as this metric remains stubbornly high. Seasonal influences are now negative.

The technical picture is damaged, so I don't expect the Long Bond future to recover a great deal. The market remains under pressure in spite of strong support from dismal economic data. 124 was the break-out level for bonds on the way up. It is major support on the correction. We are trading less than a couple of points above with a pile of Treasury supply on the way next week. If 124 gives on the futures and 3% fails to hold on the 10 Year Treasury Note yield, this market could turn quite ugly in a big hurry, setting up nicely for some show of force by the Fed.

RATES: The US Long Bond future plunged another point to close at 125-27 last week, while the yield on the US 10-year note rose 12 basis points to 2.96%. The Canadian 10 year yield decreased 2 basis points to 3.02%. The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield moved to 200 basis points, which is an increase of 11 basis points.

BOTTOM LINE: Bond yields rose, while the yield curve was steeper again last week. The fundamental backdrop remains pathetic, which is supportive for bonds. Trader sentiment is neutral; Commitment of Traders positions are supportive and seasonal influences are negative. The market has put in a top. After the sharp down-trade my bond market view is neutral at this point. The results of the Treasury auctions and possible Fed intervention will set the tone during the coming week.

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

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