U.S. Treasury Bond Market Outlook

By: Levente_Mady

The bond market traded down last week. The market action was quite disappointing for a number of reasons. The fundamental data remains dismal and considerably weaker than consensus forecasts. Pressure on the stock markets has not eased up one bit. The S&P500 Stock Index broke key support at 800 a couple of weeks ago and it ended the month of February below the lows of last November. Needless to say stocks had a brutal 2008, a record January drop to start 2009 and then followed up with the worst February performance on record.

The difference between the November low in stocks and the February plunge is that it feels that the panic has disappeared; new lows are just part of the normal routine now. The VIX was at 90 a couple of months ago, now it is at 46. The bond market was running away to the upside on safe haven buying; now it is stuck in the mud and sliding downhill. The Treasury auctions were well received last week, but that did not help any either.

Next week it is the Bank of Canada's turn to slash interest rates again. The consensus forecast is looking for the Bank Rate to be cut in half to .50%. Governor Carney was on TV last week ensuring us that he has everything under control as he expects the Canadian economy to rebound soon and grow at a healthy 3.8% clip by 2010. I am not quite sure how his research team came up with that forecast, but I will take the “under” on that line please. The US authorities are throwing everything but the kitchen sink at getting the economy moving again. It ain't working just yet! Whatever credibility the new administration had is quickly evaporating with the kind of hare-brained ideas that they are coming up with. They are spending trillions to get the financial markets un-stuck and the economy rolling. At the same time they plan to rob Peter to pay Paul by taxing the “rich” to pay for their programs and make the government more efficient.

The plan is also to cut the deficit to $500 Billion in 3-4 years. Since interest costs on the cumulative deficit will most likely exceed that amount by then that effectively means that the Obama administration is dreaming in Technicolor about achieving a budget surplus by the end of his term. That seems just a tad overly ambitious under the current circumstances. I realize that the Federal Reserve personnel has been there for a while now, but the fact is that we are in the middle of the greatest credit bubble in human history bursting and in spite of Professor Bernanke's expertise dealing with such circumstances, the medicine that he and his colleagues are applying isn't very useful. Canada is slow to follow in feeling the effects of the global credit crunch, but follow it will. The old saying: “when the US economy sneezes, Canada is likely to catch a major cold” will be at work in the not too distant future. And since the US is substantially worse off that a simple sneeze, the Canadian economy will remain bedridden for a long-long time.

NOTEWORTHY: The economic data continues to be relentlessly pathetic. Consumer Confidence hit new lows in February in spite of al the talk of stimulus in the near future. The Conference Board survey dropped another 12 points to a record low of 25 while the Michigan survey remained stuck at 56. Existing Home Sales declined 5% to a new 12 year low of 4.49 million units. 45% of those sales were distressed units. Durable Goods orders fell 5.2% versus expectations of a 2.5% decline. Wee kly Jobless Claims jumped another 36k to 667k for the latest reading – a new multi-decade high again. The Q4 economic activity as measured by the Gross Domestic Product - was revised down by a country mile from a decline of 3.8% to 6.2%. The Canadian economic data is now becoming an unmitigated disaster – following in the footsteps of the rest of to world. Canadian Retail Sales plunged 5.1% in December for an annual decline of 6.4% for calendar 2008. The Canadian Current Account Surplus has vanished with blinding speed. We were looking at a surplus of $8.2 Billion just in the second quarter of 2008, but by the 4 th quarter the balance turned down to a deficit of $7.5 Billion. The trend is definitely down at this juncture and it is expected to remain down for the foreseeable future. Next week's schedule will be highlighted the IMS economic activity surveys and the monthly Employment report.

INFLUENCES: Sentiment surveys are about as neutral as neutral gets. The Commitment of Traders reports showed that Commercial traders were net long 339k 10 year Treasury Note futures equivalents – an increase of 52k from a week ago. This remains supportive for bonds. Seasonal influences are neutral for a week before they turn negative. The technical picture is damaged and the market is trading very heavy. The market is trying to hold and even do a little better around the present level. 124 was the break-out level for the bond future on the way up. It is major support on the correction. If it breaks, this market could turn quite ugly in a big hurry. We are back to key support that is looking mighty fragile here.

RATES: The US Long Bond future traded down 3 points to 124-20 last week, while the yield on the US 10-year note jumped 22 basis points to 3.01%. The Canadian 10 year yield increased 20 basis points to 3.13%. The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield increased to 204 basis points, which is 19 basis points higher than last week.

BOTTOM LINE: Bond yields rose, while the yield curve was steeper 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 neutral. My bond market view is: look to sell the bounces or if they don't show up this week, sell the break of 124 in the March Long Bond futures.

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

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