The US Treasury market seems to be running out of steam here in spite of supportive data from economic fundamentals. Canadian long term bonds have kept pace with the trend to lower yields in the US market and seem to be poised for a breather as well.
The cream of the financial crop is relentlessly taking turns at blowing up. Last week it was Fannie and Freddie – the largest mortgage companies in the world, this week it was Lehman Brothers - another one of the largest investment dealers on the planet, next week it looks like it could be AIG – not long ago the largest insurance company around – that might be on the bankruptcy block. I keep getting asked the question when this crisis will be over and the news indicates that the financial boat just keeps on springing new leaks. It seems to me that this might be good time to replace Bozo Bernanke and Powerless Paulson with a bunch of octopi as more hands might have a better chance of plugging up more leaks in that sinking financial boat.
Contagion is now spreading to the consumer. The economy will continue to weaken and the Fed will not raise rates any time soon. While I was a lonely voice talking about the Fed and the Bank of Canada easing again a few months ago, now it looks like the market is starting to assign some real probability that the Fed could lower rates again as soon as at the next FOMC meeting this coming Tuesday, September 16th. One thing is certain, all of the sudden I don’t feel so lonely calling for further rate cuts from North American Central Banks any more. Boring as it may sound, stay safe and settle for the 2%+ yields that 2 year Canada bonds and Treasury notes offer. It is not just the emerging stock markets that are getting annihilated. The Canadian Venture Exchange is down about 50% from its recent high 10 months ago. If you want to be adventurous, there is a pile of money to be made (or lost???) in the options market if you can stomach the excessive volatility across the board.
NOTEWORTHY: The economic data was disappointing again last week. The consumer – over 70% of the US economy – is showing signs of terminal fatigue. No, I am not talking about the University of Michigan Consumer sentiment Survey that bounced a massive 10 points to 73.1 for September. Although this metric is up close to 17 points from its low 3 months ago, it is highly likely that it will be plunging back towards those lows once the novelty of lower gas prices wears off. What is really significant here about an impending consumer crash was 2 data points last week: first the slowdown in Consumer Credit growth and second the outright negative readings on Retail Sales in recent months. Consumer Credit stalling is page 16 news – i.e. not much attention is paid to it. I personally think it is very significant as job losses and declining wealth due to lower house and stock prices combined with record consumer indebtedness will prevent folks from further spending. Weekly Jobless Claims decreased 6k last week to 445k. In other economic news, the US Trade Deficit swelled $3.4 Billion to $62.2B, mostly due to record energy prices, PPI dropped 0.9% to almost entirely reverse July’s 1.2% increase, Wholesale Inventories jumped 1.4% in July after a 0.9% increase in June and the Treasury Budget Deficit was in excess of $100 Billion for the third time in 4 months. We ain’t runnin’ out of Treasury bonds any time soon folks! The Canadian Trade Surplus dipped slightly to a still respectable $4.9 Billion. Unfortunately, declining commodity prices are forecasting further, more sizeable declines in this data series. In addition to the FOMC Meeting, next week’s reports will include Capacity Utilization, Industrial Production, CPI, Housing Starts, Leading Economic Indicators and a couple of regional surveys on the state of manufacturing in the North East region of the US.
INFLUENCES: Trader surveys continue to tick up and they are now at overly optimistic levels on bonds. This is a negative influence for the market. The Commitment of Traders reports showed that Commercial traders were net long 220k 10 year Treasury Note futures equivalents – an increase of 20k from last week. This is neutral for bonds. The seasonal influences are neutral for the rest of September. The 10 year note yield is struggling to hold below 3.75% in spite of strong fundamental support. My view is somewhat negative; I expect the 10 year note yield to head back up toward 4%.
RATES: The US Long Bond future traded down half a point to close at 118-19, while the yield on the US 10-year note increased 2 basis points to 3.72%. The yield curve was steeper and I am retaining my steepening bias just a little longer. Long-short accounts can take advantage of the steepening trend by buying 2 year Treasuries against selling 10 year Treasuries on a risk weighted basis using cash or futures. This spread increased 12 basis points to 152 last week.
CORPORATES: Corporate bonds remain suspect, especially the weaker credits.
BOTTOM LINE: Bond yields were mostly either side of unchanged, while the yield curve was steeper last week. The fundamental backdrop continues to deteriorate, which is supportive for bonds. Trader sentiment is bullish – which is negative - while COT positions as well as seasonal influences are neutral. The recommendation is to invest in the 2 year Treasury and Canada bonds, and to shun the weaker corporate credits. I am expecting the 10 year Treasury Note yield to drift back up toward 4%.
Levente Mady 604 484 4767 - email@example.com
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