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.

The Treasury market streaked to 3 positive weeks in a row even after higher than expected inflation data.

On the financial sector front, write-offs have now exceeded $500 Billion. Conservative estimates from established organizations such as the IMF are forecasting the final tab to be over a trillion dollars. Meanwhile more pessimistic forecasters such as Nouriel Roubini are looking for double that figure by the time it is all done. The take away from this story is that the write-offs are nowhere close to being finished. The flavour of the past week was auction rate securities. A number of the leading banks and dealers have agreed to buy back billions of these securities to add to the inventory of impaired assets on their books. Capital requirements will be an ongoing issue in the financial sector. As long as they need to raise massive amounts of capital, financials will struggle to put in a long term bottom. On-going problems on this front are likely to support the bond market.

Short term rates lead the decline in yields globally again last week. The majority of commodity charts now look like blow-off tops. Bond markets world wide are starting to realize that inflation is a lagging indicator, so the high CPI and PPI readings are discounted as yesterday’s news. While PPI is close to 10% at this time, I would not be surprised to see a negative sign in front of it 12 to 18 months from now. The credit crunch is still gaining momentum. In a recent survey over 80% of bank lending officers indicated that they plan to further tighten lending standards. The bond market has been in a trading range for the most part of this year with the 10 year Treasury note yield stuck around 4%. While the Fed has eased aggressively over the past 12 months, their efforts to increase liquidity and get the Treasury to print boatloads of new money have failed miserably. They are pushing on a string. Staying safe in the short end of the Treasury market has been and continues to be the most stable investment out there. At the expense of repeating myself, I would like to reiterate that as time passes by I remain convinced that the Fed will not raise rates in the foreseeable future.

The Treasury market managed to make it 2 positive weeks in a row even in the face of a stronger stock market.

Last week it was Fannie Mae and Freddie Mac’s turn to report losses that were out of this galaxy. Both of those stocks are now trading comfortably under $10 per share, but the Administration still maintains that there is no bailout necessary to save these mortgage behemoths. Credit spreads remain under pressure and liquidity is not improving. The Wall/Bay street analyst community is slow to react but the torrent of downgrades keep poring in as a result. On-going problems on this front are likely to support the bond market.

The Treasury conducted a couple of quarterly refunding auctions: 10 year notes on Wednesday and 30 year bonds on Thursday. The auctions were both very well received by both domestic and international investors. As a matter of fact, the 10 year Note was so aggressively bought that the bond market rallied strongly into the 30 year auction. The other event of some significance was the FOMC policy meeting last Tuesday. As expected, the Fed left its overnight rate unchanged at 2%. As per my previous comments, I am standing by my forecast that the Fed is months if not years away from changing the Fed Funds rate and when they do, they will be more likely lowering - not raising rates as the consensus would have you believe at this point. In addition to the Fed meeting, a couple of European Central Banks held policy meetings as well on Thursday. Both the ECB and the Bank of England acknowledged that the European economies have slowed considerably and they have no immediate plans to raise rates at this point. The US Dollar had its best week in years in reaction to the dovish chatter from Europe’s leading central bankers. Add to the pile the weak economic reports coming out of even countries that have resource based economies such as Canada and one gets a picture of a significant slowdown not only in the USA but also across the rest of the globe. As a result a number of bond markets are now discounting further Central Bank rate reductions. In Canada for instance, the Central Bank Rate is 3%, but the 2 Year Bond Yield last traded at 2.72%, indicating that in the bond trader’s opinion the Bank of Canada rate is artificially high and it should be lowered sooner than later in spite of the concerns expressed about inflationary pressures after the last couple of BOC meetings.

Buy bonds; wear diamonds! The Treasury market rallied a couple of points last week.

In spite of the bounce in the financial stocks, the negative news continues to pour in on the earnings (or lack thereof) front in that sector. Last week we saw Merrill Lynch in the news again as they wrote off another $5 billion+ in assets. Leading basket cases Fannie and Freddie will be rescued by the government but that will not be much help to the shareholders. Ongoing problems on this front are likely to support the bond market.

Next week the Treasury market will have a slightly different focus from the second tier economic data and the other markets such as stocks, energies and currencies. The Treasury will conduct a couple of quarterly refunding auctions: 10 year notes on Wednesday and 30 year bonds on Thursday. The auctions usually have a negative effect on the bond market, especially in the case of long term supply such as the upcoming issues.

The other event of some significance will be the FOMC policy meeting on Tuesday. The Fed has never raised rates in a rapidly deteriorating employment environment like the one we are experiencing now. Last week’s employment news pretty much ensured that the Fed will leave rates unchanged next week. In spite of the fighting words, I don’t think the Fed is about to change tactics on that front, especially heading into a presidential election campaign. The shorter maturities of the yield curve remained well supported. I am standing by my forecast that the Fed is months if not years away from changing the Fed Funds rate and when they do, they will be more likely lowering - not raising rates as the consensus would have you believe at this point.

After extending its gains for a 4th week in a row, the Treasury market pulled back as equities recovered from the abyss.

The trend of bonds and energy trading in lock-step remained intact as bonds now sold off as energy prices corrected sharply. There was a recovery in stocks – especially financials during the latter part of the week, so the reverse safe-haven flows pressed bonds lower. The sharp increase in headline inflation also added fuel to the sell-off. Real returns on Treasury bonds are now negative across the entire yield curve, as even 30 year bonds provide a -.35% return after adjusting for inflation. That is great news for spenders and the government (who gets to borrow massive amounts of money at ultra low rates) but not so good for savers.

The drumbeat of anti-inflationary rhetoric continues from various Fed officials. The Fed has never raised rates in a rapidly deteriorating employment environment like the one we are experiencing now. In spite of the fighting words, I don’t think the Fed is about to change tactics on that front, especially heading into a presidential election campaign. The shorter maturities of the yield curve remained well supported. I am standing by my forecast that the Fed is months if not years away from changing the Fed Funds rate and when they do, they will be more likely lowering - not raising rates as the consensus would have you believe at this point.