A weekly commentary on bond markets and other industry trends by Levente Mady, Managing Director, Derivatives at Union Securities Ltd.
The bond market was up last week on the strength of a $2 move on Friday. We had another auction cycle of the shorter (2-5-7 year) maturities that were sold during the middle of the week, and the market again reacted in textbook fashion by selling off into the auctions and rallying back up once the supply was out of the way. The new issue calendar was not only busy on the Treasury front, but heavy corporate supply was also easily and eagerly absorbed by the market. The disconnect between bonds and the risk trade continues and Friday’s trading was a prime example. Although yields declined sharply, most commodities (especially the agricultural sector) managed to turn in stellar performances and pulled the stock market into the green column along the way. Until the next wave of credit concerns hits the market, bonds will continue to have a positive fundamental backdrop.
I had a couple of comments from folks asking why I thought that the European Bank Stress Test was the biggest farce I have seen in a long time. Well, first and foremost, I don’t think the test had much stress in it. Worst case scenarios that were looked at included flat economic performance (most likely scenario as opposed to a stress case in my humble opinion), only the trading books of the banks were tested (not the majority of so called longer term holdings) and the so called bad apples in the portfolios were assumed to be ever so slightly rotten with self healing capabilities and no chance of a default. Second, I don’t think we really gleaned any new and valuable information from these tests – I think most people already knew that the biggest basket cases were the Spanish Cajas and mostly the smaller institutions that did not even make it to the list of being tested. But for the time being, things appear to have settled down on the European front, so stay tuned for further excitement down the road. While we are on the Bank Stress topic, I reckon it is appropriate to mention that in the US the number of Banks that were shut down by the FDIC in 2010 due to failure has reached 103 as of the previous weekend, which is about 40% ahead of the pace for this time last year. The financial distress situation in the US is very similar to the European one: smaller financial institutions continue to struggle mightily. As a matter of fact, various Federal Reserve officials – including stalwart hawks such as Bullard – are talking up the arsenal that the Fed still has to fight deflation in spite of reaching 0% policy rates 20 months ago.
NOTEWORTHY: The economic calendar continues to disappoint. New Home Sales set new records in futility as the 2 lowest readings in the data’s history were recorded for June and May (at 330k and a downward revised 267k respectively). Consumer Confidence was pretty much unchanged and still mired at recessionary levels. Durable Goods Orders disappointed with the second negative print in a row as both the headline and the ex-transport component fell 1% and 0.6% respectively. Weekly Initial Jobless Claims decreased from 468k to 457k but remain stuck north of 450k. The first peek at the Q2 GDP indicated that the economy was estimated to grow at a weak 2.4% clip. The Q1 figure was revised up from 2.7 to 3.7% however. The market did not seem to be impressed with this report as some of the internals were not terribly healthy. In Canada, May GDP was up 0.1% after a flat April, providing more evidence that the economy is losing steam. This week’s economic schedule will be highlighted by the ISM Surveys (both manufacturing and services) and the monthly Employment report.
INFLUENCES: Trader sentiment surveys we follow were lower last week. On a scale of 0-10, the surveys are at the 6.5 level, which is on the high side of neutral. The Commitment of Traders report showed that Commercial traders were net long 217k 10 year Treasury Note futures equivalents – which is down 30k on the week. This metric is neutral. Seasonal influences are slightly negative for the first half of August. The technical picture is positive as the bond futures continue to hold up well. Support at 125 was not even a factor as bonds continue to trade higher lows and higher highs. As a result, the technical picture remains solidly positive. With the long bond yield near 4% and the 10 year yield near 3%, the market is acting like it could consolidate in this area before embarking on the next leg up. We retain our slight positive bias on bonds but we moved to a neutral trading position at this point
RATES: The US Long Bond future was up 1½ points to 128-23, while the yield on the US 10-year note decreased 8 basis points to 2.91% last week. The Canadian 10 year yield decreased 11 basis points to 3.11%. The Canada-US 10 year spread moved in the Canadian market’s favour. The US 10 year yield is trading 20 bps lower than the Canadian 10 Year yield. The Canadian 10 year is trading cheap to the US here. The US yield curve was 6 basis points flatter with the difference between the 2 year and 10 year Treasury yield now at 235. The yield curve was ultra steep when 2s-10s were trading near 300. Now it remains only very, very steep, trapped in a range and struggling to normalize.
BOTTOM LINE: Bond yields were slightly lower across the board last week, while the yield curve tilted flatter. The fundamental backdrop looks increasingly supportive. Trader sentiment was less positive this week; support provided by the Commitment of Traders data has evaporated while seasonal influences are neutral at best for the first half of the month. The bond market had another solid week while testing the top end of its trading range. My bias is neutral to slightly negative for the first half of August.
Levente Mady 604 646 2088 Lmady @ union-securites.com
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