We start the week somewhat optimistic on the near-term prospects for the market
– less from any grand expectations for further softness in the data and more from a technical perspective. The bear-flattening we have seen over the last week has been accompanied with a sharp pullback in expectations that the Fed will ultimately need to ease on the 31st. We are playing for a bounce in expectations sometime between now and the end of the month — there is still plenty of data to skew the pre-Fed trade.
We are encouraged by the market’s resilience this morning, despite the news that a group of the largest asset-backed commercial paper players (namely, Citi, Bank of America, and JP Morgan) are in the process of setting up a fund of about $80 bn to help provide liquidity and support to the ailing ABCP market — troubles in the sector are not new news, but we might have expected more pressure on Treasuries, so are somewhat encouraged.
Today’s data is limited to the Empire State manufacturing release — with the consensus call for a slight downtick to 13.1 Oct. vs. 14.7 in Sept. Potentially supportive, but not as near-term policy relevant as comments from Chairman Bernanke this evening in New York at the Economic Club meeting — 7pm. We expect the forum and timing will lead to some tradable comments, although we ultimately see the Fed focused on maintaining flexibility into the FOMC meeting.
New corporate deals will surely provide some meaningful pressure on both sides of the market — there are currently about $3 bn of deals set to price in the near-term, although we expect there will be plenty of additional supply announced and priced intra-day — particularly if last week’s issuance was any guide.
HIGHLIGHTS FROM THE U.S. GOVERNMENT BOND WEEKLY:
It was a grind, to be sure, but the market did weaken and the curve flatten over the past week for reasons we would describe as non-economic. The action sets a tone for the start of this week, with our cautionary note that the bearish flattening seems to be losing momentum and partially accomplished unwinding the chance for a Fed ease this month or next. In context, November Fed Fund futures ostensibly give about a 1/3 odds for an ease and even that likely overstates the case since the effective Funds rates has been under the target.
We are less confident that the Fed won’t go than the market and feel the NEXT bear flattening leg is the one to buy — but we to advise letting the market move to buying targets vs. getting on board for a short-term bear flattening, or jumping ahead.
On our mind is the traditional steepening as the Street sets up for the refunding, the fact alluded to in the prior paragraph that the market has largely priced out the Fed through the Dec 11 meeting (we think the risk are better than 50/50 they DO go), and the relatively limited volume/momentum manner of the recent bond market price action. Further, the data continues to look softer vs. firmer — the Fed acknowledged as much in the minutes and the staff cut back on their inflation and growth forecasts for 2008.
TACTICAL BIAS: We think the market is closer to the end of a corrective bear flattening phase and advise a bit of patience to let this unravel. And unraveling is the operative word. The curve flattening is about unwinds of more aggressive easing trades derived from September’s data not being so weak as to secure an October move AND an improvement in behavior of spreads. The chart below shows this via 3mo LIBOR and 3mo bill rates.
Did we learn anything new in recent days to suggest that either the economy is improving and so skirted the `bullet’ that would require easing? We don’t think so. To our way of thinking, the Fed’s 50 bp move was done to break the logjam of the credit freeze in August (an event that might see a mini repeat with FY ends and balance sheet constraints in Nov and Dec). While credit spreads remain wider than they were, improvement is manifest.
This, however, is half the story. The other is the general state of the economy where further weakness, we expect, will be priced back in. Last week we learned of a 1) nearly doubling in foreclosures YoY, 2) we read of the Fed’s interest in PRIVATE NFP growth (slowest gain on a 6 mo MA basis since ‘03) , 3) we heard from the National Association of Realtors about a downgraded housing forecast,
4) we listened to retailers caution about some softer sales (in part due to weather), 5) saw a sharp drop in Consumer Confidence expectations and a shaving of inflation expectations, 6) see oil up near a taxing $84 as we approach the heating season, and 7) gained from SMR that investors are now a bit short for the first time since April — further weakness does not force duration selling
– but are actually more bullish than they were.
The economic concerns may not pan out to further weakness. However, the market has given up a lot of the pricing for that and we think this is premature at best, downright wrong at worst. One way we see of trading the improvement in front end credit and potential easing is to buy March Euro$ vs. Dec08s. This spread should NOT be inverted and should steepen into an easing cycle.
IMPENDING EVENTS:
* Empire State Manufacturing, Oct 13.0 consensus vs. 14.7 Sept.
* Bernanke Speaks tonight on the Economic Outlook
OVERNIGHT EVENTS:
* Citigroup, Bank of America and JP Morgan have reportedly agreed to set up a $80 bn fund to support the Asset-Backed Commercial Paper market. The fund is expected to buy assets from SIVs — providing some additional liquidity in that market and hopefully preventing holders from having to divest at rock-bottom prices.
* BBG article highlights the risk for Treasury issuance to increase by 50% this fiscal year as the federal budget expands — owing to a decline in corporate tax revenues.
* Japanese Industrial Production (final), Aug 3.5% vs. 3.4% prior MoM and YoY 4.4% vs. 4.3% prior — modest upward revisions weighted on JGBs and modestly helped Nikkei.
* Hang Seng has a strong 2.4% uptrade — hits a record, supported by oil-related stocks as prices for crude oil surged.
NOTE: The views expressed are not of Bonds.com but of the unaffiliated author. Bonds.com makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.
Posted by bondsblog as Morning Call at 7:39 AM EDT
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Maybe it’s just us, but we’re struck by, and at odds with, the reports in the media of a ’strong’ employment report. They’re NOT making that big a deal about it, to be sure, but nonetheless we think the emphasis is on the wrong thing and offer an insight that may keep us from getting quoted for a while.
First, our baseline. Between the uptick in unemployment and, more critically, the tame PRIVATE job gains the report strikes us as lame. The upward revisions are all about local government workers in education, and even in Sept government made up 37K of the overall gain. We are concerned with the wage gains, strong, but in the months ahead are more concerned about unemployment.
So what’s our take on the media’s view? Simply that they don’t look at the details per se AND have to come up with some rationale and sound bites to explain away why stocks are doing so well. We’re bond guys and we get calls about various economic reports and why stocks are doing better on them EVEN WHEN THOSE REPORTS ARE WEAK. The point being is that sometimes price action needs a convenient rationale and few pundits will admit that price action can be random and at odds with the information at hand.
So much for that rant. We are impressed with the way the curve held key levels and resteepened after the headline flattening post NFP. This says a few things.
One is that the bond market was less sanguine about the data than, for example, stocks. Second, it points to a widespread desire to be in steepening trades for either impending weaker data and more Fed OR uncertainty connected to the inflation scenario. A third is that a lot of flattening trades were unwound prior to NFP — weak hands sold to stronger hands. Which is to say, we think steepening will prove the stubborn trajectory.
Today sees the Sep FOMC minutes and these are important. Why did the Fed go 50 bp and surprise the market? Was it meant as a shock to the system with the hope that would be enough? Does the Fed put more emphasis on blowing up the credit logjam or their economic fears? How did the rhetoric change so quickly from the days before the ease to the days after? Our expectations are that we will likely come away with at least the current amount of confidence in a 25 bp move later this month — maybe more. But we allow that this is a priced in story and are anxious to see the market’s reaction to that potential confirmation.
HIGHLIGHTS FROM THE U.S. GOVERNMENT BOND WEEKLY:
Ours feels like an academic argument for the moment. We concede that the data last week was far more balanced than what the market had been pricing in leaving exposed weak-handed long and weak-handed steepeners. The response to NFP was, we think, overdone from the bearish side. The details that followed on the nominal increase to September showed that the bulk of the testy revisions were from Government workers (113k of the overall 94k for July and August) and the bulk of those from local teachers (local education was revised up 90k).
We’re left with private employment looking softer. This is no surprise and has been the trend for several months running. But what we’ve seen is not, apparently, enough to satisfy the lust of the market for more determinedly weak data and we’re left in limbo. We define limbo as the extremes garnered in September and we expect those to hold as we receive further data about the state of things last month.
Our underlying bias is 1) the Fed has an October ease to go, 2) that we have yet to see the full gamut of economic repercussions, 3) the downside is limited by uncertainty and enough data to suggest weaker growth, and 4) the upside is limited by positions and enough data to suggest that the weakness post housing bubble burst may also be limited.
TACTICAL BIAS: We err on looking at seasonal patterns (yawn) and the technical patterns because the economic data is not right now triggering the market to make/break a new direction. As much as we view the latest NFP report as confirmation of softening labor, we are respectful of the price action and so will use that as an opportunity to express our underlying bullish bias. Bear in mind that most of our position measures are very, very neutral. That means there won’t be pressure to sell into weakness, making dip buying less risky.
Our trading perspective thus focuses on the range established in Sept AND the pivotal mid-point of that range; 2s (3.80-3.97-4.132%), 2s/10s (39.5-51.8-64.2 bp), 5s (3.954-4.173-4.392%), 10s (4.295-4.503-4.711%), TY (10812-10922-11031).
As shown just below, the seasonals are bearish for the next couple of weeks and favor steepening into early November. The risk, then, is for a break out of the range so we’d scale in at the lows in the event. It is notable that the curve has steepened both into market weakness and strength.
What this tells us is that the flattening action pre-NFP was about unwinds and so the position risk attached to steepening has been reduced and we continue to advocate trading accordingly. As stated above, we’re looking at the bottom of September’s range to hold — i.e. a buying opportunity. Let’s be frank; as we start this week those lows are with easy, easy grasp and so the risk is they give way — the point we advise is that you are better off buying A BOUNCE off those lows once they’ve demonstrated they will hold or scale in. In the case, for example, of 5s, an important breakout level comes in at 4.50%, or the 200-day MA in 10s near 4.75% — we would sorely like to buy those sorts of yields.
IMPENDING EVENTS:
* IDB/TIPP Economic Optimism, Oct — 49 expected vs. 48.2 prior.
* Tsy announces est 6 bn 10-yr TIPS for auction Thursday
* FOMC Minutes from 9/18.
* NFIB index
OVERNIGHT EVENTS:
* UK, BRC Retail Sls, Sep — up 4.9% vs. 3.7% prior.
* German IP, August — 1.7% vs. 0.5% expected, and 0.2% prior.
* Japan, Eco Watchers Survey, Sep — 42.9 vs. 45.3 expected and 44.1 prior.
NOTE: The views expressed are not of Bonds.com but of the unaffiliated author. Bonds.com makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.
Posted by bondsblog as Morning Call at 8:08 AM EDT
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For all our bullish steepening bias — and it’s not been a bad call — the last few weeks since NFP have been really about a choppy range albeit with that steepening bias. Still, as we face the mass of employment data this week, let’s not lose sight of the fact that 2s and TY are at the 50% retracement of the range since NFP day. This as a generic proxy is as close to neutral placement as you can get. (Do note that TY is in a triangle in the uptrend since June, ask for chart.)
And that is striking as the data since NFP has been largely very supportive — housing, inflation, retail sales, for example, and even Fedspeak as erred more dovishly (Fisher, Mishkin) in what is a sharp turn and a 50 bp cut amidst all that. We won’t grouse about the market’s inability to make a more determined move in September; we recognized that the pricing going with NFP carried things a bit too far for the FIRST fed ease. The issue we confront, and expect, is how the market handles the next Fed ease.
And THAT potential rests heavily on this week’s data. Given the market’s priced right in the middle of range since the last report and positions seem to be more neutral by pretty much any measure, we don’t expect prices to behave like a flushed woodcock with an explosive takeoff on friendly data. We do, however, expect a gradual probe if the data proves soft that fully tests the highs of Sept 10 and risks cracking those yields with 2s/10s moving to new wides (to 70 bp).
And if the data is NOT persistently weak? People won’t believe it, but sell a bit anyway (they don’t want to get too short) and that will steepen the curve too as convexity selling kicks in and people think about the November refunding on both a yield and spread POV. (And we think such will prove USD bullish as this is an overbought trade with DSIs oversold at 91 and CoT specs near the shortest they’ve been in many weeks).
We are keying in on the employment components and anecdotes that accompany all the release up to Friday. We’ve noticed that these proxies have been getting it right in recent months, more or less, especially ADP. We’re talking direction vs. absolute magnitude. And here’s a tidbit — the Sept NFP report has been LESS than forecast 70% of the time over the last 10 releases, with the average miss on those days -106k. When the miss is positive, it’s averaged 73k, so the skew here is for a softer-than-forecast report. We’ll suggest that with more or less confidence by Thursday.
HIGHLIGHTS FROM THE U.S. GOVERNMENT BOND WEEKLY:
The market traded well last week, with the front-end nearing its highest levels since ‘05, with 2s flirting with 3.95% and 10s near 4.55%. The market has priced in expectations for further weakness in the economic landscape and additional easing from the FOMC by year-end. The near-term risk to the market is the real economic data is unable to keep pace with the weakness priced in to the Treasury market.
Friday’s Employment Report poses the biggest challenge to the market — A sharp reversal from the August’s -4k NFP read would undoubtedly weigh on the market and potentially bring into question the merits of playing for further rate cuts — that said we would expect such a response to be short-lived and the market to dismiss the data as noise/lagging/volatile-series and focus on the signs of deterioration in other aspects of the economy (i.e. housing).
From a technical perspective, we see mixed signals. On the supportive side, demand remains strong as evidenced by last week’s 2- and 5-year Treasury auction takedowns — impressive by any standards. In addition, 10-year yields have broken a significant resistance trendline with a monthly close below 4.65% (see Strategic Considerations for full discussion). Somewhat offsetting this bullishness are the seasonal factors — which tend to push yields higher between mid-September and the November Refunding. During this period, 10-year yields typically back-up between 14-18 bps — suggesting another test of 4.70% in 10s is not off the table
TACTICAL BIAS:
The seasonals for the 10-year sector are negative between now and the November Refunding — similarly, the 2s/10s curve tends to steepen out — further galvanizing our steepening bias. We tend to see between 6 bps and 8 bps of steepening in the curve between now and mid-November. A move of this magnitude would bring 2s/10s to our 70 bps target for ‘07 and is consistent with the channel-top resistance we have been following.
For a longer-term skew of the market, we continue to follow the monthly 10-year charts and have been impressed by the technical break that we have seen. After holding to the trendline resistance since 2003 — the monthly close below 4.65% has breeched this level and suggests a tone shift from a technical perspective.
While this is somewhat offset by the near-term seasonal factors, we except it will become increasingly significant as we move toward year-end .
One of the biggest wildcards for the Treasury market remains the US Dollar.
Friday we reached some of the lowest levels in a very long time — for instance, the DXY (dollar index) reached its lowest level on record - since ‘67 according to BBG. The softening dollar ahead of a potential slowdown in the US economy makes sound fundamental economic sense — less foreign investment and the dollar becomes unattractive on a carry-basis. The open question is how soft does the dollar get before US assets look attractive even despite the divergence in economic prospects and monetary policy — moreover will it take a realignment of those factors?
IMPENDING EVENTS:
* ISM Manufacturing, Sept 52.9 consensus vs. 52.9 Aug.
OVERNIGHT EVENTS:
* Citi cuts forecast, sees profits down 60% in Q3.
* UBS losses, press reports highlight expected announcement of write offs on billions of FI assets to the tune of USD2.6 bn.
* Tankan survey, Q3 — 23 vs. 23 last for large Manufacturers, a bit more than expected and suggestive of continued expansion.
* UK Home Prices, Sept — flat.
* UK PMI, Sep — 55.1 vs. 56.3 prior.
* EC PMI, Sep — 53.2 vs. 53.2 prior.
NOTE: The views expressed are not of Bonds.com but of the unaffiliated author. Bonds.com makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.
Posted by bondsblog as Morning Call at 7:34 AM EDT
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