I would be a rich man if I had a dollar for every adviser who, over the past 15 months or so, argued that a recession was imminent because the yield curve had become inverted.

I’d be a very poor man if my wealth were dependent on getting a dollar for every one of those advisers who, since late last week, has even acknowledged that the yield curve has become positive again - much less conceded that, by the logic of their previous argument, a recession has become less likely.

It just goes to show how difficult it is to be truly objective in this business.

The yield curve, of course, refers to the relationship between interest rates of different maturities. Normally, longer-term maturities are higher than shorter-term maturities. But, occasionally, this relationship becomes reversed inverted, if you will. Many economists (though not all, by any means) believe that an inverted yield curve is a good leading indicator of economic recessions.

There is no consensus among economists concerning which particular maturities should be focused on when determining whether the yield curve is inverted. One pairing that is widely used, however, is the difference between the yields on two-year and 10-year Treasuries.

The yield curve as thus defined became flat in late 2005, and was inverted during much of 2006. Its maximum inversion in recent months came last November, when the two-year T-Note was yielding 19 basis points more than the 10-year note. As recently as the end of February, the curve was still inverted to the extent of a 14-basis-point difference between the two maturities.

But Wednesday the relationship righted itself. Currently, according to data from the Federal Reserve, 10-year Treasury notes are yielding 4 basis points more than the two-year note.

To be sure, a yield curve shift of this magnitude doesn’t guarantee that happy economic days are here to stay. According to one widely-cited econometric model that two Federal Reserve economists created a decade ago, in fact, this shift reduces the probability of a recession by no more than between 5 and 10%.

I’ll leave it to you to determine whether a shift in recession probabilities of this magnitude is noteworthy.

But I have a different agenda in devoting this column to the yield curve: The difficulty that all of us have in being scrupulously objective in interpreting economic news.

Consider how advisers might justify their not saying anything in recent days about the yield curve turning positive again.

They might, for example, argue that a 5 to 10% reduction in recession probabilities is not large enough to be significant. I don’t believe them. Most of these advisers who made a big deal a year ago about the yield going negative were focusing on changes in recession probabilities that were even smaller than 5%.

If such changes in probabilities aren’t significant now, why were they meaningful then?

Alternately, advisers might try to argue that the yield curve’s recent positive turn is a temporary phenomenon, reflecting short-term anomalies in the interest-rate market emanating from last week’s meeting of the Federal Reserve’s Open Market Committee. I saw some hints of this line of thought over the weekend.
But I’m not persuaded by this argument, either. It in effect is an admission that it is not the yield curve that is the crucial variable on which to focus, but some other factors entirely. That may very well be true, but that isn’t what these advisers were arguing last year when the yield curve was inverted.

This discussion reminds me of a classic line that, as a child, I was told was something Adlai Stevenson used to say. (Stevenson was the Democratic candidate for president in 1952 and 1956, among other things.) Stevenson supposedly used to make fun of opponents’ arguments by saying, mockingly, “Here is the conclusion on which I will base my facts.”

Advisers who believe there will soon be a recession in the U.S. may be right. But I get the unmistakable impression when reading the arguments of many of them that their reasoning has nothing to do with their believing there will be a recession. And this impression becomes confirmed when they don’t change their mind even when the data underlying their arguments change.

Of course, there are plenty of knee-jerk advisers on the other side of the recession argument, Pollyannas who would insist that all is rosy, even on the deck of a sinking Titanic.

To be scientific in our approach to the markets, we need to be ruthlessly empirical in following the lead of the data, in whatever direction it might take us, regardless of our preconceived notions.

That’s a tall order, I know.

But the alternative is to lead one’s investment life in denial, divorced from reality. And that can’t be a good investment strategy. End of Story

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.

NOTE: The views expressed are not of Bonds Financial but of the unaffiliated author.  Bonds Financial Inc. makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.

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Posted by bondsblog as Market Trends at 8:24 AM EDT

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We start the week on a defensive note with the market up against the odd piece of data that generated the rally just one month ago — Durable Goods. We err on the somewhat bearish side and see a pretty full retracement of some of the gain made of the intervening weeks to at least TEST that breakout move.

While we certainly will fixate on the economic data and behavior in related markets, we caution of downside limits given the position of the market. By a trio of measures (SMR, CoT, JPM) the market is shorter today than it was just before the rally that ensued on Feb 27. Further, we’d argue that the data continues to spell potential spillover from the subprime story (although the rates market had priced a lot of that in even as the mass media cottoned onto the idea).

And the Fed has made a step towards a more balanced/neutral view. We even heard from Mishkin, voting hawk, over the weekend who suggested that core inflation could come off to 2% even as energy prices hampered further improvement. That’s an interesting view — has the Fed lifted its implicit inflation target of 1-2%?
Is it dovish that they see falling core inflation even as energy remains high?
Sounds like a potential BEAR steepening idea.

With a lot of supply hitting, the market dealing with bearish technical momentum, and that Durable Goods figure seen HIGHER (vs. the 8.7% decline that started it all) we are biding our bullish desires and waiting for somewhat higher yields to entice the real money shorts in — and we do think that shorts deem the current back up a largely technical gift.

Month end, Friday, is a mixed bag. While the market is short, some of that has accommodated the expected loss in duration in the Aggregate index (due to inclusion of hybrid ARMS). With small gains to the Tsy and Agency indexes, however, and potential for higher yields by that time, we think this week will mark a peak in yields for the near term. What we are watching for is a bullish response to a bearish event.

HIGHLIGHTS FROM THE U.S. GOVERNMENT WEEKLY:
The singular event that we carry into this trading week is the Fed’s ginger step  off restriction to a more neutral posture — from the market’s perspective, you  could call that an “easing” into neutral. The impact was felt directly on the yield curve, which steepened sharply to a positive slop — first in about 6 months. Prices were less spectacular, with the 2-yr sector holding to the very center of its post Feb 27 range, but the balance of the curve underperforming.

The steepening is a significant shift and an appropriate one as the Fed leaves its hiking cycle in a formal sense to a neutral stature — one that focuses both  on growth and inflation. This is a doubled-edged sword from a rates perspective  BUT FAVORS STEEPENING along both edges. IF growth weakens further to the point of an ease (still an H2 event for us), then it’s a bull steepening. IF growth is  sub-trend, but inflation remains tense, then the Fed stays on hold much longer as it waits out slower growth to dampen price pressures. In the event, the longer end of the curve wrings its hands over the Fed being behind the curve and  the curve steepens.

The nearer-term rates picture is not convincingly bullish or bearish. We are (and have been for several weeks) skewed towards the downside and attempting to sell both upside technical resistance and breaks of supports. This strategy has done nothing to help or hurt a virtual P&L. We remain biased for downside — modestly so — at the confluence of 1) lingering poor seasonals, 2) flat lows and lower highs on technical charts, 3) prices holding under the big volume bulges post Feb 23, and 4) no sense of urgency to buy. We target 10-yr yield to 4.67-73% — the 50% and 61.8% retracement of the year’s range. We’d sell just over the 38.2% at 4.62% to ride those technicals down.

TACTICAL BIAS: Having alluded to a more bearish bias near-term, we maintain steepening interest AND a bias for wider TIPS BEIR. In terms of outright rates, the 10-yr chart below describes our target. The 50-61.8% retracement of this year’s range targets 4.67-73% — given that the market’s short, we’d expect decent buying there into month (on the Treasury side) simply to get a little less short. Further, we note that this very area represents both the breakout from late February AND the projection of a technical pattern of flat highs and rising lows.

With that sort of yield rise in 10s, we expect 2s to outperform. This works for curve seasonals, rate seasonals, and the recent outperformance in BEIR — see the next chart in this section. The steeper curve in bearish fashion simply reflects a restoration of some inflation risk premium — consider what oil has been doing.

For our ultimate BULLISH call to prove accurate we’ll need a shift in that premium — falling BEIR, falling inflation, restoration in credit fears. We are,  in advance, still consolidating gains and deem pullbacks a buying opportunity.
When we reference filling a gap in TY at 10801+/06 and then 10724/28+ we are reiterating targets that have been in place for nearly a month.

OVERNIGHT EVENTS:
* Fed’s Mishkin, voting hawk, says inflation will gradually drop to 2% vs. 2.25%  now but remain pressured by fuel prices. FT says this challenges implicit 1-2% “inflation target” and makes something of a big deal about it.
* BoJ Minutes — rates to remain low for some time, underlying inflation to rise, chance of US soft landing, weak weak Jpn consumption temporary.
* UK housing prices rose most in 4 yrs in March, Hometrack — up 6.7% annualized.
* French INSEE confidence gains to 109 vs 107.
* CoT data — Net Spec long fell sharply — net long 188K contracts vs. 493K and  the least long since last Feb (since just before rally). Biggest selling was in  E$, which fell to 134K longs vs. 441K and the least long since mid Feb.

IMPENDING EVENTS:
* New Home Sales, Feb — expected to rise to 1.02 mn vs. 937K prior.
* 18 bn 2s (est) and 13 bn 5s (est) announced.
* 5.3 bn CMBS to price today or Tuesday.
* hearing potential 20-25 bn in corporate issuance this week

OVERNIGHT FLOWS: The market is off a bit and the curve steady though it had been  a bit steeper. Volumes are mixed with TY at 90% of normal and cash at 145%. 2s swamp overnight volume with 48% of market share. Mishkin comments overnight may have sparked somewhat steeper curve — with his idea of core inflation coming off to 2% but energy limiting a deeper softening. Desk notes that Europe is UNDERPERFOMING US in a downtrade — that’s unusual.

Our flows were subdued. We had real money selling some long end paper, options related selling in 10s, decent Asian buying in front end, bills and 2s, US selling long end, retail buying 10s.

NOTE: The views expressed are not of Bonds Financial but of the unaffiliated author.  Bonds Financial Inc. makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.

Posted by bondsblog as Morning Call at 6:55 AM EDT

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We are anxious that the activity of Monday and the overnight session reveal the likely course of today’s action — that is, not much. Arguably, Monday was a bit  bearish given that the only piece of data we has was a dip in NAHB with a downward revision and such could not inspire the market.

On the other hand, no great technical supports were pierced and that the bond market held up relatively well in the face of an outside day up in stocks (ask for chart) and full expectation for a steady restrictive bias to be the outcome of the FOMC meeting.

This is a precarious balance, perhaps, but a balance nonetheless.

We remain — yawn — quite controlled by the post Feb 27 consolidation, which allows a bit further weakness. We’ve been biased towards selling to little satisfaction as 1) we anticipate the FOMC holding steady, 2) note the rejection of upside breaks and the more recent pattern of lower highs and flat lows (in TY), 3) the inability to do much with bouts of friendly data, and, 4) the chance  the consensus call for an uptick in Permits/Starts comes to fruition. This bias  is as much an excuse to stave off boredom and get to levels that prove a bit more interesting than current mid-range.

We like the idea of a shallow pullback, maybe with a bit of inversion (small) into the FOMC and reversal coming out. If Monday alerted us to anything it’s that the bond market’s fixation and high inverse correlation with stocks may be dissipating. The correlation was 80% in early March and is now closer to 60%.

TACTICAL BIAS: We’d use any flattening to carry a steepening position into the FOMC. Our logic here is two-fold. First, we think a steady Fed policy and virtually unchanged accompanying statement is priced in and so skew the risks to  relief and the chance to see some subtle shift in the Fed’s viewpoint. Second, if you believe point #1 and the recent flattening weakness is the best we can get then the market is telling us something.

We are thus encouraged to buy pullbacks. What shies us away from buying right now (10s at 4.569%) is that volumes have been so poor, directional flows really absent, those to allow for a deeper dip than has been seen.

We readily identify that daily technical indicators look more bearish than bullish — overbought momentum has turned. Sideways to modest pullbacks in the context of the tedium of the narrowing range and lack of activity is a reasonable way to offset the bearish momentum.

We and some on the desk like buying EDZ7 vs. EDU8, the idea being that this spread is the most inverted its been — -24.5 bp — and we see some risk of at least a minor narrowing if nearer term Fed ease prospects rise. Target -20 bp to
-15 bp.

OVERNIGHT EVENTS:
* BoJ meets, steady policy at 0.5%. Sees economy expanding moderately, CPI may be zero in short run. Taken slightly dovishly. Nikkei rises 153 pts.
* UK CPI, Feb — up 0.4% MoM vs. -0.8%, up 2.8% YoY — firmer than expected.
Core up 1.7% vs. 1.6%.
* Canada CPI, Feb — up 0.7% MoM, up 2% YoY — stronger-than-expected.

IMPENDING EVENTS:
* FOMC meets, DECISION ANNOUNCED WED
* Housing Starts, Feb — GCM sees 1.39 mn vs. 1.408 mn last (greater than consensus at 1.450 mn. Consensus on Permits is 1.55 mn vs. 1.568 mn)

OVERNIGHT FLOWS: The market is off a very small bit, with 3s the best peformer and 30s the weakest. Volumes continue to be as uninspiring as they can get, underscoring our neutral views — TY was 71% of average and cash came to 59%. 2s  took 47% of market share, which is quite high.

We had c/b buying in 2s and 3s, Japanese buying in 3s, real money buying in OTR 5s vs shorter paper and 30s, vs bank and financial selling in 2s and 10s. Away hearing of equally subdued flows though skewed to buying including HF buying in belly, spec selling in 5s, buying in 2s, Europe selling bonds.

NOTE: The views expressed are not of Bonds Financial but of the unaffiliated author.  Bonds Financial Inc. makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.

Posted by bondsblog as Morning Call at 6:31 AM EDT

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