By: Levente Mady | Wed, Dec 1, 2004
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Interesting to note that what was advertised as a quiet US Thanksgiving week turned out to be official "back-paddle" week on a number of fronts in a number of different countries. The back-paddling activities were started off by Mr. Stephen Roach of Morgan Stanley fame. After a Boston based newspaper carried a story that Mr. Roach made a presentation to some institutional investors with the main theme that the US had a 90% chance of heading into an economic Armageddon, old Steve was quick to change his tune both on the Stanley website and in a column published in the New York Times that as long as the US$ can be devalued in a controlled fashion, everything should be honky-dory-peachy. Armageddon? What Armageddon? I don't see no Armageddon!!! That 90% probability disappeared instantly. Perhaps it was zapped with one of them Taser guns over the weekend. Then there was Captain David Dodge of the good ship called the Bank of Canada. He finally came over to the dark side by admitting that an 85-cent Canadian dollar might be a slight problem for the Canadian export sector. About time, Dave! And it just gets better... Next we have a guy named Yu YongDing. He happened to be a Bank of China Official, which did not preclude him from being a DingDong and publicly discuss the fact that the Bank of China (BOC) has stopped buying Treasuries for a few months now and is making a conscious effort to diversify its assets away from US$ denominated securities. Well it did not take Chinese officials a few months (like Dodge on the dollar) or a few weeks (like Roach on Armageddon) to back-paddle. Although Treasury holdings by CBs are public knowledge (all that those hordes of economists/strategists needed to do is look at the Fed custody data), the market really did not expect a BOC Official to point out this strategy. I also kinda wonder how China will hold the Remnimbi-peg in place if it stops buying US Treasuries? Shoelaces are good. And last, but not least, PIMCO Bond Guru B(ig) B(ad) B(ill) Gross is out with a fresh new monthly comment. I believe it is well documented that Big (Bad) Bill has been consistently looking for higher bond yields (and not quite finding them) for the better part of a year. So our hero is now hedging his bets and telling us that lower bond yields might be here to stay a little longer as long as they get continued support from those darned Asian CBs... But didn't Mr. Yu Yong, the DingDong from the BOC just tell us that they stopped buying US Treasuries months ago. Oh, right, that was erased from the public record and Mr. Yong has since been reassigned to tend to the administrative affairs of a remote Tibetan monastery. This is all soooooooooo confusing!!!! I don't know about y'all, but what I reckon is that we have some payroll data coming this Friday. Consensus is 200k. If the number is at 200k, bonds go sideways, perhaps slightly lower in yield for the rest of the year. If the number is South of 100k, yields go back to 4% and the Fed stays put in December (my favoured scenario), and if the number is reported North of 300k, then we go to 4.5% in a jiffy. Period. And no paddles. Just a few hedge-funds maybe.

NOTEWORTHY: The economic data was minor and mixed last week.

INFLUENCES: Fixed income portfolio managers more bearish again last week (RT survey down 3 points to 39% bullish). These guys just don't know when to quit. Commitment-of-trader stats are not yet available due to the Thanksgiving break. The technical picture on bonds remains constructive although there are some people that are interpreting the charts as topping. As long as the bond futures contract stays above 109.50, the technical climate remains positive. Seasonals are decidedly positive heading into December.

RATES: US Long Bond futures closed at 112-21, down 2 ticks last week, while the yield on the US 10 year bond was slightly higher, up 3 basis points to 4.23%. I expect the long end to continue to see solid support. The Canada - US 10 year spread collapsed to 16, in 15 basis points on the week. Buying Canadian 10 year bonds to sell US 10 year notes and pick up 50 basis points was recommended a few weeks ago. Well, the way I figure is that if PIMCO Big Bill likes Bunds at 48 through Treasuries, I will hold out for a few more beeps on the Canada-US 10year spread. The March05 BA futures position I bought at 97 closed at 97.29, up 22 cents this past week (thank you David Dodge). Upside in this contract is limited to 5-8 ticks at best, so it is time to unload this position. Let's take the 30 cents and run. On the other hand, the front end in the US is dirt cheap relative to Canada. Dec05 BA futures are trading 40 basis points through Dec05 EuroDollar futures. It makes sense to sell BAZ5 to buy EDZ5 north of 40, especially on the box with the 10-year US-Canada bond position. The belly of the Canadian curve was unchanged to the wings last week, but the belly is still cheap. Selling Canada 3% 12/2005 and Canada 5.75% 6/2033 to buy Canada 6% 6/2011 is at a pick-up of 62 basis points. As the curve continues to flatten, the belly should continue to outperform. Assuming an unchanged curve, considering a 3-month time horizon, the total return for the Canada bond maturing in 2012 is the best risk weighted value on the curve.

CORPORATES: Corporate bond spreads were well supported last week. The buy side is way long this sector. Long TransCanada Pipeline bonds were in 3 more basis point to 114, while long Ontario bonds were 1.5 wider at 46.0. A starter short in TRAPs was recommended at 102 back in February.

BOTTOM LINE: I remain positive on bonds even in the face of substantial US$ weakness. With an ongoing slowdown ahead of us, I believe the front end is cheap in the US. The Bank of Canada will be slower to raise rates again as long as the C$ stays around 85 cents. An overweight position in the belly of the curve is still recommended. Short exposure for the corporate sector was advised since February. A long position should be sold in the March05 BAX futures. Long Canada - Short US 10 year position was established at +50.

GENERAL COMMENTS: I would like to beg for all my readers' forgiveness, but I just could not keep it all on one page this week. I solemnly promise to get it back to 1 page next week.


Levente Mady

Author: Levente Mady

Levente Mady,
Institutional Advisors

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