BondWorks

By: Levente Mady | Thu, Jul 14, 2005
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The past week was a terrible example in the emotional swings a city, a country, and most of the world could go through in very short time span. The G-8 Chieftains meeting was rudely overshadowed by the terrorist bombing of the London transit system. Just one day after the IOC announced that London has won the right to host the 2012 Summer Olympics, the city woke up to a deplorable act by a group of nut-bars that claimed to have Al-Qaeda connections and agenda. After a 2 hour rush to safe havens such as US Treasury securities, the market decided that if that is the best the terrorist could do, it is just not good enough to lose any sleep over or sell any securities. The stock market bounced back with vengeance and by Friday's close stocks worldwide were well above pre-bombing levels. One market expert astutely observed that by now a terror premium has been built into the market. The trailing p/e of the NASDAQ composite dipped briefly below a panic stricken 44 on Thursday morning, only to bounce back to a more normal (including a hefty dose of terror premium of) 45.35. Treasuries spiked on the terror news, but ended the week under water again, and even the weaker than expected employment data could not provide enough support to keep them in the green column. Meanwhile the Fed is expected to continue raising rates.

NOTEWORTHY: The economic calendar was overshadowed by the events described above this past week. The employment data was below consensus even with the positive revisions to the previous months' numbers. The workweek measure was disappointing, while hourly earnings increase was subdued. Most of the rest of the indicators last week were positive. Consumer and manufacturing surveys topped expectations again, ISM Services was rock solid bouncing back above 60 after a decent bounce in the Manufacturing ISM Survey the week previous. The monthly employment figures in Canada were positive. While Weekly Jobless Claims have been moving sideways, the Challenger Grey Layoff Survey has shown a significant increase in corporate layoff announcement. The increase in this metric does not bode well for the employment picture ahead. Next week is going to be busy again, with Trade Data, Retail Sales, and inflation data highlighting the schedule.

INFLUENCES: Fixed income portfolio managers are becoming less bearish. (RT survey rose to another multi-month high reading of 46% bulls a week ago. This metric is now into neutral territory from a contrarian perspective.) The 'smart money' commercials are long 93k contracts (a sizeable decrease from last week's 192k). This number is becoming slightly positive again for bonds. Seasonals are neutral and choppy heading into July. Bonds spiked up on Thursday and continued the recent pattern of Friday sell-offs. On the technical front, bonds still have a positive bias, but the market seems to be taking 3 steps forward and 2 steps back.

RATES: US Long Bond futures closed at 116-27, down almost a dollar this week, while the yield on the US 10-year note increased 5 basis points to 4.10%. The market seems to be settling into a trading range around the 4% level on the US 10 year note. The Canada - US 10 year spread was steady at -20 basis points. We are officially neutral on this spread at this point. The belly of the Canadian curve outperformed the wings by another basis point last week and held the break through the 40 bps level. Selling Canada 3.25% 12/2006 and Canada 5.75% 6/2033 to buy Canada 5.25% 6/2012 was at a pick-up of 38 basis points. Assuming an unchanged curve, considering a 3-month time horizon, the total return (including roll-down) for the Canada bond maturing in 2013 is the best value on the curve. The inflection point on the Canadian yield curve is moving out. During the past 6 months the best value maturity date has alternated between the 2011 and 2012 issues, now this point is shifting further out to the 2013 area. Bond market participants, not only in the Canadian government bond market but also in provincial and corporate issues, are advised to shift the focus of their investments accordingly. In the long end, the Canada 8% bonds maturing on June 1, 2023 continue to be cheap on a relative basis.

CORPORATES: Corporate bond spreads moved in slightly last week. Long TransCanada Pipeline bonds were 2 basis points tighter at 121, while long Ontario bonds were in .5 to 46.0. A starter short in TRAPs was recommended at 102 in February 2004. Corporates have been narrowing for the past few weeks, but I believe they are close to ending this trend. Shorter maturity, quality corporates should be favoured over lower rated issues as I believe corporate spreads will continue to be under pressure. Any credit that is connected with the consumer and discretionary spending should be avoided. As a new recommendation we advised to sell 10 year Canadian Bank sub-debt at a spread of 58 bps over the 10 year Canada bond. This spread closed at 57 basis points last week.

BOTTOM LINE: Neutral continues to be the operative word on bonds. An overweight position in the belly of the curve is still recommended for Canadian accounts. The inflection point on the Canadian yield curve is shifting from the 2011-2012 and to the 2013 maturity area. Short exposure for the corporate sector is advised. We recommended an increase in short corporate exposure this week.


 

Levente Mady

Author: Levente Mady

Levente Mady,
Institutional Advisors

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