By: Levente Mady | Mon, Apr 7, 2008
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The long end of the Treasury Bond market continues to outperform the shorter maturities as the stock market seems to have turned the corner for now. The good people at the Fed and the Treasury appear to have calmed the markets, so not only do we have Rookie Ben and his cohorts hailed as saviours, but the Fed is on the verge of being granted additional powers in order to be able to better supervise not only traditional banks but investment banks and securities dealers as well. It is truly unbelievable how governments have an uncanny ability of rewarding incompetence. Meanwhile, the short squeeze that caused long term yields to decline sharply 2 weeks ago was neutralized in 1 trading day as the long bond melted down over 2 points to its present level and proceeded to trade sideways for the rest of the time. More weakness is likely in bonds.

NOTEWORTHY: The economic data was unequivocally weak again last week. Construction spending declined for the fifth month in a row. Both ISM Surveys were slightly higher than in February but they both remained under 50, indicating a contraction in both manufacturing and services going forward. Auto Sales also declined again in March. Factory Orders declined 1.3% in February after falling 2.3% in January. Weekly Initial Jobless Claims jumped 38k to 407k. this is the first time in 5 years that Claims were over 400k. The only surprise here is why it took so long to get here and the question mark is how much higher it will go. The monthly employment report was weaker than forecast, and the previous months' data was revised down significantly. These numbers were bad but they are still painting an overly optimistic picture on several fronts. One front is the birth/death adjustments. Those adjustments still assume that construction and finance are still creating jobs. I am prepared to eat my shorts for breakfast if that was indeed the case not only in March but any month thus far in 2008. Another front would be the amount of revenue generated by self employed folks especially in the real estate field. A real estate agent might not make a sale for months - perhaps years - before he/she is willing to declare unemployment. As we all know, Canada's employment machine has been generating jobs at breakneck speed. This trend continued in March as there were 14.6k new jobs added to payroll in our country during March. The only crack in this silver lining is the fact that while part time jobs increased 34.2k, full time employment actually declined 19.2k during the same period. More substantial weakness is also expected on the Canadian jobs front. Next week's headliners will include mostly second tier reports such as Consumer Credit, the Trade Deficit and the Michigan Consumer Sentiment survey.

INFLUENCES: Trader surveys remained optimistic on bonds during the past week. The present levels are creating a slight headwind from a contrarian perspective. The Commitment of Traders reports have indicated that the commercials are becoming increasingly long in their positioning. Last week's data indicate that Commercial traders are net long 264k 10 year Treasury Note futures equivalents, which is at the top end of the neutral range. Seasonals are decidedly negative for the foreseeable future. The 10 year yield seems to be gravitating towards the 3.5% level during the past two weeks. I maintain that bonds represent no value here, so the recommendation remains to stay short.

RATES: The US Long Bond future traded down 2 points to close at 119-03, while the yield on the US 10-year note rose 14 basis points to 3.47%. The yield curve was flatter for the fourth consecutive week. Long-short accounts can take advantage of the steepening trend by buying 2 year Treasuries against selling 10 year Treasuries on a risk weighted basis. This spread moved down 9 bps to 166 during the past 2 weeks. It looks like the curve steepener has run into solid resistance at the 200 level. This may take months to overcome.

CORPORATES: Corporate bond spreads remain under pressure. During the past week the 30 year TransCanada Pipeline bond was 20 basis points wider to 215 ticks over long Canada bonds, while 10 year bank sub-debt moved out 40 basis points to 260 basis point premium to the government benchmark, its widest level yet. I recommended shorting the TransCanada Pipeline issue at Canadas +102 and the bank sub-debt issue at Canada bonds +58 basis points a while back. Certain segments of the credit markets represent good value now. However, with margin clerks very much in charge of the market, more near term pain is expected. At this juncture I recommend that accounts review their short exposure and fine tune it somewhat. Out of the above 2 short recommendations, I am now recommending to cover the Trans Canada Pipeline position and remain short the financial sector. The profit booked on the Trans Canada recommendation is 113 basis points, which is equivalent of a price gain of approximately 18% on a 30 year bond (which was also specified in the recommendation). I would like to make it very clear that this recommendation is only a suggestion to reduce a short exposure on the sector. It is by no means a sign that I have turned positive on corporate spreads. The intent to stay with the financial short exposure was also deliberate as I expect this sector to continue to suffer.

BOTTOM LINE: Bond yields traded in a narrow range last week. The fundamental backdrop remains bleak as the economic data continues to disappoint. The trader sentiment and seasonals are negative, while the COT positions are becoming somewhat bullish. My recommendation is to stay with the curve steepener, continue to shun the weaker corporate credits. The view on the long bond is negative.



Levente Mady

Author: Levente Mady

Levente Mady,
Institutional Advisors

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