Bond Market Matters: Levente Mady
The U.S. treasury market appears to be running out of steam in spite of supportive data from economic fundamentals. Canadian long-term bonds have kept pace with the trend to lower yields in the U.S. market and are poised for a breather as well.
The cream of the financial crop is relentlessly taking turns at blowing up. First it was Fannie Mae and Freddie Mac – the world’s largest mortgage companies. Last week, it was Lehman Brothers – another one of the largest investment dealers on the planet. As I write this column, it’s AIG (American International Group) – not long ago the largest insurance company around – that has been rescued from collapse in an US$85 billion U.S. government bailout.
I keep getting asked the question when this crisis will be over, and the news indicates that the financial boat just keeps on springing new leaks.
Contagion is now spreading to the consumer. The economy will continue to weaken, and the Federal Reserve will not raise rates any time soon. While I was a lonely voice talking about the Fed and the Bank of Canada easing again a few months ago, now it looks as if the market is starting to assign some real probability that the Fed could lower rates again. One thing is certain, I suddenly don’t feel so lonely calling for further rate cuts from North American central banks.
Boring as it might sound, stay safe and settle for the 2%-plus yields that two-year Canada bonds and treasury notes offer. It’s not just the emerging stock markets that are getting annihilated. The Canadian Venture Exchange is down about 50% from its recent high 10 months ago. If you want to be adventurous, there’s a pile of money to be made (or lost) in the options market if you can stomach the excessive volatility across the board.
Noteworthy: The economic data was disappointing again last week. The consumer – over 70% of the U.S. economy – is showing signs of terminal fatigue. No, I’m not talking about the University of Michigan Consumer sentiment survey that bounced a massive 10 points to 73.1 for September. Although this metric is up close to 17 points from its low three months ago, it’s highly likely that it will be plunging back towards those lows once the novelty of lower gas prices wears off.
What’s really significant here about an impending consumer crash was two data points last week:
•the slowdown in consumer credit growth; and
•the outright negative readings on retail sales in recent months.
Consumer credit stalling might be page 16 news, but I think it’s very significant as job losses and declining wealth due to lower house and stock prices, combined with record consumer indebtedness will prevent folks from further spending.
Weekly jobless claims dropped 6,000 in the second week of September to 445,000. In other economic news, the U.S. trade deficit swelled $3.4 billion to $62.2 billion, mostly due to record energy prices, the producer price index dropped 0.9% to almost entirely reverse July’s 1.2% increase, wholesale inventories jumped 1.4% in July after a 0.9% increase in June, and the treasury budget deficit was in excess of $100 billion for the third time in four months.
We ain’t runnin’ out of treasury bonds any time soon folks!
The Canadian trade surplus dipped slightly to a still respectable $4.9 billion. Unfortunately, declining commodity prices foretell bigger declines in this data series.
Bottom line: Bond yields were mostly either side of unchanged, while the yield curve was steeper in the second week of September. The fundamental backdrop continues to deteriorate, which is supportive for bonds. Trader sentiment is bullish – which is negative – while COT (commitments of traders) positions as well as seasonal influences are neutral. The recommendation is to invest in the two-year treasury and Canada bonds and to shun the weaker corporate credits. I’m expecting the 10-year treasury note yield to drift back up toward 4%. •
MF Global Canada Co.’s Levente Mady ( lmady@mfglobal.com) specializes in derivatives investments. The data and comments provided above are for information purposes only.
