Risk aversion ebbing as non-farm payroll approaches

Participants look set to continue adding back the risk jettisoned over the last few weeks.

It will be interesting to see how bonds respond today with non-farm payroll numbers typically bringing the volume that allows for big moves.  I would expect with momentum weakening in the recent rally and some talking of up to 700k jobs added in May that bonds end the day lower.

In commodities, it looks like oil is set to regain some of the ground it lost to gold recently.

Related articles

• Technical Analysis 101: Adam and Eve (globaltrader.blogspot.com)
• Employment Report Prediction: Bad Reporting! (calculatedriskblog.com)
• Thursday payrolla (ftalphaville.ft.com)

Link summary from my other blog

I had begun a new blog a few weeks ago while Globaltrader.blogspot.com was still unavailable for posting.  I plan to continue posting only on this blog now that it is restored but if it is removed by Google again I will return to that one.

Posts over the last few weeks had been:

• A look at some of the causes of the financial crisis and some thoughts on where the new regulations should focus.  This speech noted recently by Mark Thoma is also a good summary.  It is a bit odd that the US regulators still do not seem to acknowledge their role in the crisis.  
• China's position on the yuan.  The story is changing a bit with China's economy apparently shifting to domestic consumption without any currency adjustment but my conclusion is still the same.
• A news summary for the last full week in March. 
• Another summary focusing on mortgage delinquencies.  The note on yields possibly reaching a peak still holds with bonds trading strong last week and likely to benefit from continued Goldman / financial regulation fall out in equities.
• I celebrated the reappearance of Global Trader's Diary by looking up an old discussion on Fed policy and whether it was leading to distortions in the markets and underlying economy.  While not exactly predicting the crisis, it was fair to say many people saw the highly leveraged environment as ripe for catastrophe.  Naming GM, AIG, and FNM in 2005 as trouble spots, was a reflection of consensus among financial professionals and not due to any personal insight.  How were these problems allowed to fester until 2008?  I would give myself poor marks in estimating the timing of debt problems but I think the Fed failed in its dual mandate to maintain maximum employment.   A less leveraged economy in 2005 would almost certainly have led to an earlier adjustment of US saving rates and consumption patterns leading to a smaller shock to employment.
• Another update on mortgage delinquencies as Equifax data contradicted the city by city delinquency rates from CoreLogic. 

Japan's Impact on the U.S.

There is interesting comparison of of JGB and UST rate paths at the Big Picture and the Skeptical Speculator throws in a look at how the Nikkei performed. While it is an interesting coincidence I have a hard time getting over the idea that it is Japan's current economic troubles that are helping to pull U.S. rates down and not an inevitable reaction to the popping of a stock market bubble.

Also, the most unique part of Japan's history is the 1994-1999 segment where rates fell from a 4 handle to a 1 handle. The policy mistakes (failure to clear out bad loans and banks mostly) in that period led to the long bottoming process we are seeing in that economy. The U.S. rate cuts of 2001-2003 were done specifically to avoid the deflationary trap that Japan fell into and so far it has worked. This comparison of bond yields also ignores the very different saving and fiscal situation of the two countries. Japan's high saving rates bias its policies towards deflation (defending the purchasing power of savers) while the U.S. will lean towards inflating its debts away.

I think JGB yields bottomed in March of '03 which not coincidentally is when U.S. deflation fears peaked. I would rather bet on U.S. interest rates following Japanese rates in the present than in the mid 90's.

Corporate Spreads Still a Problem

From the FT:

The supply of new European corporate bond issues more than halved in May compared with the same period last year as borrowers were pushed to the sidelines amid the sharp volatility in the secondary market.
The supply of new bonds with investment-grade credit ratings reached just EUR6.875bn in May, down 52.5 per cent from the same month in 2004. The supply in the year to date is running 26 per cent below last year's levels, which ended up being 40 per cent weaker than 2003.
But the reason behind the low issuance in May and late April differed from that of the preceding months, in that it was the market that turned away from borrowers and not the other way round.

The article continues by discussing the return of investor demand in later May. Even so I think the trend of spread widening that started in March has a ways to go. Because of that I am leaning towards shorting stocks here but am patient to see where this rally goes. Seems like we could hang out around these levels for a few weeks.

Of course I am still watching TOL as a main tell. It seems like sentiment could keep squeezing it higher but it will be interesting to see how housing stocks can do if the market has a bad week.

Also watching silver and the yen to see if the dollar rally will run out of steam.

All in all not much to do.

Rising Japanese Bond Yields

From Bloomberg:

Japan's 10-year government bonds fell as yields near a 14-month low deterred investors from buying amid signs the world's second-largest economy is growing.

A government report on May 30 will probably show Japan's industrial production gained in April, according to a Bloomberg News survey. The economy in the first quarter expanded at more than twice the rate forecast by economists.

Hard to see why this trend wouldn't continue. To change it I think you would need to see a hard landing in China.

Equities, Bonds, and Inflation

I imagine we are making near term highs in the equity markets. Maybe slightly above here over the next 4 days and then a pullback. Maybe to 36.20 in the QQQQ. I am chucking out some of my longs with plans to kick the rest out tomorrow. Maybe we are into a topping process that leads to some good long term shorts but I would say it takes a couple of weeks and will be staying flat on equities and watching.

I am going to start building a long bond short in here. Going to go slow as it seems like the dollar might need to top out to create any real weakness.

I don't see this mornings inflation number as a problem and generally just see it lagging the PPI top. I don't see how that top can get taken out without a massive reversal in commodities. Those charts are disaster zones and probably need to base for 2 months. If I am wrong and that rally relaunches I would reconsider my view that inflation fears peaked in March and are headed lower.

Auto Supplier Bankruptcy

My brother works as an engineer at an autoparts supplier and he asked me if he should buy some shares in Collins & Aikman, which filed for chapter 11, yesterday while it trades around $0.10. I replied that he has plenty of risk on the books just by working in the industry and that the action will be in bonds once the stock price is below a buck.

The company has some 2011 bonds that are trading near $0.40 at a roughly 35% yield. It may have overshot in the short-run but at those levels there is not much hope for the stock. I mentioned investinginbonds.com as a source for corporate bond prices the other week and while it is not a very good market for individual investors the prices can give some insight into a company's prospects. Definitely worth checking out before playing in the equity.

Norway Sells Half its U.S. Treasury Bonds

From Reuters:

A surprisingly small flow of foreign money to the United States in March was due mainly to a halving of oil-rich Norway's U.S. Treasury bond holdings, raising questions about whether overseas governments are cutting huge holdings of U.S. assets.

A U.S. Treasury report on Monday showed the net flow of foreign investment to U.S. securities at $45.7 billion in March -- more than $20 billion below expectations and less than needed to cover the $55 billion U.S. trade deficit that month.

Foreign official institutions, consisting mainly of foreign central banks, were net sellers to the tune of $14.98 billion.

Close examination of the data shows these sales were dominated by Norway's more than halving its holdings of Treasury bonds to $16.9 billion from $33.8 billion.

Analysts said Norway's holdings are most likely those of the $160 billion Government Petroleum Fund, a fund of foreign stocks and bonds set up in 1996 aimed at saving oil and gas revenues for the future, when energy resources run out.
...
Norway's Treasuries holdings rose by more than $20 billion in the second half of 2004 to $35.1 billion in January, said Goldman Sachs economist Thomas Stolper. He added that March looked consistent with a very active investment stance.

This was an interesting take on some pretty widely covered news. As Brad Setser says, "...Norway is not likely to sell $17 billion of Treasuries every month." Even so I am surprised the euro didn't get a little more mojo back against the dollar.

Today's news continues the trend of taking some pretty surpising data in stride. In the last two weeks we have gotten over strong employment data (too construction heavy), a shrinking trade deficit (it was Chinese New Year), and strong retail sales (screwed up by Easter). My answer to all this is that the market is just not focused on the data. It probably doesn't help that there has been a pretty mixed picture.

I kind of feel the path of least resistance for the markets is higher (lower for UST bonds) as lots of people seem to be looking at long-term problems to drive current prices. This is most noticable in housing but so far there is little sign that market can't stay strong through the fall.

Tea Leaves

Looking through the charts today. The strength in housing looks impressive. Toll Brothers (TOL) is one of few charts that is still in position to challenge the March highs. It is especially impressive given that the bonds turned lower on the jobs report. I guess the market likes the construction jobs in spite of the higher rates. Same story in Fluor (FLR).

I also see strength in the Asian ETFs (EWY, EWS), semiconductors (INTC, SMH) and some of the retailers (SMRT, ANN).

Oil stocks look alright but other commodities sectors are still struggling near lows.

I am taking a wait an see approach to the charts. I would expect this rally to lead to some nice shorts in a bit but if home builders can break new highs it might postpone the markets demise by months.

Handy Bond Market Data

Brad Setser stuck in a comment that had me checking out bond data. I still have not found net long-term corporate issuance for 2004 but thought I would organize some of the resources I ran into.

Bond Market Association has a table of outstanding debt by sector from 1985-2004. Other BMA tables here.

Thomson Financial's capital market summary 4Q 2004 (U.S. total debt issuance by sector on page 13 shows long term issuance excluding MBS, ABS, and Munis down 2.5% from '03) and lots of other reports (mostly league tables) here .

The BMA also provides InvestingInBonds.com which is a good starting point for current bond prices and spreads. The corporate page will pop up the most active corporate issues and you can even watch a bond market ticker.

The U.S. treasure curve with swaps included is available at GovPx and there is a bond market outlook and news summary provided by Stone and McCarthy. You can also get economic headlines refreshed every 2 minutes if that is your pleasure.

Summing Up the Week

We end the week weighing the auto downgrades and steepening yield curve (new 30-yr) against an unexpectedly positive jobs report and Kerkorian's bold bottom fishing maneuver in General Motors (GM).

On the auto downgrades it seems very likely that the bond market had already anticipated the downgrade. Its arrival shifts the focus off of the auto bonds and towards the wider bond market. I would not be surprised if GM and F bonds bottom here or shortly while junk spreads continue to widen. A best case would be junk widening while investment grade tightens but I would guess such a trend would be short lived. I am not really sure where Kerkorian's bid fits into this picture other than to muddy the waters. It is not clear what his motivations are and I am not sure that GM's equity is the best risk / reward trade in here.

I said any investment grade tightening might be short lived because the jobs report and new 30-yr created a lot of uncertainty in the long end of the yield curve. On Tuesday I thought the market would start to anticipate an end to the hiking cycle but this jobs report brings us back to considering 50 bp hikes. Easy to see why it was important for the Fed to reinsert a benign long-term inflation outlook. Anyway, the jobs report is just one data point and it needs confirmation in the rest of the data this month as well as next month's report. People were all about the "soft patch" at the beginning of the week so this report should cause a serious reexamination.

At some point between now and August the market will probably have serious doubts as to whether the 30-yr actually comes back. There are also supply constraints until the new bond is a sure thing so if the shorts get too heavy while it is only an idea that could set up quite a squeeze. A decision in August seems to put the new 30's issuance in Nov or Feb.

All this U.S. news has managed to crowd the yuan revaluation out of the news. Asian currencies are still trading strong though. Even though China does not want to reward speculators, the pressure internally are only going to get worse until they revalue. I thought they were coming to grips with that but maybe it takes another couple of months. They would need some help from Japan or Korea to scare the speculators at this point and I don't see much of a cause for that. The dollar also rallied nicely on the back of the jobs data but the theme to me is still European weakness. Gold and silver are focused on USD/EUR rather than JPY/USD. I am not sure why that is.

General Glut on the New 30-year

He really read my mind with this one:

As I type the 10-year is up to 4.23%, rising over 1% today. Now this is still nothing compared to where it was in late March (~4.6%), but one has to wonder if the ultra-low ten-year yields can last with the 30-year on the way. And more importantly, what will this do to mortgage rates which tend to move in tandem with the 10-year? After all, it was late March when the 30-year FRM topped 6.0% for the first time since July 2004.

A while back Brad Setser pointed out the tight supply of U.S. long maturity debt as a reason for the yield curves flatness and I commented:

While the limited supply of long-maturity bonds is an interesting data point I am not sure it explains a whole lot about the low yields. There has been no supply limit on the corporate side of debt issuance.
If the restricted supply of treasuries is keeping yields down then corporate spreads should be wide and not historically tight as they are. Maybe it is a second tier effect of some sort where the low treasury yields create the illusion of stability which leads to spread tightening but that is bit tougher to believe.
Probably easier just to say that bond investors expect inflation to remain low for a long time.

Sitting here today I was probably wrong and Brad was right. My comment puts way too much faith in the capacity of investors to act rationally and widen out spreads as non-UST debt grew.

I did not show up today with bond shorts on but have been looking for steepening (and been wrong) for quite a while. I am not planning to chase yields here and expect some retracement of this mornings move. Unless the Treasury announces in August that we don't need a long bond after all, this announcement looks like a green light to sell the long end of the yield curve.

A New Long Bond on the Horizon

From CBS Marketwatch:

"We will examine if we have the flexibility to issue 30-year bonds while maintaining deep and liquid markets in our other securities and determine if nominal bond issuance is cost effective," said Timothy Bitsberger, assistant secretary for financial markets.

Treasury will announce a decision about issuing the 30-year bond on Aug. 3. If reinstituted, the bond could be sold again in February 2006. Read the report.

I guess (like Greenspan) the government is finally acknowledging the budget surplus might not be here to stay. Kind of a head slapper that this was on the horizon, now that it is out there.

They probably could have picked a better day to announce this than after the FOMC misprint. While I am not a big believer that supply has any lasting impact on the level of interest rates, when they announced the end to 30-year issues the yield on the long bond fell 40 bps in 2 days.

CPI and Chinese GDP are Lagging Indicators

Lots of comments on the CPI setting a 5 month record yesterday but my thoughts are that it is a lagging indicator. Last week Wednesday the markets decided the growth phase was over. I would attribute it to the unrest in China the weakness in the copper and steel sectors. Not sure to what extent one led to the other but they certainly got a reaction in the Nikkei and global markets, eventually even causing interest rate markets to consider an end to Fed hikes. Oil is well off recent highs (some see that market as a double top) which fits nicely with a view that Asian growth has already peaked. The deterioration of U.S. export growth also added some fuel for those that wanted to see an international slowdown underway.

Long story short the world changed last week and if that change is correct the CPI, record or not, is meaningless. It is a lagging indicator plain and simple.

Chinese GDP which also came in stronger than expect has the same problem. Demand in the commodity sector is a much better indicator of what future expectations are for Chinese growth.

Bond yields peaked yesterday around 8:45 AM and I am guessing it is the "lagging indicator" logic that caused it. The beige book came in weak but that was much later in the day, after the market had made up its mind.

On these data points I am not expecting any impact beyond what we saw immediately after the release. I disagree 100% with the view that these inflation number force the Fed's hand and need to be reflected by higher bond yields. Even if I did see the CPI (or Chinese GDP) as a reason to adjust growth expectations, I would prefer to go long copper or oil futures. For bonds to run into trouble here I think we need to see the dollar slip further.

I will try to put up several posts today to round out my views on where the economy is going and my interpretation of recent market moves.

About this Reversal

The most interesting thing to me is the reversal in steel stocks. Contrahour flagged the breakdown yesterday but I would lean towards a short-term downtrend that creates an entry point in a longer uptrend.

Keep in mind with bonds the shorter maturities should put a pretty solid floor under longer-dated yields. The 2-yr is around 3.70%.

*update 3:30 PM - I should add that Phelps Dodge (PD) filled a gap this morning (from 2 weeks ago) and is now attempting to climb into the green as well.

Back in the Saddle

Last week didn't do much but pass time. The sentiment in equities feels like a bottom but of course a look at a charts shows we are actually still at the top. Strange. I am sticking to the idea of shorting rallies just because of my views on the interest rate environment. Accelerating rate hikes don't usually launch bull markets.

We have now passed the weeks away with the DXY bumping up into its 200 DMA. This week should be good for a turnaround. Gold and silver are strong this morning which confirms at least a short-term return to the old trends. I am wondering a bit we will get strong equities and strong bonds too in a return to the old paradigm. I would be surprised to see bonds play along in that but maybe it could happen for a week or two.

Not too much has been going on in the news. I liked this article from William J. Polley that shows the similarity of the current Fed Funds cycle to the cycle we went through in the early 90's. He is planning a series of posts on the topic and I am looking forward to what he has to say.

Non-Farm Payroll Summary

This is a solid free summary of the payroll data on briefing.com (from Bill Cara). I stand by my choice of the word "lackluster" to describe it earlier this morning.


Around 4.0 - 4.1 the five year yields are retesting last years highs.

Ready for the Jobs Report

Bill Cara summarized the odd strength in bonds in the face of some scary oil news. Also on oil I would point out the IEA recommendation to help panic consumers. Sounds like the rolling brown outs in California a few years back, but for cars. News like this has the potential to eventually undermine the anchoring of inflation expectations if and when it is affecting day-to-day living.

I first heard calls for $85 oil back in December, then again at the beginning of March. Then we had an OPEC meeting that basically indicated spot prices are now driven by estimated demand in Q4 and thereafter. With spot prices unhinged from the present details that market is ripe for speculators to push the price wherever they want. In judging the moves it is probably best to keep an eye on the far forward contracts rather than the front month.

Adding to the inflationary comeback yesterday, Merrill Lynch increased its price forecasts for copper, aluminum, nickel and zinc for the next three years. The industrial metals did not respond too dramatically but stocks like Phelps Dodge (PD) are now back wrestling with their breakdown point from Tuesday.

The dollar was steady to down and bonds rose on all this information. I don't think the jobs report will add to inflation pressures but instead will continue to be lackluster. This provides fuel for people like Roach who question whether the Fed will really fight inflation in the face of weak growth. That is a recipe for steepening.

Stocks look like they could stay strong no matter what the number but it kind of feels like the dollar wants to come back down a bit. We shall see.

Stocks get Whacked on Bond Selloff

Didn't really see that coming. It is hard for me to understand the weakness in stocks given the FOMC statement. Since they hit my "bullish" case (along with expectations), I hate to think what would have happened had they not.

My feeling is that bonds got caught very wrong footed following this AM's PPI. The sharp reversal easily broke new lows in 5s and 10s which left them little chance to recover. Stocks in all sectors got sold , being led lower by Citibank (C) and AIG (AIG). I still think there is a chance for an equity rally tomorrow but am generally surprised at the way the stock market fell apart today.

I am particularly surprised that gold, silver, and copper stocks all came off with the market. I realize the dollar rallied but there is a disconnect between inflation fears and commodity weakness.

Before the Fed

My take is that the Fed comes out of this meeting with a 25 bp hike and removes the "measured" language to gain some flexibility. I have heard some traders talk of a 50 bp move but don't see much reason for that. I would put the chance of keeping the word "measured" around 30%. That is just my feeling because the changes possible in central bank statements, oil prices, and labor demand before the next meeting will make it harder for the Fed to know what it wants to do. The Fed needs to prepare the market now to be more open minded at the next meeting.

If the Fed keeps the "measured" language U.S. stocks look like they are in position for a nice bounce. I don't think tomorrow means much to bonds (keeping measured may cause some buying of 5-yrs) while the dollar seems to be getting too much of a bounce in front of a widely expected move. The metal weakness looks like a knock-on effect from the dollar.

I liked these thoughts from the Capital Spectator:

Meanwhile, there's plenty of talk. Fed Governor Edward Gramlich opined last September that there are no easy monetary policy answers in managing oil shocks today than there were in decades past. "Today the question of how to respond to oil price spikes is better understood, but the outcomes are no more pleasant," he asserted. "It is virtually inevitable that shocks will result in some combination of higher inflation and higher unemployment for a time. But I must stress that the worst possible outcome is not these temporary increases in inflation and unemployment. The worst possible outcome is for monetary policy makers to let inflation come loose from its moorings."

The worst possible outcome is in fact what worries one David Gitlitz, chief economist with TrendMacrolytics, who warns in an essay to client today, "Record crude prices mean a monetary mistake could be not just dumb, but disastrous." Some at the Fed look at the recent past and conclude that since the economy's chugged along nicely despite the higher oil prices there's little to worry about on this front. "This reasoning," Gitlitz writes, "also accords with the idea that since the oil price moves have apparently been marked by significant speculative excess, they are not a 'fundamental' factor that need be of particular policy concern."

It is not clear to me that high oil prices are more than a short-term problem but agree that it is a risk the Fed should not really be playing with.