Bond Expert: Thursday Wrap

My back is riddled with herniated disks and at various points they are expressing their displeasure today. So I will attempt this close in abbreviated fashion and in a different manner than my normal presentation.

There is an interesting battle developing in the bond market. On the one side stand those who believe that the rebound is real and believe it will lead to a sustainable recovery. The economic rebound will sow the seeds of higher rates as the Federal Reserve responds to the growth by raising rates and unwinding the abundant provision of liquidity which that organization has copiously supplied.

This group would also hold that if the Federal Reserve does not act in a timely fashion, an ugly inflation will ensue and the bond market vigilantes will raise rates for them.

The other group holds a diametrically opposed view. This group will concede that the economy will manifest positive growth in the current quarter and possibly into next quarter.

But those who hold that view believe the gains will be ephemeral and fleeting as they are production-led. Cash for clunkers will (and has) generated sales and purged some inventory. It will lead to increased auto production to replenish inventories but without continued buying, that production cannot be sustained.

Sources tell me that there has been a sea change in the thinking of some large insurance companies, pension funds and others who manage liabilities.

Weak retail sales last week as well as the slippage in consumer confidence piqued the interest of these folks. Weak initial claims data today sparked another round of excitement from this crowd. This week is the survey week for the payroll data. With claims weakening, many now believe that the August employment report will manifest greater weakness than was evident last month. The economy will still be shedding jobs at an alarming pace, and at a pace not consistent with current inventory replenishment levels.

These investors piled into the long end of the market today. They were large buyers of Long Bonds, off the run bonds and bond contracts.

That is evident from the shifts on the yield curve today. The yield on the Long Bond dropped 5 basis points to 4.24 percent. The yield on the 2 year note increased a basis point to 0.99 percent. The yield on the 5 year note was unchanged at 2.41 percent.

The 30 year bond also outperformed the 10 year note as the 10 year/30 year spread is 81 basis points. That spread closed yesterday at 84 basis points.

There is also some cognitive dissonance within the bond market. TIPS bonds in the 10 year sector are sending a bit of a warning as those bonds are rallying more than the nominal rate 10 year note. The breakeven inflation rate for the 10 year is now 185 basis points. It closed yesterday at 179 basis points.

Conversely, the breakeven inflation rate as measured by 30 year TIPS declined to 214 basis points from 215 basis points yesterday.

Finally, there is a gigantic disconnect between stocks and bonds. Stocks continue to rally and buyers emerge on every dip.

Thirty year bonds and stocks should not move in tandem for an extended period (to coin a phrase). I will put my money on the bond market in this battle.

I wanted this to be shorter and it is longer than usual.

Back to the heating pad.

Comments

[qqq fox:]

$66.6 Billion in one week. That is the amount of mortgage backed securities the FED added to its balance sheet in just one week, up to a new total of 609.5 Bil. And this new total is up over $100 Bil in the last 3wks. Additionally, they added over $12 Bil in Treasuries and Agencies. Take off some for expiring swap lines & commercial paper guarantee expirations, and the new FED balance sheet is up to a whopping $2.093 Tril. Now we know why Tsy's have been so strong in the last 2 wks while the stock mkt has been going up. The Fed creating shortages of Agency MBS drives drives govt paper buyers into the Treasury mkt.

Aug 20 07:24 PM

[whidbey:]

Foremost, Take care of the back, we count on your comments.

We too are baffled by the correlation of equities and bonds. It suggests that this division of opinion is likely embedded in the policy thinking for the Fed and Treasury. The Fed's pretense that it can withdraw liquidity is disingenuous unless the housing market is being written off as beyond saving. The apparent conflicts in the administrations policy are mind boggling and must mean there are factions and unresolved policy in government. Time is short before the herd hits the trip wire and whole institutions/sectors start to disintegrate. Then interest rates will rise steeply.

Aug 20 08:36 PM

[Gravel:]

Mr. Jansen, your analysis is at once insightful, useful, and greatly respected.

Please consider seeing a chiropractor if you have not already done so. I consider it to be the best personal investment in health care today. (No disclosures!)

I have found the form in which you have offered today's analysis to be particularly useful. Please consider replicating it in future analyses.

Thank you, and be well.

Aug 20 08:58 PM

[hook:]

why should stocks continue to follow bonds and corporate spreads? companies have delevered and in some cases bought back their debt with new stock issuance. not clear to me why bonds matter to stocks as much as they in the past when many companies were levered to their eyeballs and basically depended on cheap CP for working capital.

Aug 20 10:07 PM

[bynd2009:]

Mr. Jansen,
I echo the sentiments of several well wishers above. Please take care of your back and continue your valued commentary.
I could not agree more with you regarding the behavior of TLT today. It acted like DIA was tanking while that indext was actually up! Let us hope logic prevails and these two will atleast be off-step if not going in opposite directions. Bonds moving up while market is down would be logical if deflation is going to dominate and the reverse would be true if inflation takes off. I think the long bond direction is implying the former scenario. I read in one of the news articles that most of the anticipated/observed green-shoots are those of crab-grass! While that appears to be an overly pessimistic outlook, keeping the powder dry appears to be a very good idea.

Aug 20 11:55 PM