Bond Expert: Monday Outlook

Includes: IEF, IEI, SHY, TIP, TLH, TLT
by: John Jansen

Prices of Treasury coupon securities have posted mixed (and seemingly random) results in overseas trading. I am not sure which particular factors influenced trading but there is more data and information to absorb this morning, today and this week than in any similar period recently.

The yield on the 2 year note has climbed 2 basis points to 0.82 percent. The yield on the 3 year note has remained static at 1.35 percent. The 5 year note is also unmoved at 2.25 percent. The yield on the 7 year note declined a basis point to 2.94 percent. The yield on the 7 year note slipped 2 basis points to 3.40 percent. The relative value winner of the session is the Long Bond which has seen its yield fall 3 basis points to 4.32 percent.

The 2 year/10 year spread narrowed 4 basis points to 258 basis points. I believe that spread topped out at 270 basis points last Monday in advance of the issue by my close personal friends at the US Treasury.

The 10 year/30 year spread has narrowed a basis point to 92 basis points.

The 2 year/5 year/30 year spread is 64 basis points. In my absence last week I am not sure what the richest level was for that spread.

There is a plethora of economic data available today but I think that the speech of Chairman Bernanke to the Economic Club of New York will trump other data points.

In the statement which concluded the last FOMC meeting, that august group elaborated on the reasons why it could leave rates low for “an extended period". It did so in the following sentence:

“With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.”

I think that the Chairman will take time today to give us a portal into his thinking and that of his colleagues on these matters. I think he will comment on the recent labor data which had the unemployment rate surging to multi-year highs at 10.2 percent. In my opinion he will offer some thoughts or anecdotes about the labor market's prospects and the subset of data which the Committee might subscribe to as leading indicators of change in company hiring practices.

The Chairman will also touch, I believe, on the issue of inflation expectations. It seems he will have a tougher chore navigating around this one. The yield curve flirted with record levels of steepness last week when one uses the 2 year/10 year spread and the 2 year/30 year spread. Asset prices are surging and gold, in particular, is at record highs. The once mighty greenback is under pressure from every quarter and the US does not appear to be on a course to alter its decline.

More troublesome is the University of Michigan measure of long term inflation expectations which rose to 3.1 percent on Friday from 2.9 percent in the previous report. One analyst I read noted that at that level it would be at the high end of its recent range. That is certainly something which should cause some furrowed brows amongst those who vote.

Additionally, TIPS spreads continue to surge to yearly highs. In a recent edition of FOMC minutes the Committee downplayed the efficacy of signals from that market as Committee members denigrated liquidity of that market and inflation signals emanating from it. There is a lot of truth to that but I do not recall them issuing similar cautions when break-evens were plummeting. I would suggest that they are being a little selective about the truth in that regard.

The market has continued to gain ground as I write. One trader has suggested that gains in the Bund futures have triggered stops in that market and in the US market. The same writer also posits that robust gains in the equity markets led some traders to set shorts and those traders are now paying the price for that indiscretion. Finally, there are probably pockets of shorts covering in advance of the Bernanke speech and the pile of data which I did not even discuss here.