Bond Expert: Tuesday Outlook

Prices of Treasury coupon securities have barely budged in overnight trading as bond market participants await the outcome of the FOMC meeting today. The yield on the benchmark 2 year note is 2.53 percent.The yield on the benchmark 5 year note is 3.24 percent. The 10 year note yields 3.96 percent and the Long Bond yields 4.59 percent.

Economic releases made available during the European session provide evidence of economic weakness.

The European Purchasing Managers survey remained below 50 at 48.3

European retail sales fell 0.6 percent in the month and dropped 3.5 percent from a year ago. The year on year decline was the biggest drop in 13 years.

Industrial Production in the UK sank 0.2 percent for the month and dropped 1.6 percent from a year ago.

Manufacturing production declined 0.5 percent for the month and fell 1.3 percent from a year ago.

European stocks have jumped about 2 percent as market participants somehow posit that earnings will hold up in the midst of pervasive economic weakness.

US stocks have jumped sharply in futures market trading as participants cheer themselves with the thought that non financial company earnings will trump the weakness in financial company shares.

Fixed income markets in other regions are quite firm.

The Australian market responded to the dovish statement from the Reserve Bank with sharply lower yields and a much steeper yield curve. The yield on the 2 year note decline 17 basis points to 6.00 percent. The yield on the 10 year note declined 7 basis points to 6.03 percent.

In the UK the yield on the 2 year note declined 6 basis points to4.73 and the yield on the 10 year note decline 4 basis points to4.77 percent.

In Germany there has pretty much been a parallel shift in the yield curve with most benchmark bonds down about 2 basis points.

The focus of investors around the world today will be the wording of the statement which the FOMC will release at the conclusion of its meeting.

Since the FOMC solons last gathered the economy has lost some momentum as the headwinds gather strength. Officials had worried about a wage price spiral but average hourly earnings have been declining over the last year. The Employment Cost Index contained no indication that outsized wage gains were imminent. The labor market itself remains weak as employers have shed jobs 7 months running now.

The dollar has stabilized and the principal culprit in building inflationary expectation, oil, has fallen significantly from its highs.

Financial conditions are still tense and only a government rescue has saved the GSEs from an untimely demise.

In addition overseas economies have weakened dramatically and are unlikely to be quite as hospitable to US exports.

Against that background, I would expect a slightly dovish phrasing to the statement which acknowledges that recovery will be a protracted and difficult process.

And against that background, the yield curve traders will be unshackled and the curve will steepen significantly as the Treasury prepares to sell $17 billion 10 year notes tomorrow and $10 billion 30 year bonds tomorrow.

Some overnight flow:

Hedge fund buyers of 10s.

Central Bank buying 5s.

Spec sellers of 10s and 30s.

Japanese buyers of short Europe versus short US

Australian News

The Australian service sector slowed in July as the twin bugaboos of high interest rates and high energy costs weighed on sentiment.The AIG Performance of Service Industry Index fell 2.6 points in July to 42.8. The breakeven level for contraction and expansion is 50.

The group which publishes the survey cited weakness in inventories, new orders and employment.

The employment component fell 6 points to a record low of 42.2.

The Reserve Bank of Australia is meeting as I write and speculation in the press has centered on the timing of rate cuts.

Growth in Australia has slowed. Since the last meeting of the Reserve Bank retail sales have plunged,credit growth has slowed and business and consumer confidence has dropped sharply.

In a statement very much at variance with statements by the Federal Reserve (in that it meandered ) the Reserve Bank of Australia chose to leave rates unchanged. However, the policy makers summarized their thoughts by noting that with demand slowing the scope to move towards a less restrictive policy is increasing.