Bond Expert Tuesday Outlook: Put Me in the 'W' Camp

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

Prices of Treasury coupon securities have retreated in overnight trading as better than expected economic data has buoyed European stock markets and fueled a rise in US markets in pre-market trading.

The market moving news was a report of a sharp rise in the German IFO. The index (which is a measure of investor confidence) jumped to 56.1 in August from 39.5 in July. That is the highest level for the index in three years.

In other global economic news, department store sales in Japan in July posted an 11.7 percent YOY decline.

In the UK inflation surprised the prognosticators and stayed stubbornly high at 1.8 percent in July. The increase was led by the cost of video games, DVDs and alcohol. That is a commentary on something, I am sure.

In China the central bank stopped driving up rates and money market conditions eased for the first time in six weeks.

US investors will have an opportunity to check the pulse of the housing market today with the release of housing starts data. The consensus forecast expects an increase to 598K from 582K in the prior month.

Headline PPI probably fell 0.3 percent after three consecutive gains. Gasoline prices fueled the decline. Core PPI probably rose a tame 0.1 percent.

The yield increases for the benchmark issues in overnight trading have been tame.

The yield on the 2 year note has climbed 3 basis points to 1.04 percent. The yield on the 3 year note climbed 2 basis points to 1.57 percent. The yield on the 5 year note increased 3 basis points to 2.44 percent. The yield on the 7 year note edged higher by 3 basis points to 3.11 percent. The yield on the 10 year note increased 4 basis points to 3.50 percent. The Long Bond traded well in the weak climate and its yield rose 2 basis points to 4.34 percent.

The 2 year/10 year spread is 246 basis points.

The 10 year/30 year spread is 84 basis points and has narrowed from a wide of 87 basis points yesterday.

The 2 year/5 year /30 year spread is 50 basis points. When I wrote my closing post around 330PM New York time the spread was 51 basis points.

It will be an interesting period for fixed income investors and equity market investors. GDP accounting insures that Q3 GDP will be a positive and that should send the animal spirits racing and fill the air with giddy proclamations that all is well with the world.

I do not think that we will know nor can we know for several months if reports of the recovery of the economy are premature.

The recent report on retail sales manifested an anemic appetite for spending by consumers. While some have touted the slower pace of layoffs the incontrovertible fact is that businesses are still shedding workers at an alarming pace and that suggests that there will not be a long lasting jump in consumer spending.

I think that John Q Public is also undergoing a seismic and psychic shift in attitude. He is reassessing and reevaluating the American Dream and his place in it. The dream is looking ragged around the edges as he has seen little growth in his 401K and his home’s value has eroded. As he weighs and measures those events it is hard for me to believe that consumption patterns will not shift permanently into less robust territory.

Predicting the demise of the American consumer has been a career killer but I think it is a good bet this time.

I think that business investment will be quite weak going forward. Capacity utilization remains close to 60 year lows. That is not an environment in which corporations will be spending freely for plant and equipment.

And at some point the hooples (of both parties) who govern us will have to come to grips that we are living quite a bit beyond our means. That will require higher tax rates or less government spending. You can guess which path they will choose.

I think that Q3 will be a quarter of inventory-led gains. It is hard for me to see how those gains can be transformed into something which fuels a viable recovery.

Put me in the W camp.