The Hightower Report

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The Treasury market was obviously caught assuming the worst for the economy, as a series of slightly better than expected scheduled data points served to knock down Treasury prices aggressively yesterday. With the equity markets also launching into a sharp short covering relief rally in the wake of the scheduled data flow from the US yesterday, that seemed to make the macro economic reversal even more significant in scope. However, the numbers released yesterday were 2nd and 3rd tier economic readings and the readings weren’t overly impressive. However, the bear camp can certainly suggest that Treasury prices at the highs Wednesday were factoring in a fairly broad based sustained slowdown. Clearly the ISM manufacturing report caused the greatest reaction as that report offered the most concrete evidence that the US economy retained some positive momentum. Given the reaction to the ISM readings yesterday, that should make the US Factory Orders figures today a fairly important release. In fact, the ISM figures were so far off the general consensus of expectations that the Treasury market seems to have seriously called into question the entrenched view of slowing that had served to lift Treasury prices over 8 full points in the month of August. Some of the sellers in Treasuries yesterday were probably exiting positions because the stronger than expected ISM readings served to reduce the odds of further easing by the Fed. However, the market will still be presented with a very significant amount of economic news over the coming two trading sessions and the tone of these numbers are likely to send nearby Treasury prices away from current price levels which are almost at the middle of the last two weeks trading range. The bear camp probably needs to see additional evidence of resiliency in the US economy to engineer more declines ahead, while the bull camp probably needs to see evidence that the US economic track is still somewhat suspect. The ultimate arbiter of the trend is still likely to be US Non farm payrolls on Friday and not the numbers today but some traders think the better than expected US numbers yesterday, set the market up to absorb weak US payroll readings Friday without as much upside momentum. In the near term, the market will probably see the weekly claims data as a slightly more important report today as there has been some doubt cast upon the double dip recession view and therefore all numbers look to be important to the trade again. While the Press attempted to play up the talk of a bond bubble in the wake of the sharp setback in Treasury prices yesterday it will still probably take a distinct pattern of somewhat favorable economic news to prompt a sustained rotation away from fixed income holdings and back to equities. While the slowing crowd was certainly dealt a blow with the better than expected readings yesterday, it would surprising to see the numbers suddenly turn positive and the fear of slowing completely tossed aside. However, with the recent high in bonds (August 25th) coming on a significant pulse up in trading volume and spike up in open interest, some traders are suggesting that prices were technically overextended. Not surprisingly, the market discounted a very sharp drop in August auto sales at GM yesterday and that reading probably makes the Factory orders report today slightly more important than the claims or productivity figures. With the slightly better than expected ISM readings yesterday and the last remarks from an outgoing Fed President, downplaying the expectation of direct easing from the Fed, the productivity readings this morning might carry less weight than normal.

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The Treasury markets reached another peak yesterday in the wake of a one/two punch of much weaker than expected US existing home sales figures and noted weakness in US equities. Recently the Treasury market wasn’t being presented with enough weakness in the equity markets to markedly degrade macro economic sentiment, but in the Tuesday trade, the market was presented with what seemed to be a roundly bullish overall environment. With the market also seeing a favorable US auction result in the trade yesterday and statements from the Fed suggesting the odds of a double dip recession were growing, there were a number of unrelated events that favored the bull camp. In looking ahead, the markets might be set to see a somewhat positive US Durable goods report, as the range of estimates for the Durables are mostly touting a “positive” reading. However, in the event that the durable goods report fails to meet most expectations, the trade could still come away from the report with ongoing concern toward overall growth in the US economy.

Since the Fed’s economic symposium doesn’t officially kick off until later this week that could reduce the flow of Fed dialogue today but we suspect that the market will be on the hunt for any statements from Fed officials in transit to the meeting. The market will be presented with another auction today of $36 billion in 5 Year notes and given the strong bid to cover ratio in other issues recently, many traders think the auction results will continue to be lightly supportive of Treasury prices.

While the Press was already touting the prospect of a Bond bubble in the headlines over the last several months, yields weren’t as low as they are now and the Notes and bonds weren’t “net Spec long” in the weekly Non Commercial and Non reportable COT positioning reports. With many US Treasury yields so low, that a minor pick up in inflation could present investors with a very minimal inflation adjusted return, the rational for snapping up US Treasuries could be called into question. However, as long as the fear of slowing and a double dip recession remains the focal point of the trade, Treasuries will probably stay in vogue.

In looking ahead to the scheduled data today, it is possible that rather dire macro economic concerns might be tempered slightly, as a housing report today isn’t expected to be as “headline soft” as the Existing home sales figures were yesterday and the durables report is actually expected eek out a positive result. With the range up move yesterday seemingly factoring in some form of additional quantitative easing move by the US Fed, some traders are suggesting that the official word on QE/asset purchases from the upcoming Fed symposium might result in a temporary peak in Treasury prices off a buy the rumor/sell the fact market reaction. However, others in the bull camp suggest that weakening in the economy is likely to continue and that the next US payroll report is likely to confirm the slowing and that could allow prices to make even higher highs.

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Treasury markets traded higher this morning in reaction to the Fed’s quasi move at quantitative easing. The Fed’s decision to reinvest the proceeds from maturing mortgage securities to purchase longer term treasuries has provided a bid throughout the yield curve. As a result, September 10-Year Notes forged another new contract high overnight, and that has pushed yields out to new 16-month lows of 2.717%. Yields on the 2-Year Note have registered a new record low this morning to trade under 0.50%. Global equity markets traded lower overnight led by a 2.36% decline in the Nikkei while European shares traded around 1.0% lower as they factor in recent measures by the Fed along with a downgrade to the U.S. economic outlook. Tuesday’s 3-Year Note auction was very well bid even though it registered a new record low yield of 0.844%. The bid to cover ratio was well above the recent average at 3.31 to 1, at the same time the final yield was one basis point under market levels at the deadline. Perhaps this positive demand will again surface in today’s $24 billion 10-Year Note auction.

The recent decline in yields (rally in prices) since Tuesday afternoon has the potential to make this auction a market mover. Additionally, part of the Fed’s treasury purchase program targets the 2-Year to 10-Year maturities and will be interesting to see how the market absorbs today’s supply. In fact, a noted bank analyst team indicated that the Fed’s purchase of Treasuries under the new plan could total $300 billion over the next 18-months, based on their current portfolio of mortgage securities. In other words, it is a far cry from the Fed’s tone just months ago when they sought out exit strategies.

Spread differentials between the 2-Year and 10-Year notes have continued to flatten out in response to the Fed decision and have come in to 221 basis points (settled 227 Tuesday).September bond futures continue to hold the uptrend pattern with key support levels that have ratcheted higher after Tuesday’s surge to stand at 129-03. There is a similar pattern in the September 10-Year notes, which now has support below at 124-09. However, of concern are technical momentum indicators that have become overbought during the recent advance and have begun to diverge from current high price levels.

The bulls have the edge to start this morning, but a favorable reading in this morning’s economic statistics or a disappointing result in today’s 10-year Note auction could disrupt the advance.

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The Treasury bond market looks set to start the US trade at the top of the recent consolidation and seemingly poised to probe higher levels. In the wake of the scheduled US data flow on Tuesday, the Treasury market has the justification to price in its concern for the US economy. With Pending home sales falling to a fresh record low reading, the trade actually saw evidence that hints at something more than a listless economic track. In other words, talk of a double dip recession enters the equation again and that in turn probably increases the focus on the scheduled data due out later today.

With the market swirling talk of renewed quantitative easing from the US Fed earlier this week that has also created a mostly bullish environment for bonds and notes. While initial expectations of a 50,000 to 75,000 Non Farm payroll loss on Friday morning, on its face, doesn’t seem to signal a huge contraction in the economy, for many that type of reading could confirm that the US economy is moving in the wrong direction. However, given the noted weakness in the US Dollar and the relative proximity to all time highs in Bonds and Notes, it is possible that Treasuries might have a marginally weaker Friday reading already factored into the equation.

At least in the near term, the Treasury market doesn’t seem to be overly concerned with oversupply or creditworthiness issues, but that might be the only angle the bear camp can hope to play up in the current environment. There will be a quarterly refunding announcement this morning, but it just doesn’t appear like the trade is poised to foment and embrace fears of rising supply. One would think that a slow economy would be producing reduced tax inflows to the US government and that in turn would manifest larger borrowing needs, but the US government is masterful in disguising its borrowing needs with accounting methods that would be considered illegal in the private sector. In other words, downside action in bonds and notes might be difficult to engineer in the near term, especially given the pattern of recent US data flows and a choppy to weaker global equity market track.

The bulls will suggest that bonds deserve to move back to and perhaps above the old highs, because of the additive influence of quantitative easing expectations from the Fed and with the renewed deflation fears in the marketplace it would appear that the bull camp has a pretty solid case. Initial resistance is seen up at the old high close of 128-27 and then again up at 129-07 in September bonds. Similar resistance in September Notes is seen at 124-08, which is the old high.

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The Treasury market surprisingly showed some weakness yesterday in the face of news that the US planned to undertake more deficit spending to pay for an extension of unemployment insurance. Congress was divided over cutting from the existing budget and simply adding the spending on to the overall debt tally. The GOP was apparently for the extension, but wanted the spending paid for with offsetting budget cuts. In the end, the Treasury market saw the prospect for more debt supply ahead as Congress was expected to pass the measure soon. It is also possible that part of the weakness in the prior trading session was the result of comments from a Chinese economist that China should reduce its exposure to US debt and part of the setback might simply have been the result of a better than expected NYSE stock market opening on Monday morning.

In the end, the market saw a decline in the NAHB Index and the softest reading in that report since the fall of 2009 and that kept the string of softer than expected economic readings intact. With the US housing starts and permits data due out today and the general expectations calling for weakness in those readings, we have to think that the Monday lows and the early morning lows today, are going to be solid support from which the Treasury market will attempt to work higher from.

We do think that this market is prone to becoming overbought and perhaps prone to temporary lapses of buying interest, especially if the Dollar fails again, as that action could chase away some foreign investors. In fact, part of the weakness in the prior trading session might have come from the combination of suspicions that US Treasuries were losing their flight to quality status. However, in the event that the housing permits come in weaker than expectations that could clearly rekindle the talk of a double dip recession and since the semi annual Fed testimony doesn’t start until Wednesday, that could give the double dip crowd 24 hours to lift Treasury prices.

The Permits number could be the key figure in the release schedule today, as that reading tends to be a leading indicator and therefore a bigger than expected decline in permits could be justification for Treasury bond prices to quickly return to their early July highs. Countervailing the upward tilt in Treasury prices is a sense that the European stress tests results at the end of the week are likely to see most financial entities pass. There are some concerns that a European real estate bank might fail the stress test but there are funds available to plug the holes for those in need of cash. In short, the bias is up with close-in support in September Bonds seen at 127-13, with similar support in September Notes seen at 122-29.

As suggested before, there might not be much in the way of resistance this morning if the housing data is softer than expected, but first resistance in September bonds is pegged at 128-13, with resistance in September Notes pegged at 123-13. The bear’s biggest risk today comes in the direct aftermath of the Housing Permits release, but the equity markets and the currency markets don’t seem to be overly sensitive to potential flight to quality issues within the Euro zone today.

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The Treasury market remains near the upside breakout point on the charts this morning, despite the fact that US equities have effectively rejected a downside breakout seen last Friday morning. However, with the German DAX opening higher and the US equity markets also showing positive action early today that could have undermined Treasuries and in turn knocked them back away from the upside breakout point on the charts. However, we suspect that the market is still pent up for a continuation of weak scheduled US data as that has been the pattern for well over a month. Apparently the weekend G20 yielded little in the way of significant developments and that should make the US data a little more important this morning. We suspect that the Personal Income reading will be the main focal point from the Data flow, with Personal Spending and the PCE core Index monthly readings also critical news. However, the PCE Index reading probably won’t show inflation, it is likely to show deflation and that is why that reading could surprise the Treasury trade this morning.

It is probably a little early for the trade to begin considering the week ending US Non farm monthly payroll reading but in the event that today’s rather active flow of data is generally weak, that could turn the focus of the market back toward economics.

The Commitments of Traders Futures and Options report as of June 22nd for U.S. Treasury Bonds showed that Non-Commercial and Non-reportable combined traders held a net short position of 30,549 contracts, with the Note market showing its Non-Commercial and Non-reportable combined traders holding a combined net short position of 157,031 contracts. While the Bond and note position readings are probably understated, due to the rally forged since early last week, the data appears to show that the Treasury market still has technical short covering capacity.

We think the data this morning will either underpin the Treasury market, or begin lifting it back toward the late May highs, as we think the economy is slow enough to prompt Washington to act with additional stimulus measures. In fact, Obama would probably have went along with the G20 “company line” of reducing deficits this weekend, if he wasn’t aware of the slowing pace of the US economy and the need for incumbents to get the economy moving well ahead of the upcoming elections.

We see the market respecting fairly close-in support around the 125-11 level in September Bonds and at 121-15 in September Notes. As for resistance, we suspect that 126-00 will be very weak resistance in September bonds, with the next resistance level seen at the old high of 126-05. Similarly, September Notes have initial resistance at 121-25 this morning. We suspect that Treasuries will see new highs sometime this week.

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The Treasury market failed to see distinct flight to quality buying surface in the prior trading session. Somewhat surprisingly the Treasury market was unable to forge a fresh new high for the move yesterday, despite seeing a positive reaction to the 3 Year Note Auction and ideas that US rates were destined to remain low from a US Fed member. However, the Fed’s Hoenig remains a dissenting force on Fed policy, with that lone policy hawk reiterating his view that the US needs to raise rates later this year to avoid a track toward inflation. In our opinion, Hoenig losses a lot of credibility by suggesting that European travails weren’t going to drag on the US economy, because that area is only 15% of US exports. In other words, we have another official that is willing to discount an important component of the economy regardless of the historical ramifications of a double dip recession on a government and US Fed that are neck deep in debt!

Statements from the Fed Chairman were somewhat balanced in his speech yesterday, as he expected the US to avoid a double dip recession, but he conceded to an ongoing threat from the Euro zone situation. While international equity markets were boosted by talk of favorable Chinese export numbers overnight, we still get the sense that risk aversion remains in place, as US equities are modestly lower in the early trade today. In looking to the $21 billion in 10 Year Note auction later today, dealers expect fairly robust demand for the instruments, but we think that the market might see the typical 8 to 12 tick corrective slide in the wake of the auction results, as the longer end of the market usually sees a buy the rumor, sell the fact type reaction. While Greece GDP was reported to be down 1% overnight and that reading is a touch worse than the initial prediction of -.8%, we would suggest that a 1% decline in GDP is not as bad as the dire picture painted by the markets over the last 4 months. In short, it should be very difficult to remove the flight to quality bid from Treasuries today, especially since the US economic data flow today is thin, with the Wholesale Trade figures not expected to shift economic sentiment markedly.

In conclusion, we see fairly solid support under the market today, with the prospect of a temporary dip down to 123-30 in September bonds in the wake of the auction results. We see similar support in the September Notes down at 120-22, with the market probably set to take a lot of direction from the equity markets early in the trading session. In the event of a surprise break in excess of 1 point in either bonds or notes, we would suggest that traders consider the sale of just out of the money puts, as the Fed looks committed to holding interest rates down and the threat of deflation currently looks to be a prevalent market feature for the near future.

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Treasury prices remain in a weak downward bias but instead of entering the session somewhat overbought and vulnerable, the washouts in the prior two sessions should leave the market with a little more technical balance. However, the bear camp is likely to remain in control, as world equity market gains signal an ongoing deflation of flight to quality concerns toward the Euro zone. Apparently the markets are willing to down grade the threat of further contagion news in the short term, as the trade basically discounted news yesterday afternoon that S&P had put the city of Rome’s A+ rating on a negative watch and that yet that story was given little if any attention. The US Treasury’s auction of $31-Bln in 7-year notes yesterday came in with a yield of 2.815%, with a bid to cover ratio of 2.88 to 1, which is better then the recent average. The last 7-yr auction on April 29th came in at a yield of 3.215% and therefore the latest auction cycle is now passed with moderately favorable demand seen in an environment that should have yielded stellar results. In looking forward the market will be presented with Personal Income and Personal Spending readings as well as a PCE reading early today. We doubt that one of the Fed’s pet inflation measures (the PCE) is going to provide anything in the way of bearish fodder for prices this morning, but it is possible that the Personal Income and Spending readings will provide a light but brief measure of pressure to prices. The market will also see some consumer sentiment readings later in the session and those might provide a minor but brief boost in prices. In the current environment, scheduled data will continue to have limited impact, as the future remains highly suspect and dependant on the next iteration from the Euro zone debt saga. In the face of another upside extension in equities, signs of favorable readings from Personal Income and Spending, we suspect that September bonds will see a slide down to and below the 122-00 level, with a similar slide in September Notes seen down to 119-04 initially this morning. However, we would also expect to see a slight positive bid return to the Treasury market ahead of the close today, as the long weekend might prompt some buyers to go out with a longer position just in case a fresh Euro issue finds its way into the headlines. Therefore we see the Treasury market to be the most vulnerable early in the trading session this morning, as the positive spillover from the international equity markets and the initial US numbers weigh on prices. Critical resistance in the September bonds today is seen at 122-18 early, with similar resistance in September Notes pegged at 119-22. If there is a surprise from the data this morning, we suspect that will come in the form of a slightly bigger decline in the Michigan sentiment readings, as the influence of the early May debacle, could be seen in these numbers this morning. Therefore, the bears control looks to be in place until just ahead of 9:00 cst.

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The Treasury market remains mostly positive on the charts from the overnight action, as ongoing weakness in Asian equity markets leaves the Euro zone debt crisis on center stage. While the market will see initial and ongoing claims today, we suspect that the market will either ignore data that depicts growth, or it will embrace and rally off the data that shows further evidence of slowing. In other words, the bias is up and it could take some really surprising headline type development to alter the upward track.

Overnight a Chinese economist suggested that China needed to ask the US for special bonds that cushion the Chinese against currency risk or bonds that are cushioned against inflation. With the Chinese steadfastly avoiding a distinct appreciation in their currency, it is possible that they would very much like to see a non currency impacted instrument tailored especially for them. Since the market has already seen requests from China for more TIPS, the desire to insulate their holdings from inflation isn’t a totally new demand. Ordinarily, seeing any change in the flow of Chinese demand for US Treasuries is seen as a negative to prices but in the current condition, the flight to quality bid remains so solid that prices have seen almost no reaction to the latest diversification news.

While the US will announce the size of next week’s auction later today, that news isn’t expected to dent sentiment either as the size is expected to drop a bit, but overall the total auction supply is expected to remain rather lofty. Critical close-in support is seen at 122-22 in June bonds, with a similar support point seen at 122-04 in September Bonds. In June Notes, close-in support is seen at 120-03, with similar support today in September Notes seen at 119-04. As for the upside, we doubt that the market will make a full return to the May highs today, but we do think that is in the cards in the coming trading sessions. However, in the event that a national strike in Greece turns violent that could set the stage for a rise back to the May highs. EU officials have again suggested overnight, that the markets are overreacting to the EU crisis, but so far the US Treasuries think that a large measure of uncertainty and anxiety needs to remain in place, regardless of short sale bans and other artificial limitations on markets.

As further confirmation of the bull tilt in Treasuries, one can make note of the lack of downside action in the wake of positive economic news recently and also the lack of downside in Treasury prices in the face of recovery attempts in the US equity markets. In fact, this market probably wouldn’t show any downside action in the face of news that the auction tally for this next week comes in above the prior week. More than likely confidence readings this morning will favor the bull camp.

April US non-farm payrolls marked the largest monthly increase since March 2006 with an increase of 290,000. Expectations were for gains of 200,000 (+/-20k) and for a 9.7% print on the unemployment rate. While payrolls came on the positive side, the actual unemployment rate posted a read of +0.2% higher than the previous three months to 9.9%. Some of the payroll gains were attributed to expanding manufacturing payrolls (+44,000) and 66,000 new census workers. Overall, it was an upbeat report on improving labor market conditions. Of concern was the unexpected jump in the unemployment rate, which tempered some of the initial positive momentum. Treasury prices initially broke down into new lows for the session, while equities rallied. The dollar index caught a bid, helping it to pair some of early losses.

The Bureau of Labor statistics reading of out-of-workers greater than 27-weeks continued to inch higher and now comprises 45.9% of the total jobless.