BONDS

The background for global bond yields continues to worsen. U.S. 10-year notes slumped on Friday lifting rates from 3.46 to 3.56% throughout the week - a week that began with a return to bear market territory in China as the Shanghai composite corrected by more than 20%. A couple of days of equity selling around the globe saw investors flood into government bonds for fear of another leg down in global activity but their fears were drowned before the weekend. At the time we made the following observation to subscribers to Jurojin Weekly.

"We're pretty close to that point and it might take one or two more sessions of bad luck for equity investors to convince bonds to push higher. As we have spelled out many times before, the backdrop for lower U.S. yields is pretty ugly given the burden of the deficit. We think we are close to an advantageous point to allow us to use the current setback in stock markets to short treasury futures "- Jurojin Weekly, August 18, 2009.

Amazingly it was Friday morning that treasury notes reached our patient entry point after a couple of recovery days for stocks. However, bond prices refused to budge until Friday morning's onslaught of positive economic news. Numbers from both France and Germany indicated a return to healthy service and manufacturing expansion in August. Add that to healthy second quarter GDP data and your heading towards some political claims about the wonders of domestic governments rescuing the economy. European bonds rose.

While S&P 500 index futures were busy limbering up on the side lines indicating a healthy pre-market gain, September treasury notes were setting off weekly highs for some insane reason. Did traders bother to check the data flow?

The onslaught began mid-morning when a round of heavy selling lasting right through the closing bell saw yields surge from the lowest point of the week to the highest! The culprit was the strongest rise in existing home sales in at least 10 years. Low mortgage rates, a healthy flow of credit, a soon-to-expire $8,000 tax credit to first-time homebuyers and a flood of forced foreclosure sales conspired to lift July's home sales higher by 7.2% and presenting a fourth straight monthly gain.

Now would be a convenient time to stop and explain that we really are a long way from being out of the woods when it comes to the housing market. But the reality is that when you're trading markets, sometimes it simply doesn't pay to take the higher ground. You have to learn to accept the data and moreover one must deal with how everybody else is responding to the data.

This week we chose to fly in the face of a crushing conviction that commodity prices were doomed on account of declines in Chinese stocks. And so far we've been proved right. Dealing with the short-term intricacies of tradable markets is crucial to survival. Yet to quote the economist John Maynard Keynes, "in the long-run, we're all dead." We choose to use our trading selections to relatively short-term factors and it works well enough.

The outlook for bonds suffered a two-step setback throughout the day. This weekend, central bankers flew into Wyoming's Jackson Hole as they do each year to discuss the state of the global economy and reflect on how the reparation process is going. On Friday, just as the housing data was reverberating in the market, Fed chairman Bernanke addressed his comrades to announce that "fears of financial collapse have receded substantially." He noted how the contraction of recent quarters was indeed leveling out, while growth was apparent on the 2010 horizon.

Once again it would be easy to throw in the caveat here that repeatedly, central bankers have sought to convince markets that monetary policy won't be going up anytime soon. However, with the data developing in the fashion it is, to fight the market would be tantamount to standing on the train track between New York and Washington telling yourself that the high-speed train will stop. It will eventually stop at the station, but you really don't want to arrive as a mangled mess stuck to the nose of the train when it does. You can't fight the trend so don't kill yourself trying.

Finally, the Wall Street Journal reported late Friday that the White House is set to ratchet up its prediction for the 10-year federal budget deficit to $9 trillion from $7.1 trillion. The government will blame the deterioration on the increasing number of retiring baby-boomers and soaring costs of both entitlements and health-care programs such as Medicare.

Can anyone else see the projected deficit reaching the same amount as the overall gross domestic product in the United States?

We noted last week that bond prices were reaching the top of the range. We were absolutely correct in that observation. Expect next week to be even worse. Yields will continue to rise quickly, despite any more soothing words from Bernanke's little party in Wyoming.

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