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| Daily Jurojin - Thursday, May 28, 2009 |
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Thursday, May 28, 2009 Global Bond Breakdown - Part IIWe had intended to use the opportunity today to write about something completely different, such as cocoa plantings in the Ivory Coast. Sadly the Internet connection from the major newswires in that part of Africa is down and so we're a little short on the news there. Instead, we're going to revert to the herd of elephants trampling all over the markets right now, which we took the opportunity to write about in Wednesday's Daily Jurojin - the global bond markets.We do have an axe to grind on that front, but that's hardly a reason for an encore. Rather, the fact is that something enormous is cooking in the world of fixed income and we want to be the first to feast on this tasty snack. In this column yesterday we explained why, despite any amount of reasoning it made no sense to go looking for value in the bond market. That would be tantamount to attempting to negotiate with a tribe of hungry cannibals returning from an unsuccessful hunt ahead of a wedding feast honoring the tribal chief. You see, when markets take on a mood, a good trader knows that you trade the flow and ask questions later. In trying to fine-tune our recommendation to our loyal band of merry futures traders, we chose the German bund market to go short of on Tuesday morning. Now we're hoping to high heaven that there will be a good amount of follow-through selling on Thursday morning in response to the road traffic accident that took place in the treasury market late Wednesday. Bond traders were on the defensive all day long on Wednesday with the market trading down a tad ahead of another government auction to help pay for the financial train-wreck underlying the recession. There was good news and bad news. Short dated bonds actually fared pretty well with investors realizing that, as we noted here earlier, that there is little prospect of a near-term interest rate rise out of the Fed. Two-year note yields hardly budged all day, while the wave of selling at the 10-year area of the curve drove yields up around 20 basis points to 3.74% from 3.54% the day before. Anyone buying directly from the U.S. treasury today closed the session with a horrible capital loss. The spread between two and 10-year yields blew out to its highest in many moons. Meanwhile the 10-year American yield surpassed that on equivalent German debt for the first time in several months. We'll have to wait and see on Thursday what damage European traders inflict as the bear market for bonds takes hold. While there remains scant evidence of economic recovery, investors have more reason to dive out of bonds than out of equities. While the prospects for earnings might not be as good as the recent rally off the March lows advertises, the coming supply of treasury debt requires an insatiable appetite from willing buyers. As ever, the market arbitrates between buyers and sellers and this is its way of warning the government that such a cloudburst of supply can't be issued at such low and favorable yields as has been the case of late. Sales of previously owned homes rose again for a second month in a row in April. But buyers were inspired by a 15% drop in prices due to a rising number of foreclosures. The bad news on that front is that foreclosures can be expected to rise as can unemployment and a deteriorating household balance sheet. In addition, last week saw a near-20% drop in mortgage refinancings as rates had already started to back-up a week ago. The bearish mood for bonds is a bad thing for the better tone to the housing market. Householders wishing to free up more cash by negotiating a better fixed rate and adding to growing consumer confidence have likely missed the boat leaving the government wondering where they went wrong in terms of making policy work. We don't wish to see a bearish bond market mode for long. That would backfire against the hard work of the government in trying to mend the many problems it inherited. But as traders, we are compelled to pounce when we see such developments forming. In this case, we've turned to the German market for a deeper duplication of the problem because we see more value in picking on bunds. Stay tuned. The Supreme Council of the Secret Order of Jurojin |
