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Retail Sales and Consumer Prices In-Line, Bond Yields Drift Lower

By Rom Badilla, CFA – Bondsquawk.com

August 13, 2010

Retail Sales came in close to expectations suggesting subdued consumer activity and slowing economic growth. The U.S. Department of Commerce released its Advanced Retail Sales data which increased by 0.4 percent in July after a revised prior period decline of 0.3 percent. Despite the July improvement, the latest release failed to meet market expectations as surveys called for an increase of 0.5 percent. Similarly, Retail Sales less Autos increased 0.2 percent versus surveys of 0.3 percent. Retail Sales, stripping out auto and gas components declined 0.1 percent versus expectations of an increase of 0.1 percent and after a revised prior period reading of a gain of 0.2 percent.

After falling for three consecutive months, consumer prices in the U.S. increased in July, mostly in-line with expectations. The U.S. Bureau of Labor Statistics released its Consumer Price Index which increased by 0.3 percent on a month over month basis in July. The increase was slightly above market surveys as economists expected general price levels to increase by 0.2 percent after falling since April. Consumer Prices excluding Food and Energy aka “Core CPI” increased by only 0.1 percent in which met economists’ surveys after increasing by 0.2 percent in the prior month. On a year over year basis, Core CPI remained at a subdued 0.9 percent after this latest release which should temper inflation expectations and bond yields.

Beyond the headlines, the components are roughly in-line with stabilization in price pressures. Owners Equivalent Rent (OER) increased for the second consecutive month after falling earlier in the year. OER which represents roughly 25 percent of total CPI increased by 0.1 percent but fell on a non-seasonally adjusted basis by 0.2 percent. Tobacco increased substantially by 1.6 percent, which were offset by price declines of 0.1 percent in both the recreation and medical care components.

Finally on the economic data front, the University of Michigan revealed its latest survey which suggests that confidence for consumers remains at relatively low levels. Preliminary Consumer Confidence for August came in at a reading of 69.6, which were above surveys by six tenths of a percent but were mostly in-line with expectations. The survey increased from a July reading of 67.8 but despite this, Confidence remains low after plunging from a averaging in the low to mid 70’s throughout 2010. Comparatively, the survey reached a five-year apex of 96.9 at the beginning of 2007 and before the onset of the current economic recession.

As far as market reaction is concerned, bond yields on the long-end are lower after today’s economic data releases. Both the 10-Year and Long Bond are down 5-6 basis points to 2.70 and 3.89 percent, respectively. Inflation expectations as evident by the yield differential between the 10-Year and 10-Year TIPS are unchanged from yesterday but lower from earlier in the week at 1.68 percent. The 2-Year is trading at 0.53 percent, a slight decline of nearly a basis point from yesterday’s close.

Posted by Rom on August 13, 2010 under Bond Chatter,Bond Gurus,Bond Trading
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Initial Jobless Claims Jump, Disappoint Forecasts

By Rom Badilla, CFA – Bondsquawk.com

August 12, 2010

The Department of Labor released data suggesting that people filing for first time unemployment benefits spiked, providing further evidence that the economy is stalling due to anemic job growth. Initial Jobless Claims increased to 484k people for the week ending August 7. In addition, Initial Jobless Claims for the prior week was revised slightly upward by three thousand to 482k. This week’s jump disappointed the market since it came in four percent above forecasts as economists expected a claims number of 465k. This drives the four-week moving average, which is universally used to “smooth out” the weekly volatility and to provide a discernable trend, to a higher level of 473.5k.

Weekly Initial Jobless Claims & 4-week Moving Average

This uptick is of concern for the U.S. economy. The the four week moving average has been hovering between 450k and 500k since last November, which is more in-line with further job losses based off of previous cycles.  A moving average of below 400k is typically more in-line with a recovery.

Continuing Claims for the week ending July 31 dropped to 4452k from a revised weekly reading of 4570k. The decline was better than forecasts as economists expected Continuing Claims to come in at 4535k. However, keep in mind that the drop does not necessarily mean a pickup in hiring as many of the unemployed exhaust their federal benefits as they hit the limit of 99 weeks under current legislation.

As far as reaction to the disappointing claims figures, bond yield changes are rather subdued which should not be a surprise given the huge decline in yields. The 2-Year continues to signal ’economic slodown’ and is trading at 0.53 percent while the 10-Year is hovering around 2.74 percent, both higher by 2-3 basis points from yesterday’s close.

Posted by Rom on August 12, 2010 under Bond Chatter,Fed Watching
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U.S. Productivity Falls as Market Waits for FOMC Decision

By Rom Badilla, CFA – Bondsquawk.com

August 10, 2010

Productivity in the U.S. fell in the second quarter as output from workers slow as the economic recovery shows signs of stalling.  The U.S. Department of Labor released that Non-Farm Productivity dropped to an annualized rate of 0.9 percent.  The second quarter figures surprised to the downside as consensus forecasts were calling for an increase of 0.1 percent.  Partially offsetting the decline, the previous quarter was revised upward by more than a percent from an initial release to an annualized increase of 3.9 percent.  The decline marks the first drop in productivity gains since the fourth quarter of 2008.

In addition, Unit Labor Costs, which is a broad based measure of inflation, came in close to flat for the second quarter and below economists’ forecasts.  Unit Labor Costs increased an anemic 0.2 percent versus surveys calling for an advance of 1.5 percent.  Furthermore, the previous quarter was revised downward by 2.4 percent from the initial reading to a final drop of 3.7 percent.  The latest reading marks the end of the recent string in declines in Labor Costs which has fallen for three straight quarters.

The drop is significant since productivity growth is crucial since it allows for higher wages and faster economic growth without inflationary consequences.  Assuming stable prices, productivity growth plays a role in facilitating in increasing the overall wealth of the economy since the potential for real wages increase when workers are more productive per hour.

As the market waits for the FOMC decision on short-term rates and information on the prospects for more Quantitative Easing, market followers witnessed the release of two key surveys, which revealed dimmering hopes of a sustainable economic recovery. 

According to the National Federation of Independent Business, small businesses continue to be less optimistic on future business conditions.  The Small Business Optimism Index fell by 1.0 percent to a reading of 88.1 in July versus 89.0 in the prior month.  Analysts were expecting a higher reading for July of 88.0.  While the latest release is higher from the recessionary lows set in March of 2009 of 81.0, the fact remains that it is a far from readings established after previous recessions.

After the conclusion of the 2001 recession as determined by NBER, the 12-month average of the Small Business Index was at 101.3.  For the 1990-1991 downturn, the survey averaged 98.5 in the following year.

The numbers behind the headlines reveal a less encouraging outlook.  Of the small companies reporting, a net 2 percent of responding small businesses plan to add workers in the next three months indicating lackluster job growth (net number equals the number of small businesses offering a positive response less the number of companies providing a negative one).  The net number of companies planning to increase inventory declined to -4 percent from -3 percent in June. 

Interestingly, the net number of companies that expect a better economy fell off a cliff.  The net number expecting better prospects dropped from -6 percent in June to -15 percent in July.  For comparison purposes, this particular component dropped from a net number reading of -10 to -22 from December 2007 to January 2008, which is the period that marks the official beginning of the recession.

In addition, the net number of companies who think that access to loans is getting easier continues to deteriorate from -13 percent to -14 percent in July.  As Ben Bernanke stated early last month in a conference held in Washington DC addressing the needs of small businesses, extending credit for companies with limited workforce are the key to a U.S. economic recovery.  Conditions have not changed for small businesses and as a result, this should not bode well for the recovery going forward. 

Finally, Investors Business Daily released numbers suggesting that optimism for the U.S economy continues to decline.  The IBD Economic Optimism Index dropped from 44.7 set in July to an August reading of 43.6.  The decline disappointed as economists were expecting an increase to 45.0 based off Bloomberg surveys.

The markets are in stand-by mode as rates are generally flat to slightly higher.  The 2-Year Treasury is trading at 0.55 percent, up 2 basis points from yesterday but continues to hover near recent lows.  The 10-Year is flat at 2.83 percent.  Stocks are finally showing some doubt of the recovery it seems and is down by close to a percent to 1116.96, which is kissing support levels in the 200-day moving average.  Check back later for an update on the markets after today’s key FOMC rate decision.

Posted by Rom on August 10, 2010 under Bond Chatter,Bond Trading,BondSquawk
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Weak Jobs Report Points to Economic Slowdown, Bonds Rally

By Rom Badilla, CFA – Bondsquawk.com

August 6, 2010

The U.S. economy may be losing steam on its road toward a recovery due to a drop in government workers and anemic increases in headcount in the private sector.  According to the Bureau of Labor Statistics, the Non-farm Payrolls index for June decreased by 131,000 people.  The decrease was well below surveys as economists were expecting a decline of just 65,000.  To add further insult to injury, the previous month’s figure was revised downward from an initial reported decrease of 125,000 to a staggering drop of 221,000.  In the private sector, payrolls failed to meet expectations as latest figures show an increase of only 71,000 jobs versus economists’ surveys of 90,000.  In similar fashion to the total number, the June numbers were revised downward by 52,000 to a final increase of 31,000. 

In the lone bright spot from today’s data releases, the manufacturing sector added 36,000 people to the workforce in July versus surveys of 13,000.  The prior period was revised upward slightly to an addition of 13,000 as the initial report for June stood at an increase of only 9,000.  While this sector added bodies to the workforce in July, the problem is manufacturing activity is pointing south.  Based off of recent data such as the drop in durable goods orders and the latest ISM Manufacturing surveys, activity going forward is slowing as inventory replenishment and federal stimulus measures are about to wrap up.

Despite further job losses, the official Unemployment Rate remained the same in July, which is factored by a decline in the labor force as discouraged workers increased.  The Unemployment Rate came in at 9.5 percent in July as economists were expecting a rate of 9.6 percent.  The U-6 measure, which includes workers who are discouraged as well as those who resort to working part-time, failed to improve.  The U-6 measure stands at 16.5 percent in July, which has improved by only 1.1 percent since the high of 17.4 percent set in October 2009.

Bonds are rallying again because of the anemic jobs report.  The 2-Year, acting true to its form as a gauge on the health of the economy, is past previous resistance levels and is now trading at 0.51 percent, a decline of 2 basis points from Thursday’s close.  In addition, the 10-Year is now trading well below its most recent lows of 2.88 percent set on July 21st, and has dropped 8 basis points to 2.82 percent.   

Anyone who thought that the market was amidst a bond bubble and that yields could not go any lower before today must be kicking themselves at this point.  As we have talked about for many months, the U.S. is headed for an economic slowdown with the potential for another double dip as people deal with a “balance sheet recession” where the focus is on repair by “hunkering down” and less so of spending.  Due to these factors, disinflation/deflation will be the predominate theme which in turn should lead to lower bond yields and better returns for fixed income investors.

Posted by Rom on August 6, 2010 under Bond Chatter,Fed Watching

Jobless Claims Higher Before Tomorrow’s Key Employment Figures

By Rom Badilla, CFA – Bondsquawk.com

August 5, 2010

The number of people filing for employment benefits increased last week.  Initial Jobless Claims for the week ending July 31 jumped to 479k people.  The number of people who recently became unemployed and are accessing government benefits was revised upward in the previous week by three thousand to 460k.  The increase signals offsets the slight recent improvement to the employment landscape in the last few weeks since economists were expecting a reading of 455k.  Furthermore, the 4-week moving average, which is used to smooth out the volatility to establish a better reading of trends, ticked higher to 458.5k.  Despite the uptick, the average is on the lower end of the recent range of 450-500k that has been established since last November.  With this in mind, the number is still associated with further job losses as has been the case in prior recessions as opposed to an average of 400k that coincides more with job creation.

Continuing Claims for the week ending July 24 came in at 4537k versus surveys of 4515k.  The prior period continuing claims figure was revised by six thousand to a final figure of 4571k.

In a morning email to clients, the economics team from BNP Paribas added the following color on “regular” continuing claims and those who file for claims under the emergency and extended program which stems from the lengthy time away from the workforce.

Meanwhile, continuing claims including emergency and extended programs jumped by 4.2% in the week ending on July 17 following 5 weeks of large consecutive declines due to exhaustion of benefits. The Senate bill passed last month allowed benefits to be renewed retroactively to June 2, and will be available to workers through the end of November. However it will only be a temporary slowdown in the rate of declines in emergency benefits and the declines should accelerate again in November when the current extension expires. We are likely to see some pick up in the number of extended and emergency claims in the short term, however, there are still large numbers of people who are reaching the maximum 99 weeks of benefits which continues to be the maximum under the Senate bill. As such, benefits’exhaustions of so-called 99-ers should outweigh the inflow of newly extended benefits and should continue pushing the overall extended benefits numbers down.

Treasury yields are moving lower toward the bottom end of the range again.  The 2-Year which is a better indicator of market sentiment and of the macro picture (as opposed to the stock market) is at 0.55 percent, a decline of 2 basis points from yesterday’s close.  Also the 10-Year is pushing against previous resistance levels and is trading at 2.91 percent, a decline of 4 basis points.  Unlike prior moves toward the bottom-end of the 10-Year range, option volatility in the form of the Merrill Lynch MOVE index which acts as a sort of confirmation of the change in interest rates was rather subdued.  With the move lower in yields, the MOVE index has ticked upward significantly by more than 10 percent to 85.9 basis points.  As we have talked about before, another push lower to below the low set at 2.85-2.90 percent, coupled with a spike in option activity via the MOVE should signal a new interest rate regime that in all likelihood would be here to stay.

Tomorrow, the Bureau of Labor Statistics will release official job numbers and payroll statistics.  Non-farm Payrolls is expected to decrease by 65,000 according to Bloomberg consensus surveys.  Private Payrolls, on the other hand, is expected to increase by 90,000 people.  Despite the expected additions, the Unemployment Rate is expected to tick up by a tenth of a percent from the last release to 9.6 percent.

Posted by Rom on August 5, 2010 under Bond Chatter,Bond Trading

Service Activity Surprises Modestly, Private Sector Adds to Workforce

By Rom Badilla, CFA – Bondsquawk.com

August 4, 2010

The Institute for Supply Management reported today that non-manufacturing activity modestly grew in July than the prior month.  The Non-Manufacturing Index increased to a reading of 54.3 from June’s reading of 53.8.  Today’s release surprised the market as economists’ surveys expected a reading of 53.0.  An index reading above 50 suggests expansionary activity while a figure below suggests contraction.

Behind the headline, the individual components were mixed.  The Business Activity component dropped 58.1 to 57.4 while New Orders ticked higher to 56.7 from 54.4 set in June.  Prices Paid continues to ease downward after falling off of a cliff in May.  July’s Prices Paid component dropped more than a point to 52.7 from the previous month.  Prior to that, the Prices Paid component fell from 60.6 in May to 53.8 in June.   In a reversal, the employment component came back to the light side suggesting conditions closer to conditions, by increasing from 49.7 in June to 50.9.

BNP Paribas provided some perspective on today’s ISM data release:

“While manufacturing sector growth might be tapering off, the latest Beige Book provided some anecdotal evidence that the non-manufacturing industries are picking up the baton, noting that activity in the services sector improved across most districts. While the rapid growth in the manufacturing sector has been key to the recovery, it is the non-manufacturing sector that makes a much bigger contribution to growth. (The Manufacturing & Non-Manufacturing Composite ISM is calculated by applying relative weights of 11.7% to the manufacturing index and giving a weight of 88.3% non-manufacturing index, based on the real value added by these sectors). The composite index improved to 54.4 in July from 54.1 in June.”

Prior to the release of the ISM data, Automatic Data Processing revealed that the private sector added 42,000 employees to payroll in July.  The increase is a slight improvement after the prior month’s which was revised upward by six thousand to a final reading of 19,000 people.  In addition, the July number surprised forecasts as economists were expecting an increase of only 30,000 people.

Looking beyond the headline numbers, small and medium sized companies attributed to the modest gain.  Small companies as defined by 1-49 total employees and which represents about 45 percent of the 106,971 corporations added about 21,000 people.  Medium sized companies which have 50-499 workers total employees added the balance of the total July number.  Large companies which make up 16 percent of the sample did not add to their respective workforce from July.

Between the types, the service-oriented companies outpaced its goods-producing counterpart.  Service-producing companies which represents 83.6 percent of the total, added 63,000 people to their workforce.  Consistent with prior evidence such as the latest ISM, suggesting that manufacturing is amidst in a slowdown, goods-producing companies subtracted 21,000 people last month.

Job growth as reported by ADP is still anemic but has a history with understating government data, which is due for release this Friday.  Non-farm Payrolls is expected to decrease by 65,000 according to Bloomberg consensus surveys.  Private Payrolls, on the other hand, is expected to increase by 90,000 people.  Despite the expected additions, the Unemployment Rate is expected to tick up by a tenth of a percent from the last release to 9.6 percent.

Posted by Rom on August 4, 2010 under Bond Chatter,Bond Trading

iTB Corporate Bond Indices July Performance

August 2010

Keeping in mind our mission to enhance the flow of information and increase the level of transparency of the bond markets, we introduced the iTB Corporate Bond Indices that track the most actively traded investment grade bonds in the fixed income markets. The bonds selected span across various sectors and industries so that the index serves as a fair representation of the broader corporate markets. As rates have declined due to rising risks of an economic slowdown and declining inflation expectations, the bond markets have outperformed most asset classes, as apparent by the July performance of the ITB indices.

iTB-CBI 1-5

Since its inception on July 12, the iTB CBI 1-5, which tracks the performance of 20 bonds having less than 5 years to maturity, ended the month at 1076.61 for a gain of 1.35% on a price basis.  When including interest earned since inception, the index posted a total return of 1.64%.

 

The average yield for the index fell by 48 basis points or 0.48% to 2.69% at the end of the month fueled by a combination of lower Treasury rates and compressing credit spreads. The spread over comparable maturity Treasuries tightened 25 basis points to 1.76% during the same period as corporate bonds outperformed.

 

The best performer for the month, as seen by the narrowing of spreads was BP Plc’s 5.25% bonds maturing November 2013. As the firm sealed the leaking well with a tighter cap, and started operations to seal the well permanently, the bond rallied in July, posting a total gain of 3.98%. In this period, its spread to Treasuries tightened by 95 basis points to 3.95%. The rally is mainly a return to its true yield, as the bond fell rapidly after the explosion of its oil-rig Deepwater Horizon on April 28. Compare the return of the bond with its stock, which returned 4.64% over the same period. Given the much higher risk of holding stocks over bonds, BP bonds posted impressive returns.

The worst performer for the period was Kraft’s 5.625% bonds maturing November 2011. The bond returned a total of 0.13% as its spread widened by 0.07% to 1.29%. Its counterpart in the longer end, a 5.375% bonds maturing February 2020, performed comparatively better, returning 2.91% in that time horizon (Jul 12 – July 30).

iTB CBI 5+

The long iTB index gained 1.91% on a price basis in July, ending at 1126.81. When accrued interest in included, the index gained a total of 2.22%. The index marginally outperformed S&P, which gained a total of 2.18% (including reinvested dividend) over the same period.

The average yield on the index fell 28 basis points to 4.27% on July 30. Spread to Treasuries with comparable maturity tightened 9 basis points to 1.64% as credit risk premium demanded by investors decreased.

 

The best performer of the index was the U.K. based steel giant ArcelorMittal. Its 9.85% bond maturing in June 2019 returned a total of 4.35% over the period. The price of the bond appreciated in price to 129.20 on July 30 from 124.34 on July 12. The spread to comparable Treasuries tightened 43 basis points to 3.04%.

The worst performer over the period was Microsoft’s 4.2% bonds maturing in June 2019. The bonds returned 0.32% over the period, as the spreads on the only AAA rated bond in the index widened 18 basis points to 0.30%.

Posted by Maulik on August 3, 2010 under Bond Chatter,Bond Trading,Uncategorized

Consumer Spending Halts, Income Stagnant, and Pending Home Sales Drop

By Rom Badilla, CFA – Bondsquawk.com

August 3, 2010

Today’s economic data releases suggest that the U.S. recovery may be slowing as we head into the second half of 2010.  The Commerce Department released figures that both Personal Income and Personal Spending failed to grow in June, following a tenth of a percent downward revision in the May readings to final levels of 0.3 and 0.1 percent, respectively.  June’s flat readings disappointed economists as surveys called for an increase of 0.2 percent in Personal Income and a move higher of 0.1 percent in Personal Spending.

BNP Paribas added the following look behind the headline numbers in a morning email to clients:

Personal income did not change for the first time since September 2009, consistent with the aggregate income data from the June employment report, which were particularly weak dropping by 0.5% m/m. Annual benchmark revisions were released with this report. Personal spending trajectory was revised notably down, which resulted in a much higher savings rate. Savings rate in June was 6.4% up from an upwardly revised 6.3% in May (was previously estimated at 4.0%). Core PCE was flat on a monthly basis, implying a y/y rate of change of 1.4% down from 1.5% m/m in May.

Factory Orders unexpectedly dropped in June giving more reason of a slowdown in manufacturing activity, according to the U.S. Department of Commerce.  Factory Orders fell by 1.2 percent versus surveys of a decline of 0.5 percent.  To add insult to injury to the disappointment of missing expectations, the prior period’s reading was revised downward from an initial release of -1.4 percent to a final -1.8 percent.

Pending Home Sales dropped 2.6 percent on a month over month basis in June as government tax incentives expired for prospective home buyers.  Economists were expecting a bounce of 4.0 percent after May’s massive decline of nearly 30 percent.

Pending Home Sales gives insight into forthcoming Existing and New Home Purchases which does not bode well for the millions of homes sitting idle on the market.  BNP Paribas added that “Pending home sales are recorded when a sale contract is first signed. Existing home sales are recorded when a mortgage is closed, implying there is usually a one to two months lag between the series. Therefore, pending home sales freefall points to further weakness existing home sales in July. Housing demand outlook for this year remains very uncertain.”

The Bureau of Economic Analysis released its Personal Consumption Expenditures Price Index (PCE) which is another gauge of inflation and price pressures.  The PCE Core index was flat for June as surveys called for a month over month increase of 0.1 percent.  In addition, PCE Core for May was revised downward by a tenth of a percent to a final reading of an increase of 0.1 percent.  Given this data, inflation expectations should remain subdued in the coming months.

Posted by Rom on under Bond Chatter,Fed Watching

More Quantitative Easing on the Way?

August 3, 2010

The Federal Reserve purchased tremendous amounts of fixed income securities such as Treasuries, Agencies, and Mortgage Backed Securities during the height of the financial crisis and recession in order to pump money back into the system and to promote growth.  Now with the Fed’s balance sheet at nearly three times its original size from before the onset of the crisis, the question becomes what to do with it.  As economic data releases reveal that the recovery may be stalling, the Federal Reserve may consider further action to stimulate growth by maintaining or adding more to their balance sheet when they meet next week, according to the Wall Street Journal article, “Fed Mulls Sumbolic Shift.”

Federal Reserve officials will consider a modest but symbolically important change in the management of their massive securities portfolio when they meet next week to ponder an economy that seems to be losing momentum.

The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change—only four months after the Fed ended its massive bond-buying program—would signal deepening concern about the economic outlook. If the Fed’s forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy.

Moving to stop the Fed’s portfolio from shrinking would prevent monetary policy from slightly tightening in the face of a weakening recovery.

The central bank’s $2.3 trillion portfolio has nearly tripled in size since 2007.

Buying new bonds with this stream of cash from maturing bonds—projected at about $200 billion by 2011—would show the public and markets that the Fed is seeking ways to support economic growth. It could also be a compromise that rival factions at the Fed support, as officials differ about whether and how to address a subpar recovery.

Whether the Fed makes any move next week depends in large part on economic data, particularly the government snapshot of the jobs market due Friday. Since Fed officials last met in June, data on consumer confidence and spending have softened and job data haven’t improved. But overall financial conditions have improved somewhat, with a rebounding stock market.

Officials in the Fed’s anti-inflation camp aren’t convinced the economy is slowing significantly and are wary of taking new actions. Others are eager to consider new steps to address recent signs of a slowdown and persistent high unemployment.

Fed officials aren’t yet prepared to take the larger step of resuming large-scale purchases of mortgage-backed securities or U.S. Treasurys. But they are holding open that option if the economy deteriorates. Private forecasters generally expect real GDP to grow by an annual rate of about 2¾% in the second half of 2010. If the picture deteriorates and they forecast growth falling below 2%, the Fed would be more likely to act.

Read the Full Article

Posted by Rom on under Bond Chatter,Fed Watching

Economic & Bond Market Recap – August 2, 2010

By Rom Badilla, CFA – Bondsquawk.com

August 2, 2010

 Stocks surged and bond yields bounced higher on the re-emergence of the risk trade as manufacturing activity and construction spending came in better than expected.

Economic Data

Manufacturing activity in the U.S. continues to de-accelerate, signaling that the economy is slowing down at the onset of the second half of 2010.  The Institute for Supply Management reported that its manufacturing survey index decreased to a reading of 55.2 in July from a print of 56.2 in the prior month.  Despite the decline, July’s number surprised to the upside as economists forecasted the manufacturing index to come in at 54.5.  While the July figure is still reflecting expansion since a reading above 50 indicates growth, today’s release is the third consecutive drop after peaking in April at 60.4.

The Prices Paid survey component ticked up to 57.5 from June’s reading of 57.0, surpassing consensus surveys.  After dropping nearly 20 points from May to June, economists were expecting a further decline as evident by surveys standing at 55.0. 

In other economic data releases, construction spending in June unexpectedly improved.  The Department of Commerce stated in a report that construction spending increased by 0.1 percent surpassing surveys which called for a decline of 0.5 percent.  Despite the positive surprise, the prior period figure was revised significantly downward by eight-tenths of a percent to a May decline of 1.0 percent.

For more details on today’s economic data releases, click here

Interest Rates

U.S. Treasuries sold off as rates bounced off of last Friday’s lows with the long-end of the curve underperforming rest of the maturity spectrum in a bear steepener trade.  The Long Bond suffered the most with today’s better than expected economic data releases as the 30-Year Treasury crossed above the four percent threshold by jumping 7 basis points to 4.06 percent.  Similarly, the 10-Year spiked almost 6 basis points to end the week’s opening session to 2.96 percent.  The belly of the curve widened slightly less as the 5-Year finished at 1.64 percent, a move higher by 4 basis points.  The 2-Year barely budged and closed at 0.55 percent.

10-Year U.S. Treasury Yields - Intraday Chart

Much of today’s jump in yields can be explained by higher inflation expectations according to the change between nominal Treasury yields and TIPS.  The yield differential between the two increased by 8 basis points to a spread of 1.83 percent.

Inflation Expectations aka Breakeven Rate - Historical Chart

Across the Atlantic, government bond yields for developed economies increased following today’s bullish economic data.  Germany’s 5-Year Bunds increased 3 basis points to 1.68 percent while France’s 5-Year added 2 basis points to 1.96 percent.  5-Year U.K. Gilts closed at 2.08 percent, an increase of 3 basis points.

For peripheral countries, yields were generally tighter with the exception of Greece.  Portugal witnessed its 5-Year benchmark note tighten 8 basis points to 4.00 percent.  Spain, Ireland, and Italy each saw their respective benchmark notes decline by 3 basis points.  Spain closed out at a yield of 2.90 percent while Irish and Italian 5-Year bond yields ended the day at 3.95 and 2.71 percent, respectively.

Credit Markets

For performance of high grade corporate bonds, check today’s ITB Corporate Bond Indices.

The BofA Merrill Lynch U.S. High Yield Mater Index tightened 3 basis points to a spread of 654 basis points or 6.54% over Treasuries with comparable maturities.

Mortgage Backed Securities were hammered today as today’s positive data gives some investors reason to believe that the Federal Reserve will not embark on Quantitative Easing measures which could entail more purchases of MBS in order to spark a slowing economy.  The yield differential between par-priced 30-Year Conventional Mortgage Backed Securities and the 10-Year Treasury increased 11 basis points to a spread of 65.

30-Year MBS Nominal Spread over U.S. Treasuries - Historical Chart

Across the Capital Markets

With the today’s economic tailwinds fueled by more positive earnings announcements, stocks found enough reason to soar higher.  The S&P 500 advanced 2.2 percent to 1125.86, surpassing technical resistance levels such as the 200-day moving average along the way.  The NASDAQ gained 1.8 percent to 2295.36.  With the fear trade off for now, the CBOE VIX plummeted 6.3 percent to 22.01.

The Dollar Index unimpressed by today’s data coupled with investors placing the debt crisis on the backburner for now fell 0.8 percent to 80.93.  The Euro gained 0.7 percent to 1.31725 while the British Pound jumped just over a percent to 1.5886.

Gold spot prices gained modestly by 0.1 percent to 1183.40.

Posted by Rom on August 2, 2010 under Bond Chatter
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