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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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Economic/Bond Market Summary – April 12, 2010

by Rom Badilla, CFA – Bond Trader and BondSquawker

With the announcement of a Greek rescue package, concerns of escalating risk in the Euro-zone eased. The Euro edged higher by 0.7 percent and ended Monday’s session at 1.3592. The Dollar Index, which is a measure against the six major world currencies, declined 0.7 percent to 80.57.

U.S. Treasuries initially sold off after the bailout announcement, pushing yields higher. However, bonds did an about face by mid-morning and rallied to a point where yields ended lower.

The yield on the 10-year opened the week at 3.88 percent and reached an intraday high of 3.92 percent before declining. In total, the 10-year declined 4 basis points to close at 3.84 percent. The yield on the 2 and 5-year declined 2-4 basis points to close at 1.03 and 2.59 percent, respectively. The Long Bond outperformed the most, as the yield curve flattened. The yield on the 30-year finished the day at 4.70 percent, a decline of little more than 4 basis points from last Friday’s close.

Some traders suggested that the quick turnaround in bond yields is a result of investors expressing caution as corporations head into earnings season this week. Investor expectations are fairly high and the risk is for a slight slip in reporting and missing estimates. Such a situation could push equities, which have traded in overbought territory for quite some time, to lower levels. For the risk takers out there, I can see a leg down to 1185, which offers some support which if surpassed, could lead to 1150.

The S&P 500 hit an intra-day high of 1199.20, which some view as a technical resistance level before ending at 1196.48, a 0.2 percent increase from Friday’s close. With this current rally trend, the Volatility Index a.k.a. VIX declined more than half a point or 3.47 percent to 15.58.

Posted by John Adams on April 13, 2010 under Bond Chatter,BondSquawk
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The Carry Trade

The principal behind the carry trade is to borrow short to purchase a longer-term bond that will pay a higher rate than the rate of the short-term loan.

Dealers finance their treasury purchases by borrowing against their treasury holdings by doing repo transactions, which are essentially loans collateralized by treasuries.

The risk/reward is determined by the spread between the treasury yield and the repo rate the dealer pays.

Longer maturity bonds will trade at a greater spread because:

  • They are more price-sensitive to changes in interest rates
  • They have a longer time horizon that presents more uncertainty as to the level of interest rates.

If the Fed raises rates – a dealer could end up with a negative spread.

The two-year note is a particularly popular security for the carry trade because its yield is closely tied to the fed funds rate and it is extremely liquid.

Posted by John Adams on April 10, 2010 under BondSquawk,Educational
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Repurchase Agreements (Repos) and Reverses

Repo, short for repurchase agreement (also known as RP), is a form of short-term borrowing for government securities dealers.

In a repo transaction, the dealer sells a treasury security to investors with an agreement to repurchase the security at a later date, usually the next day, and at a fixed rate of return to the investor (the repo rate).

Repos can also be done for a longer term, such as a week or a month (this is known as term repo) or a Repo can be done on open without a fixed repurchase rate.

The rate for an open repo is most often renegotiated on a daily basis.  It is effectively a short-term loan that is collateralized by a treasury security.  The investor (lender) in the transaction is entering into a reverse repurchase agreement or reverse.

Typically, the term repo is used for both repos and reverses since the terms only refer to which side of the transaction one is on.

Dealers use repos to finance their activities because treasury securities are subject to market risk (because the price fluctuates). Due to the changing price, the investor will not lend the full value of the security.  The difference between the value of the security and the amount that is borrowed is called a haircut.

Posted by John Adams on under BondSquawk,Educational
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Greek Bond Collapse Rumor Triggers Sell Off

by Rom Badilla, CFA – Bond Trader and BondSquawker

Greek bonds collapsed today as rumors spread of the country attempting to renegotiate International Monetary Fund involvement with the European Union’s aid plan. Market News International claimed that Greece did not want the IMF involved in any support package since they would establish tough austerity measures on the country that could ignite further social unrest.

Despite the fact that Greece denied the report, investors sold bonds leading to a spike in yields. The yield on 2 year Greek bonds increased 117 basis points to 6.22 percent. Comparatively, the yield on 2 year bonds from Germany, the EU’s strongest member, was unchanged for the day at 0.98 percent, a differential of 524 basis points against its troubled European neighbor. Yields on 5-year Greek bonds increased 51 basis points to 6.69 percent while 10-year Greek bonds finished 44 basis points higher to 6.96 percent.

Furthermore, the Financial Times reported that Greece would attempt to raise $5 to $10 billion from the U.S. in order to help cover maturing debt and interest payments. Greece is re-entering the U.S. markets for the first time since 2008 and is targeting Emerging Market debt players after waning demand in Europe and amid rumors from earlier this year of China showing a lack of interest.

The Dollar Index, which is a measure of value against the six major world currencies, increased 0.4 percent to 81.39. The Euro declined 0.6 percent to 1.3399.

Back home, U.S. Treasury bonds acted as a safe haven from the problems abroad as yields across the maturity spectrum declined. The yield on the 2-year declined 3 basis points to end at 1.14 percent. The 5 and 10-year yield dropped 4 basis points to close the day at 2.70 and 3.95 percent, respectively. The yield on the Long Bond inched a basis point lower and finished the day at 4.83 percent.

As indicated yesterday, the U.S. Treasury sold a record $40 billion of 3-year notes in the second of four auctions this week totaling a gross issuance of $165 billion. Demand for the 3-year notes was high as the bid-to-cover ratio, a gauge of investor demand, was at 3.13, versus the 2.94 average of the past 10 sales. Next up, the Treasury will be offering $21 billion of 10-year notes.

The minutes of the Federal Reserve’s March 16th policy meeting were released during the afternoon session. The minutes revealed that monetary policy will remain on hold and should not tighten anytime soon with the ultimate factor being the strength of the economy. Furthermore, there was a consensus that inflation expectations were “well anchored” but could potentially increase in the intermediate term due to its accomodative policy.

Posted by John Adams on April 7, 2010 under BondSquawk
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10-Year Treasuries Reach 4%, Signaling Economic Recovery


by Rom Badilla, CFA – Bond Trader and BondSquawker

The 10-year note bounced off of an intra-day high of 4.00 percent, a technical support level, before closing at 3.97 percent to end Monday’s action. The four-percent mark was the highest level reached in almost 18 months, as the government sets out to sell $82 billion in debt this week. Further data suggests solidified expectations that the U.S. economy is in recovery.

With improving economic reports coupled with more rounds of Treasury auctions in the coming days, yields in the bond markets edged higher after market participants returned from a long three-day weekend. On Friday the Bureau of Labor Statistics reported that the U.S. economy is turning the corner as it added the most jobs since 2007.

Today, the Institute for Supply Management reported that service industries are expanding as their Non-Manufacturing Index came in at a reading of 55.4 in March, beating economists’ expectations of 54.0 and following a reading of 53.0 in the prior month. A reading above 50 signals expansion in the service sector. March’s number was the highest since June 2007.

As a result, the bond market sold off as yields spiked even higher across the entire maturity spectrum. The yield on both the front and back end increased close to 10 basis points from Thursday’s close. The yield on the 2-year finished at 1.15 percent while the Long Bond closed at 4.82 percent.

In the first of four scheduled for later this week, the U.S. Treasury auctioned off $8 billion of 10 TIPS or Treasury Inflation Protected Securities. Unlike the last auction of its kind, demand was much stronger as the bid-to-cover ratio, a gauge of investor demand, was at 3.43 versus 2.65 at the prior auction in January.

Tomorrow, the Treasury will auction $40 billion of 3-year notes, followed by $21 billion of 10-year notes on the 7th, and $13 billion of Long Bonds on April 8th. The S&P 500 inched higher once again. The index improved by 0.8 percent to end the day at 1187.44. The Volatility Index aka VIX dropped to 17.02, a decline of 2.6 percent from Thursday’s close.

Both the equity and bond markets are barking up key technical levels, resistance for the S&P500 and support for the 10-year Treasury. Resistance for the S&P500 lies at 1185 and at 1200 while the 10-year has support at 4.00 percent and 4.25 percent. Furthermore, both have been in overbought/oversold territory for quite some time. With this week’s auctions and earnings season about to pick up steam, look for both markets to extend its current trend toward those levels in the next week or two as the economic recovery story picks up steam.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of iTB Securities LLC or its employees.

Posted by John Adams on April 6, 2010 under BondSquawk
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Investors Crave Positive Economic Data

by Rom Badilla, CFA – Bond Trader and BondSquawker

Markets will be closed on Friday. Despite the holiday, all market participants will be watching for signs of improvement in the U.S. labor markets that have remained sluggish as the economy turns the corner toward growth. All eyes are on the release of the Non-Farm Payroll Change as economists are expecting an increase of 184,000 jobs in March after a decline of 36,000 in the previous month. Furthermore, economists are expecting the National Unemployment Rate to remain at 9.7 percent.

The yield differential between par coupon 30-year Fannie Mae Mortgage Backed Securities and the 10-year Treasury increased to 70 basis points today. The spread has slowly inched higher from a 5-year low of 59 basis points achieved on March 10, 2010 as the Federal Reserve ended its Quantitative Easing Program of adding Mortgages and Agency Debt to its balance sheet on March 31st.

Time will tell if the private sector will pick up the slack left by the US Government in driving borrowing costs down as $89 billion of dollars flowed into bond funds this year, almost five times higher than deposits in the first quarter of 2009.

With the recent underperformance of the bond market, fueled by weak investor demand at the latest Treasury auctions, flows could easily reverse itself in the coming months. Furthermore, investors fear of being left behind in the recent equity rally, could result in a chase for better returns and out of bond funds. As a consequence, this could lead to less sponsorship for Mortgages that pushes spreads higher and in turn, result in higher borrowing costs to the U.S. homeowner.

MBS Yield Spread vs. Treasuries. The lower the number, the better MBS outperformance

Last week, Former Federal Reserve President Alan Greenspan stated in his “canary in the mine” television interview that he is “very much concerned about the fiscal situation,” and an increase in rates, in particular the long end of the curve, “will make the housing recovery very difficult to implement and put a dampening on capital investment as well.”

Next week, the U.S. Treasury plans to auction off $165 billion in gross issuance of Bills, Notes, and Bonds. The Treasury will be auctioning $8 billion of 10-year TIPS (Treasury Inflation Protected Securities), $40 billion of 3-year notes on April 6th, $21 billion of 10-year notes on the 7th, $13 billion of Long Bonds on April 8th.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of iTB Securities LLC or its employees.

Posted by John Adams on April 2, 2010 under Bond Chatter,BondSquawk
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Economic/Bond Market Summary – April 1, 2010

by Rom Badilla, CFA – Bond Trader and BondSquawker

Today, economic data releases suggest that the U.S. economy is rebounding and amidst in a phase of economic expansion. The Institute of Supply Management Manufacturing Index for March came in at 59.6, above economists’ expectations of 57.0. This marks the highest level since July 2004 and the eight consecutive months above 50 that is a level typically associated with economic expansion.

Looking behind the headline number, manufacturing conditions further reinforce the growth story for the U.S. economy. The New Orders index increased to a level of 61.5 in March from 59.5 in the prior month while New Export Orders jumped as well. Global growth is surging as the New Export Orders Index spiked to 61.5 in March, following a reading of 56.5 in February.

With the growth storyline firmly entrenched coupled with eyes on tomorrow’s job report, the Treasury market sold off as yields inched higher. The belly of the curve underperformed the most as the yield on the 5-year moved close to 4 basis points higher to end the day at 2.58 percent.

The 2-year ended the day at 1.05 percent, an increase of 3 basis points. On the longer end, the 10-year yield increased to 3.86 percent from Wednesday’s close of 3.83 percent. The yield on the Long Bond moved 2 basis points higher to end at 4.73 percent.

Posted by John Adams on under BondSquawk
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Economic/Bond Market Summary – March 31, 2010

by Rom Badilla, CFA – Bond Trader and BondSquawker

Economic data released on Wednesday suggests that U.S. employment in the private sector contracted.  Automatic Data Processing released their National Employment Report for March indicating that companies eliminated 20,000 jobs following a prior month’s decline of 24,000.  Economists actually expected an increase of 40,000 jobs.

Many market participants were looking for the ADP report to be a leading indicator to a strong number in Friday’s Non-Farm Payrolls data release by the U.S. Bureau of Labor Statistics.  Surveys for Non-Farm Payrolls point to an increase of 184,000 after a decline of 36,000 in the prior month.

Due to the weak number, the Treasury market rallied as yields contracted across the curve.  The yield on the 3 and 5-year outperformed the most as yields declined 5-6 basis points to close at 1.57 and 2.54 percent, respectively.  The yield on the 2-year ended the session at 1.01 percent, a drop of 4 basis points from the previous close.  The yield on the 10-year and the Long Bond declined by 3 basis points to finish at 3.83 and 4.71 percent, respectively.

The Institute for Supply Management will release its Manufacturing Index on Thursday.  The market is looking for more ammunition to fuel the economic recovery story with this release as economists are expecting a reading of 57.0.  A reading above 50 typically signals economic expansion and a successful print above that in March would signal the eighth consecutive month of expansion for the economy.

Posted by John Adams on April 1, 2010 under Bond Chatter,BondSquawk
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Economic/Bond Market Summary – March 29, 2010

by Rom Badilla, CFA – Bond Trader and BondSquawker

The yield on 5 and 7-year notes increased slightly by a basis point to end at 2.60 and 3.33 percent, respectively. The long end underperformed as the yield curve continues to steepen. The 10-year closed at 3.87 percent, a 2 basis point jump while the Long Bond moved higher by 2.5 basis points to end the day at 4.77 percent. The front end of the curve as indicated by the 2-year remained unchanged and closed at 1.04 percent.

The S&P500 improved slightly by rallying 0.6 percent to end at 1173.22. The Volatility Index aka VIX closed at 17.59, a decline of 1.0 percent.

The U.S. Dollar Index declined 0.4 percent while 10-year swap spreads increased by almost a basis point to close at -5 basis points.

Posted by John Adams on March 30, 2010 under BondSquawk
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