This Week:After a huge drop in interest rates last week, this week should see some consolidation. The stock market and the bond markets are both technically over-extended. That said, we still don’t expect interest rates will increase much even if there is some reversal this week. The overall trend is remarkably bullish on increasing U.S. economic weakness and the never-ending debt problems in Europe. Spain has serious problems in its banking sector and unemployment is increasing. Greece will hold elections on the 17th to determine whether Greek citizens want to stay in the European Union or leave it. A Greek exit of the EU would generate additional fears that Ireland and Portugal might follow. Presently there is little belief one way or the other that Europe will solve its debt and deepening economic crisis, leaving the U.S. bond market as a place to park money.
The Federal Reserve Beige Book will be released on Wednesday. There isn’t much this week on the data with the May ISM Services Sector Index out tomorrow and Weekly Jobless Claims on Thursday are the only key data this week.
Early activity this morning had the bond and mortgage markets trading lower after the explosive rally on Friday on the weak May employment report. The 10-Year Note and 30-Year Bond are falling in rate on increasing global moves to safety. Obviously Europe is leading the parade to safety as there is little progress in dealing with its debt and rapidly declining economy. China is slowing quickly and India is now showing cracks in its economy. In the U.S. we are doing better for the moment but also being pulled down by the global softening. Investors of all sizes are simply parking moneyin sovereign debt, in the U.S., Germany and other AAA rated sovereign debt (the U.S. rating is AA+). Investors are no longer looking for a return on investment, just return on the principal.
As euro-area unemployment reached its highest level on record, manufacturing output contracted for a 10th straight month in May and the currency plunged close to a two-year low against the U.S. dollar, leaders continued to wrangle over the details of support for the currency bloc. There is an increasing cry in Europe from the debt ridden countries to institute euro bonds. With markets bracing for further deterioration in Spain’s finance sector and a possible Greek departure from the 17-member euro area, there are calls for a “banking union” in Europe involving a centralized system to re-capitalize lenders. Germany’s Merkel shut off another crisis-fighting avenue the same day as she toughened her opposition to euro-area debt sharing, saying that “under no circumstances” would she agree to euro bonds. Germany holds most of the cards, so far unwilling to play many of them fearing the inevitable, decline in Germany’s economy and its own debt if it has to back euro bonds.
Treasuries and mortgage markets are technically overbought while the U.S. equity market is oversold. A bounce back is not unusual with short term oscillators and momentum indicators at extreme levels. Traders will be reluctant to step in now until markets can consolidate and test the underlying demand at current levels in financial markets. There is however no reason to expect interest rates will increase much given the underlying fundamentals.
The DJIA opened up +15, NASDAQ up +18; the 10-Year Note at 930am down -20/32 at 1.53% (+7 bps) and 30-Year MBS prices down -6/32 (.18 bps).
At 1000am the data for the day, April Factory Orders expected up +0.1%, took another dive to -0.6% and March orders were revised to -1.9% from 1.5%. The reaction turned stock indexes down from slight gains. The 10-Year Note was -20/32, it bounced up to -14/32.
There aren’t a lot of key economic measurements this week; Weekly Jobless Clams and the May ISM Services Sector Index lead the headlines. We expect a choppy bond and mortgage markets this week to ease the over-extended move we saw last week. Last Friday’s heavy buying in treasuries looked much like a capitulation from the bond bears after the 10-Year Note easily broke 1.50%. One media guru was out today conjecturing that the 10-Year Note could go to 1.00% before the rate markets turn around. We can’t get on board with that however. Although Europe at the moment looks impotent in dealing with the economy and debt problems, it isn’t unreasonable that in the next few months there will be a plan in place that will reduce risk off trades into bonds. If Europe can’t come up with a fix that makes sense in the next few months, the entire EU may come tumbling down in a heap. That isn’t an option so something will have to give In the present stalemates that have grid-locked all of the region.
