Update 5/17/10
Risks favor: Floating
Current Price of FNMA 4.5% Bond: $101.78, +19bp
The US Bond market continues to attract buying interest as a safe haven from the ongoing problems in Europe. And this morning, a weak Empire State Manufacturing Index is helping Bonds retain their bid higher. The Empire State Index came in at 19.11, well below the 30.0 expected – but a deeper look into the report does reveal a few items that are not so good for Bonds. The Employment reading climbed to the best level in six years, showing that there is hiring in this sector of the economy. Additionally, the inflation-measuring prices paid component rose to a 44.7 reading, the highest level since September 2008. So while the headline number caused Stocks to move lower and Bonds to retain their current high ground – some of the underlying data may weigh on Bonds as the day progresses.
Today also brought March’s Treasury International Capital (TIC) Report, which measures foreign investment in US securities – and shows exactly who has been buying our Bonds and pushing prices higher of late. China, for the first time in six months, was a net buyer of our debt, adding $17.7B to their present holdings. Chinese holdings now total $895B, and they remain the largest creditor to the US. Japan, the second largest holder of US Treasuries, added $16B to their portfolio during March, bringing their total holdings to $785B. The report also showed a pickup in foreign buying of Mortgage Backed Securities. During March, a net $22B in MBS was purchased, up significantly from February’s $2B.
The turmoil in Europe and weakness in the Euro is causing investment dollars to flood into the US, even though the yields are already quite low. The dramatic increase in foreign purchasing is making up for what the Fed would have been buying in MBS. Add to this US investor dollars that are now being put to work back here in the US, instead of riskier European options, and it’s clear to see why Bond prices have performed so well of late. The important thing to remember is that the improvement in Bonds is not a fundamental one – it is a trade. There is a big difference between fundamental investments and temporary trades. Trades move quickly and eventually reverse in an ugly way. We’ll need to be on guard for this eventual reversal in Mortgage Bonds. For now, we’ll enjoy the move higher.
Kansas City Fed President Thomas “BBQ” Hoenig – the lone dissenter during the past three Fed meetings on the “extended period” language – offered a few thoughts over the weekend. “We’ve gotten through the crisis. We are not out of the woods, the economy isn’t booming, but we are now in a position where we ought to be thinking about the long run. That’s what central banks should do.” Mr. Hoenig has been very vocal on his concerns about inflation over the longer term, as a result of keeping rates too low for too long. There is a big Fed meeting coming up on June 23rd, and we’ll see if more Fed members side with Mr. Hoenig.
We will Float and watch carefully in a very volatile environment with prices trading near resistance.