Wednesday, June 06, 2007
On the face of it, all remains bright and beautiful with the world. Australia registered super-strong (1.6% non-annualized) Q1 GDP growth, and the Oz (and kiwi, too, naturally) registered new 17 year highs against the US dollar. Chinese equities, so wobbly of late, appear to have stabilized. Growth remains good and liquidity remains ample. All aboard the market lift; next stop: financial Nirvana! Right?
Perhaps, but Macro Man was perturbed to see in his email box today not one but two clarion calls to buy bonds. It may be a bit trite to suggest that the ultimate buying opportunity occurs when the last bull pulls in his horns, but that appears to be more or less what's happened to US bonds (or, to put it another way, the bears on the economy have had their claws clipped off.)
Goldman Sachs and Merrill Lynch have both abandoned their long-standing calls for substantial US rate cuts in the second half of this year. Now, Macro Man actually agrees with this view, and has never really had much conviction that rate cuts are/were in the offing. Yet when he finds himself suddenly in the company of Merrill's David Rosenberg (whose forecast spreadsheet for the past five years has run off the simple alogorithm that if the day ends in 'y', deep rate cuts are forecast), he finds it an uncomfotable proposition.
When one considers some of the tactical factors that are driving the market, a cheeky purchase of bonds looks even more attractive. Yesterday appears to have been the day that rising real rates started to matter for equities, as a US 10 year at 5% proved sufficient to send the S&P 500 heading lower. While 5% need not be an insurmountable hurdle forever, it does seem likely that further near-term weakness in bonds will be met with a sell-off in equities, which should in turn put a floor under bonds.
Consider also that the recent run-up in energy prices should eventually become an issue sooner or later, whether as a hit to consumer confidence or via a more real impact on disposable income (and therefore, discretionary spending.) Moreover, ancillary market indicators that have been highly correlated bonds appear to be turning. Short bonds and short USD/BRL have been the same trade (at least directionally) for the last few months; the BRL appears to have turned, at least temporarily, and the little overlay below would suggest that TYU7 should be in the mid 106's rather than the high 105's.
Technically, meanwhile, Treasuries are as oversold (on a daily chart) as they've been in nearly four years. Not since the mid-2003 deflation scare/convexity squeeze was unwound has the RSI been this low. A guarantee of a reversal? Of course not. But it certainly raises the probability that a (at least temporary) rally occurs.