Sunday, July 26, 2009

30 Year Review Ahead of Short Term Auctions, Q2 adv-GDP and Aug 7 NFP
A brief review is in order of the long term chart before heading to the short term daily charts. Since 1984,
the 30 year has been hammering out intermediate term bottoms at key 50% retracements. See the
examples from the Oct 1987 low, the Sept 1990 low, the Nov 1994 low, and the May 2004 to June 2007
lows.

Between 2004 to 2007, the 30 year held the 50% retrace to the decade lows set in Jan 2000, with just a
smidge of slippage in the summer of 2003 and the spring of 2004, when there were signs of a mfg
recovery and a few months of surging job growth. The global financial system collapsed in Q4 2008. Then

1
in the first half of 2009, Bernanke began to see green shoots, and Obama saw glimmers of hope. The
mantra as we enter the 2nd half of 2009 is the fiscal and monetary stimulus policies are working. This has
pressured the 30 year back to the 50% retrace to the decade low set in Jan 2000. This has been the decade
of negative real interest rates created largely by the Fed in response to asset bubbles collapsing.

The question you have to answer for yourself are the green shoots significant enough to normalize long
term interest rates, or will long term rates have to remain extremely low to cushion an economy that will
be growing well below its GDP potential? We know David Rosenberg would answer this question in the
affirmative. Paraphrasing Rosenberg, long term rates will stay down until the slack in unemployment
begins to be absorbed. In my estimation, as long as output gap between actual GDP and potential GDP
growth remains wide, it is hard to imagine long term interest rates normalizing anytime soon. And so we
will continue to watch the 50% retrace support in the 112 handle very closely near term.

In the meantime, we need to turn our attention to what is happening on the daily continuation chart to see
what is going on up close on the front lines.

The above chart shows a bullish reaction on the June 11 retail sales report and successful auctions at the
long end of the curve. Could the bonds be waiting for the next 10 year auction on August 12 and retail
sales report on August 13 before heading higher? Yes, it could well wait for that. There is the near term
2
risk that the adv-GDP on Friday July 31st will be signaling the economy only contracted at -1.5% vs 5.5%
in Q1. There is also the risk that the August 7 NFP report will show net job losses contracting and a UE
rate that is unchanged or better as a result of skewed seasonal data for July related to the auto industry.
These are short term bearish inputs.

The PPI and CPI reports in mid-July were bearish inputs for the 30 year largely on account of the jump in
gasoline prices at the pump in June. This was a one and done, one time effect, not a new trend suggesting
long term rates ought to be normalizing. When retail sales, CPI and PPI come out in August, these are apt
to be bullish inputs for the 30 year as a result.

Once the near term downside risks between now and the August 7 NFP report diminish and are behind us,
there should be some low-risk opportunities position oneself on the long side of the market.