Macro Monitor

The bond market marked time for the first three weeks of July, but came on strong in the last five trading days. July gains in bonds did not keep pace with stocks, but most bonds were up a point or so for the month.

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In June, the bond market appeared to be unstoppable. After a pause mid-month, prices came roaring back edging into new high ground at month end.

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With Aussie Commonwealth bond yields again up around 14% and the Aussie dollar down to $0.75 U.S., we are moving part of the fixed income portion from both the asset allocation models back into the Aussie bond market.

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For quite some time this publication has had a pretty good feel for the bond market. But May surprised me. My expectation was a stronger market early in the May followed by a correction.

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With at least some preliminary signs the economy is slowing, accompanied by more comforting PPI and CPI numbers, it would appear the Fed is relaxing a bit.

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In mid-March, the bond market was jolted by a nasty PPI number and spent the rest of the month creeping back to pre-PPI release levels. The net result was an unchanged to slightly higher bond market in March.

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In February, stocks and bonds tracked the same course. The CRB Index came down significantly in February and was close to breaking down before a late month surge. The JOC Index remains above its January breakout level.

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This is indeed a strange environment, where higher short-term rates in effect have become a bond market positive. High short rates cool the economy and keep the dollar strong. Both of these consequences are bond market positives.

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To use the old cliche' for lack of a better term, the bond market backed and filled in December.

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Forget about the economy, forget about the uptick in the CPI, and forget about the bulge in bond supply. U.S. interest rates rose in November because the dollar went down.

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Wall Street's financial mechanics created chaos in the high grade corporate bond market last month. With exceptions, the LBO frenzy has destroyed, at least for the time being, the usefulness of bond quality ratings. The damage done to many bond portfolios was massive.

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The Gods of the bond market were kind in September, with the bond market performing exactly as we thought it would.

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For the month, the net loss for long T-bonds amounted to a half a point or less. All things considered, I thought it was an impressive performance, even though it took place in the dog days of August.

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T-bonds went into a seven trading day swoon in early July. Then for the rest of the month they backed and filled. Outside the Treasury market, damage was considerably less in July.

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Today, led by soybeans and other grains, the U.S. is getting a dose of Isolated Factor Inflation. The Fed can’t do anything to alleviate this, but Mother Nature can. Good hard rains in the farm belt could take the sizzle out of this brand of inflation.

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A month ago, institutional bond buyers were skittish, nibbling a little, but mostly sitting on their hands waiting for lower prices. As it turned out, the bond market didn’t need rain, nor did it need easier money and lower short-term rates.

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Have we entered an age of interest rate discontinuity, where past interest rate history has no meaning? Are the current high rates merely a long-lasting hangover from the high inflation of the late 1970’s and early 1980’s? Is it a matter of there being too much of a demand for dollars and not enough supply? NO!

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The first week of April brought a lethargic rally in T-bonds, but prices faded fast around mid-month, stabilized for a week and then sold off again at month end.

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T-bonds slide 4-5 points in March, with corporates holding up better. Bonds look good, but T-bonds are expected to suffer from renewed inflation fears, dollar weakness, deficit concerns and maybe big foreign selling.

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Outside of the 10% move in 30-year zeros (premium widened), the bond market in February was a quiet affair. In terms of the bond market, it was a good month to be on vacation. I didn't miss much.

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