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Wednesday, August 24, 2005

Debt market outlook

Attached is a todays news report from Bloomberg - see My comments in bold brackets.
`Investors started to push bonds higher again in afternoon trading as crude oil and natural gas rose to records on concern a storm heading for Florida may threaten production platforms in the Gulf of Mexico`.``There is this underlying demand for fixed income which has restrained the increase in yields'' said Christopher Sullivan, chief investment officer at the United Nations Federal Credit Union in New York, which manages $2 billion in debt. [Doesn`t he have this around the wrong way. Aren`t the high yields attracting demand for US treasuries, pushing up bond prices, thus reducing yields. ie. Supply-demand. I`ll have his job].

The price of crude oil surged to $67.40 a barrel in New York, up 49percent from a year ago. [How many economists predicted that? Only a few]
Treasuries also benefited as the government sold $20 billion of two-year notes at a yield of 4.014 percent. A category of bidders that includes foreign central banks bought 44 percent of the debt, the most since September. There were $2.28 of bids for every $1 sold, compared with the$2.14 average for the previous 12 sales. [Not surprising that foreign bidders dominated given that US investors are still pooring money into real estate. So expect higher demand for white goods - durables, sustenance of the boom a bit longer, but those US treasury yields are now 4% - not1%, so the US deficit is going to rise greatly. The US is paying more for oil, its paying higher interest on its foreign-held deficit, and the demand for foreign-manufactured white goods will be up. So long as property prices are rising stronger than interest rate payments, US house holds might feel comforted by the high level of economic activity, at least until house prices fall. A few bad numbers could easily kill a Japanese recovery, starting with high oil prices. Mind you the Japanese don`t relyon cars nearly as much as the Americans. Chinese factors do. But oil is likely a bubble too, and like housing, it will go higher. Certainly to$US75, perhaps $US100/bbl if the US Fed start cutting interest rates prematurely to maintain activity. Lastly, US imports will rise (ie. higher deficit) because Americans are paying more for Chinese goods - thanks tothe US deficit. Since the US has no competitive advantage in the Chinese product fields, this does not give the US a competitive benefit...rather Indonesian might benefit over China].``The 4 percent coupon may have enticed some people looking to park moneyin the short end of the curve,'' or shorter- maturity debt, said Rick Klingman, head of U.S. Treasury trading in New York at ABN Amro Inc. The firm is one of the 22 primary dealers of U.S. government securities that are obligated to bid at Treasury auctions.The so-called yield curve may have flattened to the point where two year notes are attractive, Klingman said.Two-year yields rose to within 18 basis points of 10-year yields today,the narrowest since the start of 2001, reducing the incentive for investors to buy a longer-dated, and thus riskier, 10-year security. Thegap has shrunk from 211 basis points in June 2004 as investors pushed up short-term yields in response to the Federal Reserve's 10 interest-rate increases. [An inverted yield curve signals a recession. Every war in recent history has been associated with high oil prices and recession].

Durable Goods
HomesOrders for durable goods tumbled 4.9 percent in July, compared with a riseof 1.9 percent in June, the Commerce Department said. A decline of 1.5percent was expected, according to the median forecast in a survey by Bloomberg News.Later, a government report showed sales of new homes unexpectedly rose toa 1.410 million annual rate last month. A drop to 1.328 million from 1.324million was expected, according to the median estimate of economists surveyed by Bloomberg. [See comments above].
Some strategists predict the rally will be short-lived.Ten-year yields ``just don't make a lot of sense,'' given the Fed is goingto keep raising benchmark rates, said William Prophet, an interest-rate strategist in Stamford, Connecticut, at UBS Securities LLC. The securities are ``definitely rich,'' he said. Ten-year yields will probably rise to about 4.40 percent next month, said Prophet. [Unless demand for long bonds remain strong because of uncertainty, ie. fears of asset erosion].
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