Jobs Data Preview: Expecting Directional Guidance

By: • Thu, Jun 2 2011, 5:24 PM

Although Moody’s threatened to downgrade the U.S. credit rating again and Greece agreed to another bailout “in principle”, which led to a short selling spree early this afternoon and pumped up trading volume even more, profit taking was the name of the game in the bond market today.

Scattered reprices for the worse were reported this afternoon after profit taking pushed benchmark Treasuries through key support and almost totally erased yesterday's MBS rally. As mentioned in two Live Market Updates today, this is not surprising given the speed and size of the recent rates rally. It isn't a sign of a bearish bias creeping back into the bond market. This sort of behavior is actually to be expected ahead of a high-risk event like the Employment Situation Report tomorrow. Investors are simply looking to secure a portion of their earnings "just in case" jobs data surprises to the upside. This should serve as a reminder of the risks associated with floating loans that must be locked on a short timeline though. Even in a broader bullish trend, back-ups and reversals are always a threat.

The chart below shows how yesterday's MBS rally was almost completely retraced today. We fell from outer space, all the way back to our "lift-off level". If you're wondering why we've chosen the 4.0 coupon to illustrate price action, it's because we're almost ready to award 4.0s the "production coupon title belt", but we're not totally convinced just yet. We'll need to see lock desks actually hedging with 4.0 coupons before making that call.

The June delivery FNCL 4.0 went out -15/32 at 100-26. 4.5s ended the session -10/32 at 101-00+. Current Coupon yield spreads tightened vs. the 10yr note and 10yr swaps but moved wider to 5s as the yield curve bear steepened. TBA trading volume was above-average with 30yr Ginnies and 15yr Freddie's seeing the most activity on a relative basis.

Profit taking and short-selling in the 10yr TSY note paved the way for MBS weakness. 10s went out -24/32 at 100-25+ yielding 3.032%, 8.7bps higher on the day, and the 2s/10s yield curve bear steepened a stunning 7bps. That wasn't even the worst of it, the 2s/30s spread gapped out 9bps to 379bps wide. Weakness in the long end was a factor, yep you guessed it, profit taking. Short selling was however seen which we'd prefer to blame on a pre-auction setup for next week's Treasury auctions (totaling $66bn).

The chart below highlights psychological support, which has now become resistance, at 3.00% as well as a return to yesterday's "lift-off level". Just like "rate sheet influential" MBS, Treasuries too almost totally erased yesterday's rally.

So the big day is tomorrow. We'll be looking for the Employment Situation Report to provide some directional guidance for the month ahead. After much liquidation of longs today, trader sentiment has shifted to a more neutral position. However with the overall economic tone indicative of a sputtering recovery, which we'd rather call a "false start" because the recovery never really got underway in the first place (in our opinion), a bullish bias remains in place. Still, even in a larger bullish trend, back-ups and retracements are very possible if not encouraged as a means of confirming what seems to be a sustainable rally.

If you're looking for guidance, this is what we're telling consumers.

CURRENT GUIDANCE: It might seem like it's time to consider "The Wall" as being completely destroyed at this point. Yes, "The Wall" is indeed teetering in its most precarious position this year. Borrowing costs are certainly low enough to justify that, but the most important confirmation can only be granted by tomorrow's high-risk event: The Employment Situation Report. This is the sort of report than can either confirm the recent break lower in borrowing costs, or send them right back to other side of the fence. If that data confirms the slower than expected economic recovery message that has fueled the two-month bond market rally, new improvements will be much less tenuous. If not, we'd still expect the overall econ tone to remain somewhat weak, but we'd be defensive as short term back-ups are very possible. That assumes either that your time frame is limited or that rates won't recover from any set-backs on the horizon. Longer term and more flexible scenarios are still justified in floating.

Here is the outlook from Reuters...

(Reuters) - The nonfarm payrolls report is likely to show that U.S. employment cooled in May, confirming the economy's loss of momentum as it grapples with a raft of headwinds ranging from high energy prices and bad weather to supply chain disruptions from the earthquake in Japan. A weak stream of recent data suggests the economy remained mired in a soft patch early in the second quarter. That negative tone could be underscored by details of the closely monitored employment report. Net new private hiring is expected to have slowed to 175,000 last month after scaling a five-year high of 268,000 in April. The private sector has created about 2.1 million jobs since March 2010. With government employment expected to shrink for a seventh straight month because of budget problems at both the state and local level, overall nonfarm payrolls are expected to expand by 150,000 after growing by 244,000 in April, which was the most in 10 months. High gasoline prices hurt consumer spending in the first quarter, restricting economic growth to a 1.8 percent annual pace after a 3.1 percent expansion in the October-December period.

Based on our technical analysis, a back-up to higher yields wouldn't be surprising at all. Plan accordingly "just in case", the rest of the market did today.