The day turned out to be a decent one for rates with the 10-year Treasury closing -.031% with the yield at 5.070%.

The bond market was driven by the Durable Goods Orders. Orders for big ticket items like washing machines to Boeing 747s were anticipated to be 0.0% to -2.0%; Only one source was guessing the -2.0%, and only one was looking for 0.0%, the rest anticipated -0.8% to -1.5%. The real number was far lower than last month’s +0.8%. The commerce department reproted the orders at -2.8%.

That drove the bond’s price up at the opening. The yield – which always moves in the opposite direction from price – opened at 5.053%, which was -.048% than Tuesday’s close.
Bond rates moved to their low of the day twice in the first hour of trading. The low for the day was 5.028%, moving the rate -.073% lower than Tuesday.

TOMORROW 28 JUNE 2007.

The yield on Wednesday reversed some in the last hour of trading. No doubt traders soon remembered that the FOMC makes its announcement on short-term interest rates. There is little expectation that the FED will make any changes in the Fed-Funds rate. The important part of the announcement is in the Policy Statement. The Policy Statement is little more than a summary of what the governors discussed at their meeting.
It is read very closely by analysts to try and guess the future for short-term rates. The simple placement of a coma can gain or lose billions of dollars. The FOMC will be very careful to not paint too optimistic a picture for lower rates. That happened recently and caused wild fluctuations in the bond and equity markets.

MID-TERM OUTLOOK [27 June 2007]

There are a few bright and dark spots for rates for the next few months.

First, the good news. But remember, good news for rates often means bad news for the economy.

A.) On 26 June the Consumer Confidence was slightly below expectations. This could give us strong indication for the mid-term direction of rates. Analysts were looking for 105.0 to 106.0. The Conference Board released the number at 103.9.

Lynn Franco, Director of The Conference Board Consumer Research Center said, "A perceived softening in present-day business and employment conditions are the major reasons behind this month's pull-back in confidence. In fact, the Present Situation Index now stands at levels not seen since the final quarter of last year. Looking ahead, consumers remain rather subdued about short-term economic prospects. All in all, the glass remains half empty and half full."

Consumers' appraisal of present-day conditions was less upbeat in June. Those claiming conditions are "good" declined to 27.4 percent from 29.0 percent. Those saying conditions are "bad" increased to 16.4 percent from 14.6 percent. Consumers were also less positive about the job market.

B.)The softness in consumer sentiment may be what has driven the decline in both the Redbook and UBS store Sales in the last few weeks. To date, the decline in both of these weekly numbers have not affected the more important Retail Sales Report.  They may soon and that would be a plus for interest rates.

On the negative side:

1.) Investor sentiment leans towards higher rates. The bond market has been in a selling mood since 10 May 2007

A few months back this blog wrote that the bond market seemed to be looking for any excuse to buy bonds and thus drive rates lower. That trend has reversed itself. The bond market is now looking for any reason to sell, and correspondingly raise rates.

On 31 May 2007 there was one such example. There were six items published that day. Even though most of the economic items came in as expected, three did not. Of the three, two were lower than expected and should have moved rates lower. Instead rates continued their upward trend. Clearly, investor sentiment has turned bearish on buying bonds.

Investors are becoming bearish and are starting to realize that inflation exists. They are starting to see that the FED is more determined fight inflation. More and more FED officials are making hawkish comments.

2) The housing bubble has ‘burst’. Will housing continue to decline? Is it flattening? Or, is it on the verge of a rebound? The data over the last few months has been a resounding maybe to all three.

IF homeowners start to see a rebound in housing their confidence will increase. As confidence increases, so will spending. Economic growth is moderate now with problematic inflation. Strong growth could renew strong inflation.

The slide in Real estate has not yet seemed to affect retail sales or consumer confidence. Inflation hawks can’t win for losing.

On 08 May 2007 the bond market responded to an unscheduled announcement by the National Association of Realtors (NAR). The NAR reduced its sales forecasts for 2007 and 2008, predicting that stricter lending standards would limit home buying. That only makes sense as stricter guidelines reduce the number of buyers able to get a mortgage. Given the current oversupply of houses, verses the very number of buyers we have a buyers market now as it is. Reducing the number of buyers hits the real estate market with a double whammy.

Sales of existing homes will probably fall about 3% this year to 6.29 million from 6.48 million in 2006. Sales of new homes are projected to fall about 18% to 864,000, compared with a 14% drop predicted last month. Housing starts are expected to drop 19% to 1.46 million.

When there are signs of housing market weakness it helps the price of bonds. Since it is a sing of a slowing economy it instills safe-haven interest.

3) The US and the global economy appear to in recovery. This has to be the shortest, least felt ‘recession ever experienced. (The 2.2% main stream media aside, there never was a recession; GDP never went below 0.0 %.)

A major part of the growing global economy is China. On 12 June, the Chinese consumer price index for May was +3.4% in year-to-year analysis, according to data published by the [Chinese] National Bureau of Statistics. Most of the gains were due to food prices, and haven't spread to a broad range of consumer goods. What we would call Chinese core-CPI was +1.0%. China’s food prices jumped 8.3% from a year ago.

Even though Chinese core-CPI was low, the headline inflation rate is now higher than the interest rate banks pay on deposits, currently set at 3.06% for one year. That gives Chinese consumers a big incentive to spend or invest that money rather than let it sit in the bank.

Further, and of great Long-Term bearing on US interest rates – is how this will diminish demand for US Treasuries. When demand for any commodity decreases, the price also declines. When bond prices deteriorate as they have, rates go up.

4) In February this blog wrote:

“We have one great inflation fear in the mid-term; corn prices. With all the talk of alternate fuel and ethanol, corn futures have nearly doubled. Corn is a staple of many food products that we eat. Increases in corn prices will not just impact corn flakes, but pop/soda, beef, and pig, chicken, candy bars, just about anything we eat.”

Grain stockpiles in many countries have fallen to multiyear lows, even as increased production of biofuels such as ethanol has added a new source of demand.

Even the best estimates of corn based fuel say that it will never replace the need for fossil fuels. At best it can only reduce the demand some. It would be much better for us to reduce our demand on foreign oil and decrease the price at the pump by; 1.) Drilling where we know that there is oil, 2.) Build refineries, 3.) Eat food as food.

Steve Boxmeyer [612] 799 – 6858
steve@LendWithIntegrity.com