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10-Year Note: World Economy Showing Improvement Pressures Interest Rates

by Dave Hightower on February 27, 2012

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The US Treasury market is showing signs that the next move outside of the 2012 congestion zone is down. The June 10-Year Note contract has spent the first two months of 2012 inside of a tight three point trading range, from 129-16 to a contract high of 132-05. The latest round of US economic data has shown continued improvement in the labor market, expanding US manufacturing activity and modest signs of inflation. With the European debt situation appearing to be on the mend, there is an increasing chance that the Treasury market will shift its focus towards improving growth expectations and higher levels of inflation.

The favorable trend to US economic data readings have continued in 2012 and has at times pressured prices on 10-Year Notes. While the June contract registered a new contract high on February 5th, much of the gains were fueled by flight-to-quality buying, as Greek and European leaders hammered out an arrangement for a second bailout. But with that out of the way and US economic data continuing to improve, the prospect for lower US Treasury prices is a growing probability. A recent example of this came following US initial jobless claims data on February 16th that showed new claims falling to a new four year low. Inflation pressures also appear to be cropping up, highlighted by the yield differential between 10-Year Notes and 10-Year TIPS. This spread relationship has climbed to its highest level since mid-August of 2.27%, and that shows the presence of inflationary expectations rising in the Treasury market. The January Consumer Price Index showed a monthly gain of 0.21%, largely attributed to a 0.9% gain in gasoline prices. Estimates provided by the EIA show US retail gasoline prices increasing by more than 10% in the first two months of the year.

A number of US Fed officials have talked recently about the risks of an artificially low US interest rate environment. Comments by St. Louis Fed President James Bullard in early February highlighted his concerns over the period of extremely low interest rates, suggesting that it could hurt the US economy in the long run. Dallas Fed President Richard Fisher adopted a similar tone, telling Wall Street not to expect QE3 or any further central bank participation. Fisher also noted that the US economy had improved since the Fed’s vow to keep US interest rates low out to 2014.

In one sense, the European debt debacle has helped the US Treasury with its active 2012 auction calendar. But there is a possibility that the market will demand higher interest rates for US debt as the global economic backdrop improves, and this could apply greater downside pressure on June 10-Year Notes. The market has struggled to gain any upside recently, despite concerns over European debt and the potential for a hard economic landing in China. While there is a chance for additional safe-haven support coming into the US Treasury market, we suggest looking to May options to position for a breakdown in prices.

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Commodity Outlook – 2012.02.13

by Dave Hightower on February 13, 2012

As of this writing the Dow Jones Industrial Average was clawing its way up to its highest levels since 2008. In addition to much better than expected US non-farm payroll figures for the month of January, the trade has continued to see consistent declines in weekly initial unemployment claims figures, and that in turn has added to the hope that job growth will continue. Progress in the US economy has at times become significant enough to temper expectations for additional quantitative measures. However, some Fed members (Evans in particular) have indicated that more easing is needed even if employment shows some signs of improvement. At times over the last month the Fed has seemingly alluded to the need for ongoing easing because of the potential knock-on slowing threat from Europe. We expect the direction of events in the Euro zone to continue to be very important to US Treasuries, US equities and a host of other commodity markets.

Unfortunately for the bull camp, many markets had already purchased a large portion of the expectations of a Greek debt deal, and now it could be time for the markets to turn their focus to the next biggest threat to the EU. However, we continue to think the ECB, IMF and other interested parties have already moved to significantly shore up the financial backstop and that an ongoing flow of growth from the US could serve to deflate negative speculation in the Euro zone. As we have indicated before, we think the Euro zone debt crisis will drift out of the spotlight instead of ending dramatically with a disorderly default or under some grand plan.

Over the last five weeks a number of physical commodities seem to have outperformed their fundamentals, and many of these markets are giving off the impression that they are rallying without clear evidence of renewed growth in China and the Euro zone. We do think that many markets have become short term overbought off the combination of a declining dollar and speculation that Greece is going to get a deal in place. Therefore, traders need to be on the lookout for corrective action. However, traders and investors should not discount the importance of consumer confidence and sentiment. Last year saw more than its share of adversity, and we could be entering a period when relative calm on the political and economic fronts could allow for continued gains in equities, precious metals and livestock.

In looking at the chart of Consumer Confidence since the beginning of 2009, it is clear that sentiment is climbing back from the very low levels registered in the wake of the sub-prime debacle. Without a repeat of a Fukushima-like natural disaster, the US deficit disaster and incendiary breakdowns in the Middle East in the weeks ahead, one should see economic prospects continue to improve. The magnitude of the decline in consumer confidence in 2011 probably served to hold back the economy more than anyone realized, and yet the US economy still clawed through with forward motion! In this day and age it is a tough call to predict social and economic calm, but recent gains in stocks would seem to confirm that clouds are dissipating.

If the markets manage to avoid a buy-the-rumor/sell-the-fact reaction off a Greek debt deal, we suspect that many physical commodity prices might be poised to run up into and peak shortly after an anticipated much-improved Consumer Confidence reading, due to be released on February 28th.

Cattle: Supply Continues to Tighten

by Terry Roggensack on February 13, 2012

The cattle market’s supply fundamentals continue to tighten, and traders see the smallest increase in production from the first quarter to the second quarter in the past 12 years for 2012. This could lead prices sharply higher into the spring “if” there is not too much consumer resistance. Per capita supply this year is expected to be down 5% from last year. The USDA January Inventory Report was not a big surprise, but it did confirm the smallest inventory in 60 years. The report looked slightly supportive, as the beef herd was a little below expectations. In addition, the number of heifers weighing 500 pounds and over came in at 101% of last year. Traders were looking for 98.5%. This means fewer females available for feedlot placements into the spring, and that could help support the deferred contacts. If there is a shift to begin to expand the US herd, the near-term supply of cattle will tighten further, as there will be fewer heifers available to move to feedlots.

In order to see an expansionary move by the industry, however, it will be important to see an easing of the drought conditions in Texas and Oklahoma in the months just ahead. As of this writing, the extended forecast models were predicting relief from the drought. Traders will need to monitor this situation into the spring. Also in the Inventory Report, feeder cattle supply outside of feedlots came in down 4% from last year. Total cattle and calves as of January 1st came in at 90.769 million head, which was 97.9% of last year. The calf crop was 35.313 million head, 98.9% of last year. Nearby feeder cattle futures hit all-time highs on February 1st.

Poor packer margins and talk of weaker demand from packers for live inventory as they cut back on slaughter has kept the short-term cash fundamental news sloppy. Tightening supply is seen as a positive force for cash markets, but beef prices have lagged, and this has driven packer margins deep into the red.

The long period of very negative profit margins for packers and sluggish beef prices, even with a slowdown in the slaughter pace, were factors that helped spark negative price action into February 6th. With the market’s overbought technical condition, there could be follow-through selling, but with a more positive tilt to the outside market forces, an expanding US economy, improving employment data and expectations for a tightening cattle supply, the cattle market may continue to attract buying interest from fund traders. The Commitments of Traders reports as of January 31st showed non-commercial traders buying were net long 85,643 contracts, an increase of 7,221 for the week. This buying trend is a short-term plus. In the past, non-commercial traders have held a net long of as high as 144,200 contracts.

Beef demand tends to be its strongest in the spring, and beef production typically increases by 250-300 million pounds from the first quarter to the second quarter. The USDA shows an increase of just 135 million between the first and second quarters this year, the smallest of the last 12 years. If the cattle expansion phase kicks in, production could be even lower. Exports are becoming more important to the market, and demand looks favorable ahead. If beef prices turn higher over the near term, the market will be in a position to attract further buying support from fund traders. Look for an eventual test of the 140 level into the late spring.

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Commodity Outlook – 2012.01.23

by Dave Hightower on January 21, 2012

From a physical commodity market perspective, it might not take much forward movement in the global economy to see many commodity prices rally in 2012. We would suggest that commodity markets in general have already seen a healthy liquidation of speculative long positions (as can be seen in a chart of the composite non-commercial and nonreportable net long positions for non-financial commodities). Therefore, we think that the risk to longs in markets like silver, copper, platinum, rice, cocoa, natural gas, and soybean meal might be somewhat limited in the months ahead.

Traders should not underestimate how important China is to several physical commodity markets. In addition to their possible shift to an easier monetary policy stance, China will also have a noted impact on commodity markets that receive fresh demand from restocking efforts. Those include corn, soybeans, sugar, cotton, copper and pork. In the near term, the best leading indicator for many commodities might be the action in the Shanghai stock market, which appears to have managed a bottom with the action in early January. If the equity market action isn’t convincing enough to declare a turn up in the Chinese economy, one might simply look back to China’s four record monthly coal import readings over the last year as evidence that their economy has retained its capacity for forward motion.

So far, 2012 has seen a better than expected chain of events than might have been expected at the end of 2011, as Euro zone fears have tempered slightly, there have been indications that China could be in the process of shifting away from a tightening stance, and US economic activity has continued to give off signs of forward progress. Certainly the floating of surging European debt will be a long, drawn out affair that could at any time serve to yank the rug out from under the markets, but so far the take-down of their debt has gone favorably. It is possible that the markets are starting to settle on the idea that Greece might be allowed to fail and in turn be forced from the EU. While that event will most certainly foster significant volatility, it could end up being the de facto end of the Euro crisis. On the other hand, with even a moderate improvement in macroeconomic conditions in the Euro zone, it could become increasingly more difficult to spark full-blown anxiety events, and that more than anything could speed the crisis toward a favorable outcome. Recent suggestions from the US Fed seem to indicate that the US will remain supportive of the global economy, even in the face of improvement in the job market and, more surprisingly, even in the face of an increase in near term inflationary pressures. In other words, some members of the US Fed are acknowledging the severity of the Euro zone crisis, and they are apparently willing to increase the risk of inflation pressures in the US in order to facilitate a return to global stability.
From a physical commodity market perspective, it might not take much forward movement in the global economy to see many commodity prices rally in 2012. We would suggest that commodity markets in general have already seen a healthy liquidation of speculative long positions (as can be seen in a chart of the composite non-commercial and nonreportable net long positions for non-financial commodities). Therefore, we think that the risk to longs in markets like silver, copper, platinum, rice, cocoa, natural gas, and soybean meal might be somewhat limited in the months ahead.
Traders should not underestimate how important China is to several physical commodity markets. In addition to their possible shift to an easier monetary policy stance, China will also have a noted impact on commodity markets that receive fresh demand from restocking efforts. Those include corn, soybeans, sugar, cotton, copper and pork. In the near term, the best leading indicator for many commodities might be the action in the Shanghai stock market, which appears to have managed a bottom with the action in early January. If the equity market action isn’t convincing enough to declare a turn up in the Chinese economy, one might simply look back to China’s four record monthly coal import readings over the last year as evidence that their economy has retained its capacity for forward motion.

Interest Rates: Due for a Pullback?

by Dave Hightower on January 21, 2012

While March 30-Year Bond prices climbed to a new 4-week high recently, we feel they are richly priced and vulnerable to a temporary setback. The recent trend of US economic data has shown continued improvement, suggesting that the US recovery could be gaining some momentum. While the US Treasury market will continue to ebb and flow with developments surrounding the European debt debacle, it is possible that the worst of that situation has already been priced into the market. So far in 2012, European debt auctions have gone generally better than expected, and that has helped to thaw short term lending markets in the region. Also, interest rates yields in Italy and Spain have eased from their recent extremes. Those governments have come to the market with new issuance, but so far the market doesn’t appear to be extracting a high cost for their borrowings. One of the market’s primary fears became a reality back on Friday January 13th when Standard and Poor’s downgraded credit ratings on eight European countries, but even that didn’t seem to prompt a typical anxiety event. While that negative headlines generated some safety bids and in turn served to push March Notes above their December highs, March bonds were not able to take out their December highs. Europe’s ability to successfully tap the capital markets could extract some of the fear premium out of the US Treasury market in the coming weeks.

The recent trend of US economic data has provided some hope that the US recovery will begin to stand on its own. The US labor market saw continuing jobless claims fall precipitously from their June 2009 peak of 6.398 million to the lowest level in 13 quarters at 3.657 million as of December 10th. More recently, US June Consumer Confidence climbed to its best level in eight months to 64.5 in December, and manufacturing activity has shown signs of leaving its 2011 summer trough. Additionally, the US housing market has also shown signs of improvement, evidenced by a surge in building permits and construction spending and US housing starts reaching 685,000 in November, their highest level since April 2010. Meanwhile, inflation is beginning to increase, with the December Producer Price Index (excluding food and energy) coming in at an annualized rate of 3.0%, the highest level since June 2009. Coincidentally, there has been a growing chorus of Fed officials that are leaning toward a pro-inflationary stance, as indicated by the continued commitment to extremely low interest rates even in the face of modest inflationary pressures.

While the latest string of US Treasury auctions showed very active participation at extremely low interest rates, there is growing competition from other nations (particularly the Euro zone) as well as from the private sector seeking capital. This could present a challenge in the weeks ahead. If the situation in Europe shows any sign of progress, that could help drive up rates on US Treasuries as they try to attract demand.

March Bonds have traded within a trading of 146-12 to 134-22 over the past four months. The market’s inability to rally to new highs in the wake of the latest European debt downgrade and in the face of recent promises of more easy monetary policy from the US Fed suggests that prices are a bit rich at 145-00.

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Special Report: Corn Volatility Alert!

by Terry Roggensack on January 11, 2012

Below is an excerpt from The Hightower Report’s most recent Special Report. To receive access to this report, with trade strategies, and our daily coverage of 16 markets, visit futures-research.com for your free 2 week trial!

Wide ranges of estimates for ending stocks and production for the upcoming USDA reports and continued weather uncertainties for late January and early February leaves the corn market in a potentially volatile trade setup into and beyond the Thursday, January 12th report window.
In January every year, the USDA Supply/Demand, Crop Production and Quarterly Grains Stocks reports are released on the same day, and for the last five years, the corn market has made limit moves on each of those days. In 2011, the market hit the 30 cent limit-up move and closed 24 higher on the day. In 2009 and 2010, the market closed down the 30 cent limit. In 2007 and 2008, the market closed up the 20 cent limit. With the wide range of estimates this year, prices look very volatile for later this week.

On top of that, extremely high temperatures after weeks of below normal precipitation has producers in Argentina nervous over the possibility that the crop had already experienced an extreme loss in yield ahead of significant rains that are due to start today. Most growing areas were well above 100 degrees over the weekend into Monday ahead of the rain, and losses are mounting. The expected lack of a shift in the weather pattern in spite of a good rain event this week leaves the market vulnerable to significant upside potential if the soils dry up again into late this month. Traders are concerned that after receiving 1/2 to 1 1/2 inches of rain this week, crops will be back into a stressful condition in another week. Temperatures are expected to move higher into the coming weekend, and there currently is no other organized rain event in the forecast.

Traders expect corn production in the US to be revised lower by about 45 million bushels for the USDA production report on Thursday morning, due to a revision lower in yield or even harvested acreage. However, there is a 210 million bushel range for the report. US Ending stocks are expected to be revised down by about 100 million bushels in Thursday’s report from the 848 million that was estimated in December. However, there is a 433 million bushel range of estimates. Traders are looking for December 1st corn stocks to be down about 660 million bushels from the previous year. Stocks last year were 10.057 billion bushels. However, there is a 500 million bushel range of estimates for that number.

Global ending stocks for the 2011/12 season are expected to be around 123.5 million tonnes, down from 127.1 million estimated last month. However, with the damage done to the South American crop since January 1st, many traders see the ending stocks eventually falling well under 120 million. If we assume an ending estimate of 119 million, world ending stocks would fall to a 50-day supply, the lowest since 1973. This compares to 56 days last year and 64 days two years ago.

Some traders are looking for lower yield, lower harvested acreage, higher feed usage, better ethanol demand and higher exports due to the sharp drop in Argentina production. This could spark extreme tightness in the old crop ending stocks for the US and the world. However, with higher plantings and normal yield this coming season, traders are expecting a lesstight situation for 2012/13. And while we debate “how tight” U.S. and world ending stocks will be if we lose 8-12 million tonnes of corn in South America, a minor jump in US planted area and a 164 bushel per acre yield for the 2012 crop would result in an increase in US production of about 50 million tonnes.

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Special Report: Fourth Quarter Petroleum Update

by Dave Hightower on November 29, 2011

The recent rise in nearby crude oil prices above $103 didn’t seem to elicit many complaints of excess speculation in the energy markets. Perhaps this was because the move was not accompanied by an increase in speculator net long positions. Regardless, this rally seems to confirm that supply and demand conditions in the market have tightened, even in the face of a possible recession. In other words, the world threw a recession party and the energy complex failed to show up.

Crude oil prices recently topped out a two-month rally on reports that the flow of crude oil from the Seaway pipeline would be shifting directions. Where previously it had flowed north from the Gulf Coast to Cushing, Oklahoma, it was announced that it would now flow from Cushing to the Gulf Coast. This is expected to alleviate the glut of supply at Cushing and ease tightness at the Gulf Coast, where refiners had been using Brent crude and others as feedstocks. This move has had a major impact on the Brent/WTI spreads. Tight North Sea supplies were one of the key factors that sent Brent’s premium to WTI to a record wide level of $28.00 in October. As conditions changed by mid-November, that spread fell below $6.00. While part of the decline in the premium of Brent relative to West Texas Intermediate was aggressive unwinding out of long Brent/short WTI positions, it was also pressured by the flow change in the Seaway pipeline.

This is widely seen as a force that will draw demand back to WTI crude oil and eventually chew down one of the world’s largest supply caches at Cushing and thereby lift WTI prices relative to Brent.

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Commodity Outlook – 2011.10.24

by Dave Hightower on October 22, 2011

The most positive thing that can be said about the global economy is that some sectors have managed to hold up against the deterioration that was seen for most of the last 4 months. Clearly the Euro zone debt crisis has been and continues to be the primary cloud hanging over consumer and investor sentiment. One only needs to look back to the negative reactions in consumer confidence to the Fukushima incident and the August US debt debate to understand that the current debt event has the potential to be a very important junction. While the US debt situation remains unsolved, the markets can be expected to trade primarily off the ebb and flow of the Euro zone crisis. In other words, internal fundamental factors are likely to take a back seat to headlines and big picture macroeconomic influences.

Since the outcome of the October 23rd EU meeting (after this writing) looks to be the dominating influence for a large portion of this week’s trade, one might expect a rather significant expansion of volatility. At stake is the latest loan of 8 billion Euros, which is only a small portion of the 350 billion Euros that Greece owes the World Bank, the EU and a long list of European banks. While the trade as of this writing was assuming something in the range of 2 trillion Euros for the EFSF, a more troublesome concern is that ratings agencies have already begun another round of sovereign debt downgrades, with Spain, France and Italy under increased scrutiny.

While recent history suggests that another “plan” won’t fully end the Euro zone debt crisis, it is possible that a euphoria window might be presented and that many markets might see an extension of the relief rallies that have already been engineered from the September and October lows. Those that are skeptical of a final and sustainable Euro zone fix (with good reason) might consider buying near to expiration, near to the money call options and buying longer dated, further out of the money put options, particularly in those physical commodity markets that are heavily tied to the recession/no recession theme.

For flight-to-quality markets or markets that could come under pressure temporarily in the wake of a favorable EFSF funding announcement from the October 22-23 time frame, one should consider buying near to the money, near to expiration puts and buying further out of the money, longer time duration calls.

From a big picture perspective, the recent slide in many commodity prices should eventually be seen as a big value play, but even if the Euro zone situation is put to rest, the markets still need to see the US come to terms with its unfulfilled promise to reduce its budget by just over 2 trillion dollars. In looking at a chart of the speculator net long position in non-financial commodities, one can see that nearly two-thirds of the peak position has already been eliminated. Another sharp slide in prices could mean that commodities will have once factor in a return to recession or worse.

In retrospect, the 4th quarter of 2011 is likely to be known as the “2 trillion” period, as the Euro zone needs 2 trillion Euros just to kick the can down the road and the US needs to reduce spending by at least two trillion to live to fight another day. In classic economic terms, the US economy continues to hold together, with a decent payroll report for September on the books, auto sales staying firm and real estate managing to avoid further deterioration. More importantly, weekly initial jobless claims figures remain close to a downside breakout (see chart), and it is possible that a period of optimism from the Euro zone could pave the way for a slight recovery in the economy and a measure of calm ahead. While it is not too late to avoid a US recession, consumer and investor sentiment will be threatened over the coming five weeks if political leaders are unable to remove the uncertainty that breeds anxiety.

Coffee: Look for the Downtrend to Resume

by Terry Roggensack on October 22, 2011

The luster has come off of the coffee bull market in recent months and rightfully so. The market pushed to a 15 year high earlier this year, as deliverable stocks tightened ahead of the Brazilian harvest due to the slow recovery in Colombian production and hiccups at other key Arabica-producing countries. Brazil is currently going through a flowering period for the 2012/13 season, and if their weather is normal over the next 3-4 weeks, they could be setting up for an all-time bumper crop. Traders will also be anticipating a large Vietnamese harvest in November, and with the main crop for Colombia harvest this quarter, end users will have little urgency to extend their coverage. If no big weather issue develops soon, look for a resumption of the downtrend. While the daily charts appear a bit oversold and the market is looking somewhat cheap after the sharp break from the May highs, keep in mind that a 50% correction of the December 2008 to May 2011 rally comes at 203.95 for nearby futures.

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Oil: A Bottom May Be In Place; 4th Quarter Rally?

by Research on October 21, 2011

We think that crude oil could be putting in a significant bottom in the wake of the nearly 35% downdraft from the May high. Economic data appears to be stabilizing, suggesting that the early October low was too aggressive in pricing in a slowdown. We would like to take advantage of potential volatility surrounding the European debt crisis/resolution to position for an extended fourth quarter rally.

The crude oil market has faced a number of negative headwinds during the August-October break that were highly correlated to developments out of Europe. Into the third week of October, the EU debt debacle seemed to be closing in on a near term resolution. Due to the tight “risk-on” and “risk-off” link between other assets and crude oil, a favorable result at the October 23rd EU Summit is likely to lift crude oil prices above their 2 « month trading range. However, there is also the possibility that a disappointing result from the EU Summit could weigh on risk assets. What to do?

The global oil supply and demand balance points to a small deficit in the fourth quarter of 2011. October monthly reports from the IEA and OPEC pegged oil demand growth at around 1.0% for 2011 and 1.5% for 2012. The EIA was a bit more optimistic, calling for 2011 demand growth at 1.5%, increasing to 1.6% in 2012. An average estimate among the agencies called for overall 2011 global oil demand to come in at 88.48 million barrels per day, slightly outpacing production by 0.01%. The IEA’s 60 million-barrel release from strategic reserves worked through the system and helped generate a flat balance sheet in the third quarter of 2011. Using the above growth estimates and assuming a modest, 1.25% increase in OPEC production, the world oil balance would likely to show a small, 250,000 barrel-per-day deficit during the fourth-quarter. For comparison, there was a 110,000 barrel-per-day deficit in the first quarter of 2011 that saw WTI crude oil prices average $100.65 and a 500,000 barrel-per-day deficit in the second quarter that came with an average price of $104.21.

Crude oil built a large base of support during its August through mid-October consolidation between $75.00 and $90.00. In the meantime, prices have closed above downtrend channel resistance drawn from the May high, suggesting a turn higher. Meanwhile, after the 18.7% rally in the first half of October, the market has become short term overbought and is hinting at a near term correction. While there’s potential for a decline in December crude oil back toward $82.42 (a 50% retracement), the longer-term prospects target a decline back towards $96.90. For this reason, we recommend buying a December put to play for a shorter term decline and buying a January call to profit from a longer term advance.

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