Long Treasury Bond Profile

Reflecting a continuing financial crisis and the sudden, breathtaking
descent of the economy into deep recession, Treasury yields across
the spectrum plummeted over H2 '08. Over a several week period
late last year, the 30 yr. yield dropped from 4.40% to 2.56% in a
panic flight to quality by investors.

Since then, the yield on the 30 yr. has backtracked up to 3.67%.
The short lead economic indicators have stabilized for the time
being, including sensitive materials prices, which bond traders
watch carefully. In addition there is the prospect of a large and
still growing stimulus program before the congress. Now at a cool
$900 bil., the program will surely add to Treasury new issue
volume.

At 3.67%, the 30 year carries a fat, roughly 350 bp premium to
the 3 mo. Bill, and a 366 bp premium to the 12 month inflation
rate. These are reasonable levels in the very short run as
confirmed by my long term regression pricing models.

Short term, the US economy has stabilized at a very low level.
My longer range economic indicators, which includes the now
steeply positive yield curve, suggest to me the US economy
should begin recovery by mid-year, fiscal plan notwithstanding.
At a minimum, I see a 5 month period of uncertainty ahead,
wherein the lead indicators could turn even lower, or morph
from stabilization into a more positive mode. Evidence that the
downturn in the economy will deepen further could easily send
the 30 yr Treas. yield back down toward the 2.50% level. But,
if indicators like sensitive material prices do not plunge and
begin to show signs of recovery as spring dawns, the yield on
the 30 yr will rise, perhaps to the 4.50 - 5.00% level. And that's
about the limit of my knowledge on the subject, at least for the
months ahead.

I have dwelled on the issue because the economy has invariably
responded positively to the kind of monetary stimulus that has
been applied. Ideas such as "liquidity trap" and "pushing on a
string" have proven chimerical when it comes to the US
economy. But, since short term indicators have yet to point to
recovery, I am stuck. Moreover, I just do not now know whether
liquidity preference, which been very strong, will continue in
unabated fashion or slacken some, allowing for recovery.

Two further points are worthy of note. Watch industrial
commodities prices over the price of oil. The bond market sees
a rising oil price as a tax on consumption and is more concerned
with a broad rise of sensitive materials prices. Secondly, if a large
stimulus plan is enacted, the market may begin pricing into yield
a premium for a bigger new issue calendar going forward. In
times past, that premium has been as much as 100 bp.

Back on Dec. 2, '08, I argued that the bond market, then 3.20%,
was strongly overbought and that advisory sentiment was too
bullish. In the next few weeks, sentiment grew to 91% bullish
and the market got even more overbought. We have had the
backlash in recent weeks as the 30 yr yield has shot up. The
overbought has been greatly reduced and sentiment (70 %
bullish) although high is not now acute. I have traded the
long bond for about 30 years. My suggestion is to watch the
sentiment indicators like MarketVane carefully and observe the
yield vs its 40 wk m/a. When it strays well away from the 40 wk.,
it does not do so for long. Yield chart here.