BOND MODEL COMMENTARY FOR APRIL 9, 2007

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1 BOND MODEL COMMENTARY FOR APRIL 9, 2007 Charts and technical commentary by David Chapman Union Securities Ltd, 33 Yonge Street, Suite 901, Toronto, Ontario, M5E 1G4 fax (416) , (416) , phone (toll free) U.S. GOVERNMENT BONDS BUY U.S. BONDS US Treasury bonds are not going to get any reprieve. They had already fallen on the week when Friday s employment numbers came out, and what the bonds got was a slap across the face. Nonfarm payrolls unexpectedly rose 180,000 when all the market was looking for was 120,000 gain (although some economists had it as high as 150,000). The unemployment rate fell to 4.4 per cent from 4.6 per cent and that matches the five-year low. The average work week rose slightly to 33.9 hours from 33.8 and hourly earnings rose as expected by 0.3 per cent. US Treasuries (which were open for the Good Friday holiday) fell immediately to their lowest prices (highest yields) in weeks. The 10-year bonds that had already jumped to 4.68 per cent by Thursday rose another five basis points to 4.73 per cent following the higher than expected numbers. The employment numbers seemed on the surface to put a lie to the story that the economy was sliding because of the housing slump. Indeed some of the unexpected gains were a hiring back of construction jobs lost earlier as warmer weather did encourage some new construction. It also eliminates for good any talk of the Fed cutting rates because of the housing slump. But it means further bad news for those holding the billions of dollars worth of mortgages that are to be reset higher this year. Many of them were taken out only in the past couple of years, at ludicrously low rates to encourage housing purchases. Now they are about to leap to reality. The prior month s non-farm payroll was also revised upward to 113,000 from the previously announced 97,000. Many of these jobs are in the service sector (merchandise and food services), Bond Models, April 9, 2007 page 1 of 5

2 particularly the lower wage variety, but the larger than expected number was still a surprise. Manufacturing continued to lose jobs but health services did pick 30,000 new workers. The US dollar naturally responded positively, rising about a third of a point. With other markets closed for Easter, it is difficult to say how they will respond to this number although stock futures in Asia did rise. Gold may sell off while the stock market goes up, but we will have to wait until Monday to find out. It was odd that we received such a good employment number on Friday, because other numbers reported during the week were generally weaker than expected. The ISM Index was 50.9 versus the expected 52.5; auto sales, particularly for the domestic producers, were generally weak; factory orders were up 1.0 per cent when the expectation was 1.8 per cent; and the initial claims on Thursday, often a shorter-term view into the employment numbers, rose to 321,000 from 310,000 higher than the expected 315,000. When we looked at the Commitment of Traders report (COT) for commercials we noted that they rose in the latest reporting period to 57 per cent from 55. The large speculators fell to 32 per cent from 36 per cent. So what we are seeing here is the commercials (banks, dealers, etc) becoming more bullish as the large speculators (hedge funds, etc) are becoming more bearish. The commercials are often right at tops and bottoms. The rise in itself does not imply a top in yields (bottom in prices), but then this number came in before the non-farm payroll of April 6. Bond Models, April 9, 2007 page 2 of 5

3 Technically we are near the place for a rebound. The chart shows how Treasury bond futures closed on the support of the 40-week moving average, and the rise (yields), fall (prices) after the numbers would probably put it closer to the up trend line coming from the June 2006 lows. So it is possible to find a temporary bottom here. If we break the support of the up trend below 110^10 then we would fall to the awkward-looking neckline of a possible head and shoulders topping pattern. That level is currently near 108^24. We say it is awkward looking as necklines usually point upward for topping patterns and the right shoulder does not exceed the left shoulder as it did (barely) this time around. So it is possible, it is not? We note it because we have seen these patterns before, and they have acted just like a head and shoulders pattern when they broke the neckline. More traditional is the huge pattern seen over the past four years that also has the look of a huge head and shoulders top. That neckline is near 106^08 and projects down to around 90 if it is real. Obviously we don t know whether it is, but it has grave implications if it is. Given the support zones we are now falling into, it would not surprise us if we received a slight rebound this coming week. After all, we would otherwise be down five weeks in a row. A further fall, however, could send us plummeting through the support zones we noted above. We also suspect that a drop this coming week would (finally) give us a stand aside signal on the buy we received about six weeks ago. Given the precipitous decline since then, a stand aside signal will be a relief. Only regaining back above 112 in the coming week could change this scenario. We don t expect that. The unexpected employment number raises some thoughts that maybe the Fed will hike rather than hold now, considering there remain inflationary pressures. We doubt that, because the Fed still has concerns about the housing market. But the real losers here are going to be the thousands of homeowners who discover that their monthly mortgage payments are about to get a lot bigger. Bond Models, April 9, 2007 page 3 of 5

4 CANADIAN GOVERNMENT BONDS BUY CANADIAN BONDS No joy here either, as we fell almost a full point in the past week. Still not enough to give us a stand aside signal, but given that we have broken an up trend line and that indicators are turning down very bearishly, a stand aside signal for Canadian bonds is just a matter of time. The Canadian economy continues to grow. Last month 55,000 new jobs were pumped out and the unemployment rate was left at 6.1 per cent as the number of new entrants offset those who found jobs. The participation rate of 67.7 per cent and the employment rate of 63.5 per cent have risen to the highest levels in a generation. The Canadian employment market is tightening. Many may be working but keep in mind that many of these jobs are not of the high-paying variety. So it is like good news and bad news. As a result of the job growth, inflation is up to 2.4 per cent higher than the Bank of Canada s target of 2.2 per cent. So will the BofC tighten? We doubt it, but that doesn t mean that there will not be pressure on Canadian bonds. The Canadian dollar is still rising of late against the US$ (up another one-fifth of a cent this past week). That is both good news (a strengthening currency is a sign of a healthy economy) and bad Bond Models, April 9, 2007 page 4 of 5

5 news (numerous exporters were not prepared for the rise and are being squeezed; as a result, exports are being squeezed). So while overall we have to be pleased with the performance of the Canadian economy, the bond market is selling off and that is a negative. These numbers, coupled with the US bonds falling as noted above, adds to the potential bearishness. We have broken down below a support up trend line and indicators are turning down very bearishly. We don t yet have our stand aside signal but we wouldn t really want to be caught in long-term bonds right now. Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data. Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union s own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material, are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K. Bond Models, April 9, 2007 page 5 of 5