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Treasury yields fell to a five week low yesterday.  Two weeks ago the street was “puking bonds,” reasonable bids virtually impossible to find and spreads between the bid and ask were gapping higher. In my view the economic environment is continuing to improve thus casting doubts to the sustainability of current yields.  I will continue to argue the bond market is illiquid a direct result of Dodd Frank and the proliferation of ETFs and HFTs.

Today is the release of the December BLS Employment report.  While some will debate the accuracy of this report, these statistics have the ability to greatly move markets.  Yesterday I referenced 1994.  I was a relatively newbie in the fixed income market and I vividly recall the March 1994 employment report issued on Good Friday.

Trading staffs were thinned because of the holiday and prices were obliterated by 5-6 points in a day.

What happens if the statistics are an upside surprise?  Will it make 1994 look like a picnic because of the lack of liquidity and the over influence of ETFs? I think yes, given the backdrop of the last five weeks and the relative lack of experience in fixed income trading staffs, professionals that have only witnessed a strong eight year bull market.

Analysts are expecting a 175k and 170k increase in nonfarm and private sector payrolls, a 4.7% unemployment rate, a 0.3% increase in average hourly earnings, a 34.4 work week and a 62.7% labor participation rate.

Commenting about potential inflation, oil rose yesterday about 1% following a WSJ report that the kingdom was reducing production and rising price to Asia as it had pledged in last month’s OPEC agreement.

Prices earlier declined on a rise in gasoline inventories even though crude stores fell more than expected.  Last year oil capped its biggest annual gain since 2009 and the first rise since 2013.  Will commodity demand pull inflation arise, the result of the lack of infrastructure spending and strong demand, a scenario envisioned by HSBC?

This is a belief that I have held for about 18 months, a scenario that is perhaps past the nascent stage given last year’s advance in crude.

The volatility in any oil related securities has been intense with many of energies’ debt obligations falling over 50% in the six months ending February 2016 and then rallying almost 100% since.  I will strenuously argue the volatility and the illiquidity in energy debt may be a harbinger of things to come in the rest of the bond market.  The six weeks following the election offers evidence to this view.

What will happen today?

Last night the foreign markets were down.  London was down 0.14%, Paris down 0.35%, and Frankfurt down 0.14%.  China was down 0.35%,Japan down 0.34% and Hang Sang up 0.21%.

The Dow should open flat but this could change radically given the potential significance of the 8:30 data.  The 10-year is unchanged at 2.35%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.