Leveling the Playing Field June 3, 2013 _______________________________________________________________________

True story. On Friday, Pensfords Charlotte office was visited by two vultures. They hung out on the window sill all day. I tried spooking them, pounding on the glass, throwing a ball at the glass, etc. They were utterly fearless. In fact, they even puffed up, spread out their wings, and pecked the window. At first, I assumed it was just a nasty omen for Pensford. Or maybe they are drawn to the homemade Eagles sign my kids made me for my birthday last yeareither way, Im nervous about the possible foreshadowing. (insert cheesy segue alert) But perhaps, just perhaps, the vultures are circling the bond market...oooooohhhh, see what I did there? Very clever, right? Long term bonds have been on a 30 year bull run, pushing yields near zero. Every client we have is primarily concerned about where 10 year rates may be in one to two years. The message we have stressed repeatedly is that generally speaking, the spike in long term fixed rates occurs at least three months prior to when you can reasonably expect them to spike. Theres a lot of very good reason to suspect we are going to see long term rates move higher in short order. Many casual observers are expecting a possible increase in early 2014, possibly tying out with the cessation of QE. In response, weve suggested that perhaps that means the actual run up will occur in the fall of this year. And that means it may occur three months prior to thatwhich is right about now. Some food for thought:

Yield curve steepness is generally measured by the difference between 2 year Treasurys and 10 year Treasurys. A few weeks ago prior to the recent selloff, the spread was below 1.50%. Today, this spread is 1.89%. Two years ago in the midst of the recession, the spread remained above 2.50% for almost twelve months. o This spread could widen by another 0.75% and be at comfortable levels. With the Fed keeping the front end of the curve anchored, the entirety of the 0.75% increase in steepness would have to come from a higher 10 year Treasury. As we wrote last week, we were testing the 2.11% resistance level. We spent the majority of the week over this threshold. With every passing moment that we dont see a retracement, we are more likely to shoot higher. Next technical level is 2.27% - 2.35%. Convexity selling comes into play. As rates move substantially one way or another, it impacts the likelihood of prepayment on home mortgages. As rates spike, prepayments (refinances) drop. This wreaks havoc on mortgage traders. If their trading book was neutral two weeks ago, the recent sell-off has effectively shifted them into a longer duration position (fewer prepayments extends duration). This move forces them to hedge their position. If lack of prepayments naturally shifts you into a longer position, you need to sell to get shorter. So they sell Treasurys. What happens to yields as every trading system on the street triggers selling to hedge books? Rates take off in leaps and bounds. o The next key convexity level? 2.25% on the 10 year Treasury. Swap spreads over the last few years have moved counter-directional to yields, meaning as rates moved higher, swap spreads tightened. This mitigated the impact of large moves. This trend appears to be ending. Spread movements have been positively correlated to yield movements, meaning as rates move higher, spread move higher, compounding the total move higher. o This is especially important for anyone considering a swap or a CMBS deal priced over swaps. Sovereign bonds around the globe are under selling pressure. Germany and Japan have experienced similar movements lately, so this isnt just a US phenomenon. From The Best Trader I Have Ever Known (TBTIHEK): In the medium to longer term I do think that sovereign rates are headed higher and concomitantly investment grade and high yield as well, as these are wildly over-owned both institutionally but also on an individual level. Stocks continue to move higher despite last weeks minor retracement. The dividend yield on the S&P exceeds the 10 year Treasury yield, which puts selling pressure on Treasurys (think portfolio managers). Supporting this position are some graphs I came across from a report written last week by Richard Gordon, one of my favorite fixed income strategists.

Delinquencies and foreclosures are down substantially

Real estate prices, notably residential, are stabilizing and improving

LIBOR Outlook Continues to remain anchored, but we do wonder how the Fed will have to amend its language should the UR approach 6.5%.

Fixed Rate Outlook See everything above.

This Week Markets are hyper-sensitive to data and Fed-speak right now. The most important data relates to jobs, and we get the next round of labor data on Friday (NFP and UR). Wednesdays ADP report will be used as a leading indicator for the real number on Friday, but the ADP has been proven to have little correlation to the actual NFP release a few days later. Consensus forecasts on Fridays NFP call for a gain of 165k jobs. Excepting Februarys absurd 322k gain, three out of the last four months have shown relatively disappointing gains. The three and six month average gains are still north of 200k, but barring another print with a 2-handle we will see these averages move lower.

The UR was 8.2% a year ago, so weve experienced considerable improvement, but much of this is attributable to a lower participation rate. While the consensus is for the UR to hold steady at 7.5%, we actually think there is more risk to a weak print. The UR improvement has dramatically outstripped NFP and GDP, so it feels like theres potential for a miss this week. This weeks Fed speakers all have been rattling the cages recently about tapering sooner rather than later. That means markets will likely have to digest more remarks about tapering to predict the language well see at the next FOMC meeting on June 19.

Generally, this material is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. Your receipt of this material does not create a client relationship with us and we are not acting as fiduciary or advisory capacity to you by providing the information herein. All market prices, data and other information are not warranted as to completeness or accuracy and are subject to change without notice. This material may contain information that is privileged, confidential, legally privileged, and/or exempt from disclosure under applicable law. Though the information herein may discuss certain legal and tax aspects of financial instruments, Pensford Financial Group, LLC does not provide legal or tax advice. The contents herein are the copyright material of Pensford Financial Group, LLC and shall not be copied, reproduced, or redistributed without the express written permission of Pensford Financial Group, LLC.

Economic Calendar
Economic Data Day Monday Time 10:00AM 10:00AM 10:00AM Tuesday 8:30AM 9:45AM 10:00AM Wednesday 7:00AM 8:15AM 10:00AM 10:00AM 2:00PM Thursday 8:30AM 8:30AM Friday 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 3:00PM Report Construction Spending (MoM) ISM Manufacturing ISM Prices Paid Trade Balance ISM New York IBD/TIPP Economic Optimism MBA Mortgage Applications ADP Employment Change Factory Orders ISM Non-manufacturing Composite US Federal Reserve releases Beige Book Initial Jobless Claims Continuing Claims Change in Nonfarm Payrolls Change in Private Payrolls Unemployment Rate Underemployment Rate (U6) Avg Weekly Hours All Employees Consumer Credit 34.5 $13.500B 346k 2973k 165k 175k 7.5% 354k 2986k 165k 176k 7.5% 13.9% 34.5 $7.966B 165k 1.5% 53.5 Forecast 0.9% 50.5 49.5 -$41.1B 55.0 50.0 Previous -1.7% 50.7 50.0 -$38.8B 58.3 45.1 -8.8% 119k -4.0% 53.1

Speeches and Events Day Monday Time 3:00AM 7:20AM Tuesday 1:30PM 8:00PM Wednesday Thursday 2:00PM 8:00AM Report Riksbank holds Conference on Inflation Targeting Fed's Williams speaks Fed's George speaks on Economy Fed's Fisher speaks on Monetary Policy US Federal Reserve releases Beige Book Fed's Plosser speaks on Economy Boston, MA Stockholm New Mexico Toronto Place

Treasury Auctions Day Time Report Size