US INTEREST RATES

The rally in Mar 10-year T-notes stalled as prices consolidate just below their recent 1-1/2 month high, which was an upward correction from December’s 5-3/4 month nearest-futures low. The 10-year T-note yield is in the middle of a 1-1/2 month range bounded by the recent 1-1/2 month low of 3.56% and December’s 7-3/4 month high of 3.91%. Bullish factors for T-note prices include (1) increased safe-haven demand for Treasuries after global stock markets slumped on fears that some European countries will face difficulty financing their budget deficits, (2) the statement from the Treasury in its quarterly refunding announcement that there is no need to increase current Treasury auction sizes to finance the country's budget deficit, and (3) a Financial Times report saying that Japan Financial Services Minister Kamei is urging  Japan Post Bank Co., the world’s largest holder of deposits, to diversify its investments into Treasuries and corporate bonds, which would increase demand for Treasuries. Bearish factors include (1) comments from St. Louis Fed President Bullard who said that the risk of deflation has passed and that the US economic recovery is “on track,” and (2) the unexpected increase in the Jan ISM manufacturing index to a 5-1/3 year high (+3.5 to 58.4 versus expectations of -0.3 to 55.6).

FOMC expectations—Market expectations for Fed policy were pushed back further for a tightening of monetary policy starting in Q4 of this year. The market expects a slow rise in the funds rate to 0.50% by Nov, to 1.00% by Apr 2011, and for the funds rate not to be increased to 2.00% until early 2012.

US STOCK INDEXES

The S&P 500 index tumbled to a 2-3/4 month low and extended its 3-week downward correction from last month’s 16-month high. That 16-month high was a 53% correction of the 2-year plunge from the record high in Oct 2007 to last March’s 13-year low. Bearish factors include (1) the unexpected increase in weekly initial US unemployment claims which rose to their highest level in 7 weeks, (2) carry-over weakness from the plunge in European bourses to 3-month lows on the sovereign debt concerns of Greece, Portugal and Spain, and (3) comments from Treasury Secretary Geithner who said that small US banks “remain under enormous pressure” along with his warning that mounting budget deficits “pose a corrosive threat to our economic future.” Bullish factors include (1) the larger-than-expected expansion of Q4 US GDP which rose at its fastest pace in 6 years (+5.7% annualized), and (2) limited wage inflation after the Q4 employment cost index rose +0.5% q/q and all of 2009 US labor costs rose only +1.5%, the smallest annual gain since records began in 1982, which is positive for earnings.

Earnings expectations for the S&P 500 are as follows, according to Thomson Financial: Q4-2009 (+206.3%), Q1-2010 (+38.6%), Q2-2010 (+23.5%), Q3-2010 (+23.4%), Q4-2010 (+26.7%). S&P 500 annual earnings are expected at -5.7% in 2009 and +26.9% in 2010 (2008 -23.9%, 2007 -3.7%, 2006 +16.1%, 2005 +13.7%, 2004 +20.2%, 2003 +18.4%, vs 25-year average of +8.6%). The S&P 500 forward   P/E (based on forward-looking earnings) is at 13.8, mildly below the 5-year average of 15.3.

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