US INTEREST RATES

Jun 10-year T-notes prices are near the middle of a 10-month 7+ point range. The 10-year T-note yield is trading within a 37 bp range, bounded by the February 3-month low of 3.54% and December’s 9-month high of 3.91%. Bullish factors for T-note prices include (1) slack inflation pressures after the Feb core CPI increased at its smallest pace in 6 years (+1.3% y/y versus expectations of +1.4% y/y, (2) the Fed’s post FOMC statement that said interest rates will remain “exceptionally low” for an “extended period,” (3) the unexpected decline in the Mar NAHB housing market index to an 11-month low (-2 to 15 versus expectations of unchanged at 17), and (4) the prediction from BNP Paribas that the Fed will "stay on hold for a lot longer than the market is expecting" as the struggle to recover from recession will keep inflation absent from the US economy for years. Bearish factors include (1) weakened foreign demand for Treasuries after total foreign purchases of Treasury notes and bonds fell -12% m/m in Jan to $61.4 billion after China and Japan, the two biggest holders of US debt, reduced their holdings, and (2) a decrease in the safe-haven demand for Treasuries after the S&P 500 Index rose to a 17-1/2 month high, along with S&P’s action to remove Greece from its “credit watch negative” list.

FOMC expectations—Market expectations for Fed policy over the past week were unchanged for a tightening of monetary policy starting near the end of this year. The market expects a slow rise in the funds rate to 0.50% by December, to 1.00% by May 2011, and to 2.00% by Feb 2012.

US STOCK INDEXES

 The S&P 500 index continued its year-long rally up to a 17-1/2 month high. That 17-1/2 month high was a 55% correction of the 2-year plunge from the record high in Oct 2007 to last March’s 13-year low. Bullish factors include (1) continued evidence that the economic recovery has yet to stoke inflation after the Feb CPI and Feb PPI both came in weaker-than-expected, (2) the unexpected increase in Feb US industrial production which has now increased for 8 consecutive months along with the stronger-than-expected Feb capacity utilization which rose to its highest level in 15 months, and (3) the prediction from Deutsche Bank Securities that rising US retail sales signals that US payroll gains will average about 300,000 for the next 3 to 4 months. Bearish factors include (1) the Fed’s post-FOMC statement that housing starts are “flat at a depressed level” and that employers “remain reluctant to add to payrolls,” which indicates the economic recovery may have trouble sustaining momentum as the housing crisis lingers and the labor market remains weak, and (2) Citigroup’s downgrade of the global financial sector to "neutral" from "overweight."

Earnings expectations for the S&P 500 are as follows, according to Thomson Financial: Q4-2009 (+201.0%), Q1-2010 (+36.5%), Q2-2010 (+22.6%), Q3-2010 (+23.2%), Q4-2010 (+30.8%). S&P 500 annual earnings are expected at -5.8% in 2009 and +27.0% 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 15.0, just below the 5-year average of 15.3.

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