Bond Expert: Friday Wrap

Prices of Treasury coupon securities exhibited some rather bifurcated price action and the belly of the curve was the beneficiary. The yield on the benchmark 2 year note was unchanged at 1.61 percent. The yield on the 5 year note dropped 2 basis points to 2.82 percent. The yield on the 10 year Treasury slipped 3 basis points to 3.92 percent. The Long Bond was the sacrificial lamb and saw its yield increase by 5 basis points to 4.31 percent.

The 2 year/10 year spread flattened by 3 basis points to 231 basis points.

The 2 year/5 year/30 year butterfly richened to 28 basis points from 19 basis points yesterday.

Why the 5 basis point jump in the yield on the Long Bond? The Long Bond has been a superstar lately and has outperformed numerous other instruments. One trader thought that some of those trades were being unwound today.

The street was also rife with rumors that the Treasury would float an ad hoc Long Bond either today on Monday. This transaction would be similar to the reopenings in the 7 year sector last week which created an imbroglio in that sector. The rumor is somewhat preposterous as the Treasury will bring a 30 year as part of the refunding early in November.

And battered as the Long Bond was, the bond contract took an even deeper hit. This probably reflects more deleveraging via margin calls, collateral disputes or redemptions.

The market remains highly illiquid. Here is an anecdote to graphically make the point. Someone had an order from a customer today to buy $100 million of the old bond which matures in February 2036. In order to fill that order the spread between that issue and the Long Bond moved fully one point. Before this long episode began a trade such as that would not move spreads more than 1 or 2 ticks. Often times the trade could be done in one transaction on one ticket.

That is no longer the case and it is still very difficult to trade size without an order.

Separately, the repo situation has not improved markedly in spite of the shift in sentiment in other short term market sectors. There are about 20 issues failing, most of which are in 2013 and 2014. It will probably take more reopenings to alleviate the pressure.

There is also a Catch 22 in this regard which results from central bank policies. Many central banks have strict rules on fails and since they do not wish to be involved in fails many have pulled there securities from the repo market which serves to exacerbate the problem.

Central banks have been active sellers of the 0 to 3 year sector in agencies as well as various Treasuries across the curve. The conventional wisdom holds that the substantial selling was to satisfy domestic needs.

Next week the Treasury will announce new 2 year notes and new 5 year notes. There are estimates that they will bring $35 billion 2 years and $25 billion 5 years. The refunding auctions are right on the heels of those auctions. So there will be more than ample reason for the street to work the offered side of the market.

Agency, Swaps and Mortgages

Agency spreads were unchanged today versus Treasury paper. One trader noted that the market remains lethargic and is likely to stay that way until someone in authority offers some clarity on the issue of the less robust guarantee that the GSEs have when that guarantee is compared to the explicit backing that FDIC provides for banks in this brave new financial world.

Swap spreads gapped tighter today. Spreads in the 2 year sector  are tighter by 13 1/2 basis points, spreads in the 5 year sector have improved by 8 basis points and 10 year sector spreads have narrowed 4 basis points.

Mortgages improved about 2 basis points to the Treasury curve amidst light flows. Dollar rolls came off as Libor slipped, too.

Corporate bonds

The mood in the corporate bond market underwent the same transformation which has occurred in the money market sector. One veteran salesman and friend of the blog reported that his firm was observing inquiry from end users in the 6 year and 7 year sector. The curve is steep between 5s and 10s and the steepness of the curve makes that sector which trades off the 10 attractive.He said that buyers wanted 10mm to 20 million blocks of A and BBB paper.

He noted that it has been a very long time since they had seen that type of quality buying. In his opinion, if the funding markets cooperate, it is possible that a ton of cash will jump off the sidelines and spend some money next week.

The American Express 5 year bond I follow is at a record wide as it is quoted 750/725.

The General Electric 10 year is 445/420.

Comments

[Distressed ...:]

nice article, but what about muni bonds, those are looking attractive.

2008 Oct 18 06:58 PM