Bond Expert: Monday Wrap

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Prices of Treasury coupon securities retreated from the lofty levels attained in overnight trading and are closing the session with moderate losses. The yield on the 2 year note has jumped 7 basis points to 1.60 percent. The yield on the 5 year note has climbed 7 basis points also to 2.65 percent. The yield on the benchmark 10 year note has edged higher by 5 basis points to 3.73 percent. The yield on the Long Bond has increased just 2 basis points to 4.09 percent.

The 2 year/10 year yield spread is closing the day at 213 basis points. That spread began the day at 219 basis points.

The interesting outcome in the Treasury market today was the result of the auction of $6 billion 4 year 6 month TIPS. For the uninitiated that stands for Treasury Inflation Protected Securities. The auction was rather sloppy as the auction tail was 14 basis points. (In bond market jargon, the tail is the distance from the level at which bonds were trading on a when-issued basis immediately prior to the auction, to where the Treasury was able to complete the sale. That long tail represents a lack of interest from clients and dealers who would normally underwrite the security.)

The average yield was 3.27 percent, which means that the new bond yields more than the nominal 5 year note. The so-called breakeven spread is the spread at which inflation would need to average for the holder of the TIPS to breakeven with the nominal bond and it generally predicts a positive rate of inflation.

In this case, the TIPS is yielding above the nominal bond by about 70 basis points, in which case the market is saying that it thinks that inflation will average negative 0.7 percent per year for the next 4 ½ years.

There are some forecasters who have extrapolated from the drop in oil prices that cumulative inflation for the last 3 months of this year could be as much as -3.0 percent.

I would also reflect that the shoddy outcome is also a result of a lack of balance sheet and indicates the risk-averse nature of the business at the current time.

The plain-vanilla Treasury market still maintains an aura of dysfuctionality with many bonds in 2013 and 2015 still failing and still trading at zero percent in repo.

The Treasury will auction $34 billion 2 year notes tomorrow and $24 billion 5 year notes later in the week. The forward rolls into those issues are unaccustomedly wide at 7 basis points and 8 basis points, respectively. The wide spread reflects the tight repo for the outstanding issues.

In terms of customer activity, there was hedge fund selling of 2 year notes at the lower yields this morning. End users from Asia were buyers of the 10 year note.

Agency spreads were wider across the curve with benchmark paper 5 basis point to 8 basis points wider Asian clients were better sellers . There was some selling by domestic clients in the 5 year sector and the only buying was in the 0 to 2 year part of the curve.

Swap spreads tightened 1 basis point to 2 basis points today.

Mortgages suffered the slings and arrows of outrageous fortune and are about 20 basis points wider to swaps. There were better sellers throughout the day. Liquidity is impaired and it is difficult to move large blocks.

Corporate bonds are slightly wider when one employs the IG 11 as a measuring stick. The Index is closing 214/216 which leaves it about 4 ½ basis points wider on the day.The new issue machine was not open today and consequently, there was no supply.

One salesman noted particular strength in regional banks and observed some end user buying of the sector.

Amongst my favorite issues, the 5 year American Express seems to have found support at the +800 level as it is now quoted 825/775.

The 5 year Pepsico edges tighter and clears today at 375/365.

And the 10 year General Electric languishes 465/445.