Bond Expert: Tuesday Outlook

Prices of Treasury coupons securities suffered deep declines in overnight trading as equity markets around the globe rebounded and reduced the safe haven demand for government debt. Fear of upcoming supply also bedeviled the market as investors ruminate on the manner in which the government will fund the rescue of the financial system. The yield on the benchmark 2 year note climbed 6 basis points to 1.59 percent. Losses on longer dated securities were greater. The yield on the 5 year note jumped 10 basis points to 2.70 percent. The yield on the 10 year note climbed the same 10 basis points and rests at 3.79 percent. The 30 year bond experienced the worst clubbing as its yield moved 11 basis points higher to 4.15 percent.

The 2 year /10 year spread widened 4 basis points to 220 basis points.

Equity markets rebounded sharply overnight. In Asia the Nikkei rallied 6 percent and the Hang Seng in Hong Kong screamed higher as it climbed 14 percent. Bloomberg articles place the motivation for the rally on the perception that there are pockets of value in equities and after recent steep declines some investors chose to invest some money.

European exchanges are higher but on balance the gains are subdued compared to the moves in Japan and Hong Kong. Most European markets are higher by 1 percent to 2 percent. The exception is Germany where an unexpected increase in consumer confidence has bolstered sentiment. Consumers experienced a mini rush as they enjoyed lower oil prices.

Supply from the Treasury takes on an increasingly larger focus as a week filled with auctions continues today. (The week began with the sloppy auction of $6billion 4 ½ year TIPS yesterday.) Today the Treasury will sell $34 billion 2 year notes and after a respite for the FOMC result on Wednesday they will tap the market Thursday with an auction of $24 billion 5 year notes.

One week from Wednesday the Treasury will detail its refunding auction details and will also provide some insight into the methods it plans to use to raise the cash to fund the bailout. The 3 year note will likely return to the schedule and 10 year auctions will probably become monthly affairs rather than the current 8 month times per year. Some suggest that the Treasury need is so large that they might also resurrect the 7 year note which died in the mid 1990s.

The primary dealer herd has been culled lately and those left standing are in a risk averse posture. Balance sheets are shackled and individual traders have less incentive or ability to sell adjacent issues to make room for the new one. So I think with a diminished primary dealer community and with those left in a more risk averse stance, there should be significant volatility and sloppiness associated with the auction process.

Simply stated, the profligate spending upon which the government has just embarked will cost the taxpayers dearly.

Other notes:

The IG 11 is opening  tighter by 11 basis points at 213/215.

MBS: Mortgages are opening about 10 ticks tighter to 10 year Treasury. Dealers report robust buying from domestic banks, money managers and hedge funds.

Rolls still trade poorly and that has put a bit of a cap on the early enthusiasm.

Repo:

This is a note from a dealer’s repo desk with some color on that market for today. In essence, the situation has improved but is far from normal:

GC closed at zero last night,  in response to the increase in the outstanding dollar value of fails. The absolute number of issues with “prolonged” fails has improved considerably over the past 3-4 trading sessions. The dollar volume, however, worsened yesterday, as fails in the current 2yr note quadrupled.  With the new 2 yr settling on Friday, we expect some of the pressure on the current 2 yr note to come off. For today, 2’s and 5’s will be at zero all day, while 10’s should trade in a tight 0.15-05 range.