Bond Expert: Wednesday Wrap

Prices of Treasury coupon securities posted modest gains Wednesday in spite of a refunding announcement which detailed the enormous appetite of the US treasury to issue debt. Beginning with the refunding auctions they will embark on an ambitious fund raising program.The Treasury announced a refunding comprised of $25 billion 3 year notes, $20 billion 10 year notes and $10 billion new 30 year bonds.

If you are sleeping through these auctions fear not because the pace of issuance will accelerate dramatically. The brand new 3 year notes will become a monthly affair. Do the math and you get $300 billion 3 year notes annually.

The 10 year note until now was issued at the refunding months and then reopened the following month in smaller size. The announcement today noted that the Treasury will now issue 10 year notes monthly. In the refunding months there will be a new issue and in each of the next two months they will reopen the recently auctioned issues.

In the 30 year sector they will bring a new bond each quarter.

The announcement made for some interesting trading. The new 3 year note opened up about 35 basis points cheap to the 2 year note. In the early 1990s the issue generally traded about 35 percent of the 2 year/5year curve. At 35 basis points the issue was in that ballpark.

Ah,but here is the rub. In those days the 3 year was quarterly and not monthly as this will be. When traders realized the enormity of future issuance in the sector they began to cheapen the issue. It is now 47 basis points cheap to 2 year notes which is about 40 percent of 2year/5 year. With that many about to be issued it would be my opinion that the issue should be even cheaper.

One trader pointed out some amazing anomalies on the 3 year /4 year portion of the curve. For instance, one can sell the 3 3/8s of November 2012 and buy the new 3 year (November 2011) at even yield. The curve is quite steep so unless one expects dramatic flattening soon that trader is a winner,

Similarly, an investor can sell the 4 1/4s September 2012 and buy a combination of three year notes and 5 year notes and pick up 88 basis points of gross yield. That just does not make sense and anyone owning those bonds should sell them in favor of most anything else.

The 10 year roll opened at about 8 ½ basis points and remains there.

Once we get through this month the issuance machine will keep traders busy. Trading government bonds might once again become a growth industry. I say that because at the end of each month the Treasury will offer $35 billion 2 year notes and around $25 billion 5 year notes. But they will auction each month $25 billion 3 year notes as well as a yet to be determined block of 10 year notes. The reopening will probably be $15 billion in the first month and $10 billion in the second month. That would be a 10 year note with a total size of about $45 billion. The issuance of 3 year notes and 10 year notes will be timed to settle on the 15th of each month

The issuance of that supply will come at a time when the trading community has shrunk. There are just 17 primary dealers currently. At one time in the late 1980s and early 1990s there were close to 40 primary dealers.

Trading will be very volatile as supply approaches and the dealer community will exact a pound of flesh from taxpayers for profligate spending and prodigal behavior.

I got carried away and never cited closing yields. Yields are lower. The 2 year note yields a paltry 1.34 percent and is 3 basis points lower in yield today. The yield on the 5 year note has declined 4 basis points to 2.49 percent. The yield on the 10 year note has slipped 5 basis points to 3.67 and the yield on the Long Bond dropped 6 basis points to 4.14 percent.

The 2 year/10 year spread is 233 basis points.

The 2year/5year/30year butterfly is unchanged at 50 basis points.