Bond Expert: Thursday Outlook

Prices of Treasury coupon securities have posted mixed results in overnight trading. Securities which mature in 5 years or less languished while prices on 10 year notes and 30 year bonds vaulted higher.

The yield on the 2 year note is higher by 2 basis points at 1.08 percent. The yield on the 3 year note is unchanged at 1.32 percent. The yield on the 5 year note is 2.03 percent.

Suffering a bout of insomnia, I did observe the 5 year note on Bloomberg at 2.00 percent but I did not see it cross the Mendoza line with trading sub 2.00 percent. The 10 year note continues its historic rally and its yield dropped 5 basis points to 3.27 percent. One week ago yesterday when the Treasury auctioned $20 billion newly minted notes the issue yielded 3.78 percent. I am proud to say I participated in that auction and remain a happy holder. The yield on the 30 year bond dropped 5 basis points to 3.86 percent.

One week ago yesterday the Treasury auctioned $10 billion Long Bonds and the auction was a horrible debacle for Hank Paulson as the auction yield of 4.3 percent was fully 10 basis points cheaper than market levels. In retrospect, it was a moment of triumph for the rentier class.

The 2 year/10 year spread flattened 7 basis points to 219 basis points.

Equity markets overseas joined in the orgy of liquidation which had begun stateside yesterday. The Nikkei declined 7 percent and the Hang Seng and the Australian market shed 4 percent. Most European markets have dropped 3 percent or so thus far. Trading in the futures markets indicates that the US market will decline about 1 percent when trading begins at 930AM New York time,

The equity market closed near the bear market lows of October 2002. The intraday low for the S&P was 768.63 and the closing low was 776. We are within spitting distance of those levels.

There are several factors motivating the significant compression which the yield curve has undergone since the completion of the refunding process. The completion of that process is one of the key factors as the weight of the long end supplies pressured spreads wider as dealers made room for new supply.

Conversely, the Treasury will announce 2 year and 5 year supply today. Prognosticators are forecasting $35 billion 2 year notes and $25 billion 5 year notes.

As we approach month end, index extension becomes a factor in the flattening trade and that outperformance of the long end. In months in which there is a new long bond (as this one), the index usually has a greater than normal extension. There is probably some buying in advance of that.

Pension funds and money managers have engaged in a duration grab. That flow has not abated.

There are several key data points this morning. The Labor Department will report weekly jobless claims data at 830AM New York time. It was at a multi year high of 516K last week. The consensus looks for a lower number in the vicinity of 505K.

And at 1000AM the Federal Reserve Bank of Philadelphia will release the details of its monthly manufacturing survey. Pundits and prognosticators anticipate that it will post only a marginal recovery from the very depressed level reached last month.

I am still long 10 year notes and still short stocks. I suspect that the 10 year note will take a run at the all time lows reached in June 2003. That would put it close to 3.10 percent. I would be surprised (but happy) if it occurs today but expect that it will take several days of backing and filling before the issue mounts a final assault.