Bond Expert: Monday Wrap

Prices of Treasury coupon securities have surged today in another historic trading session as yields once again plumb depths never thought imaginable. Stock market routs around the globe motivated early trading, as did pervasive weakness in global manufacturing activity. Domestic economic data released in the US magnified the weakness as the ISM manufacturing cratered as did its component parts.

Later in the day Chairman Bernanke spoke in Austin, Texas, where the crowd was likely to be unruly because their team, the Longhorns, received ill consideration from the authority which regulates college football supremacy. (See, rating agencies everywhere are under attack.) Chairman Bernanke juiced up the animal spirits when he noted the weakness prevalent in Q3 and noted that conditions had continued to deteriorate in the current quarter.

He also noted that with the Federal Funds rate at current levels the FOMC would consider policy alternatives among which he specifically noted the purchase of long dated agency and Treasury securities. I believe one Texan in the room proffered his helicopter for use of the FOMC.

The yield on the 2 year note has tumbled 10 basis points to 0.88 percent. The yield on the 3 year note has declined 13 basis points to 1.12 percent. The biggest moves were in the belly of the yield curve. The yield on the 5 year note slumped 22 basis points to 1.70 percent. The yield on the 10 year note also fell 22 basis points and landed at 2.70 percent. The yield on the Long Bond careened lower by 19 basis points to 3.24 percent.

The 2 year/10 year spread narrowed 12 basis points to 182 basis points.

The 2 year/5 year/30 year spread is closing at 72 basis points. Observe that the 2year/5 year spread flattened by 12 basis points while the 5 year/30 year spread widened by 3 basis points.

I talked to a zero coupon trader who actually saw buyers of zero coupon bonds at these levels. Another trader of the long end did see some profit taking on some longer dated whole bonds.

A salesman who is a friend of the blog noted heavy buying from convexity types as well as receiving activity from the same crowd. Insurance companies and pension fund accounts were also observed buying duration and buying flattening exposure in the swaps markets.

Some speculators were buying in anticipation of Japanese central bank intervention in favor of the dollar. The conventional wisdom here is that an approach of $/yen towards 90 would precipitate dollar buying from the BOJ and that money would pick and choose a home in the Treasury market. Debase your own currency and then invest it in another currency at some of the lowest yields ever recorded in the bond market of that currency. Sounds like a plan to me!

Mortgages widened by about 11 ticks to swaps.

Two year swap spreads are unchanged at 109 ½ basis points. Five year swap spreads are wider by 2 ¾ basis points at 86 ¾ basis points. Ten year spreads leaked wider by 1 ½ basis points to 21 basis points. Thirty year spreads normalized by 3 ¾ basis points to NEGATIVE 38 ½ BASIS POINTS.

Here is an interesting side note. The swap rate (the rate on the fixed rate of a swap if you choose to receive) is down to about 2.85 percent. I am sure that others have said this and have polished their resumes since, but it would seem that at some point close to here, the absolute level of that rate would lead to investor resistance and that going forward if the market rallies, the 30 year swap spread should begin to normalize.

There are still anomalies abounding in the Treasury market. One long bond trader notes that the Freddie Mac 10 year with a June 2018 maturity trades T+90 basis points. The Treasury 8 1/8 August 2019 trade +63 basis points to the 10 year. The spread between the issues is just 27 basis points. The bonds have very similar durations. The mean for that spread is 51 basis points (since the issuance of the Freddie bond).

Ergo, the Treasury is quite cheap at only a 27 spread and might be a candidate for purchase by Bernanke when the helicopter lifts off from the tarmac in Austin.

Comments

[zzyzx:]

Where does the Fed get the $ to buy treasurys with? They create it. This is the expected 'monotizing' of the debt that will create runaway inflation. Before the Fed starts buying, all this bailout money was financed by others.

But now the party is over. As the Fed prints money, the value of each dollar weakens. It may take awhile before inflation shows up, but markets look ahead, don't they. How long will 10 year bonds be under 3%? When it starts going the other way, the sky is the limit and Uncle Ben will have to run the presses around the clock to buy all the Treasury has to sell to pay the bills.

2008 Dec 01 10:17 PM