Bond Expert: Tuesday Wrap

Prices of Treasury coupon securities registered small mixed changes in a lackadaisical and lackluster trading session.

Economic data was supportive of half century low yield levels. Housing prices continued their slide and consumer confidence slumped. The Chicago Purchasing manager Survey was better than expected but remains deeply in contractionary territory.

There were more themes today than my opening sentence communicates. There was some mortgage selling early in the day, and I believe that pressured the 5 year sector. The 2 year/5 year/30 year butterfly has collapsed to inside of 40 basis points. At its most expensive levels it was about 50 basis points richer.

One participant noted that he had heard of some allocation trades with money moving money from bonds to stocks.

Another salesman reported nascent activity out of the US fixed income into European fixed income. He noted that many accounts view that as the macro trade for 2009. The federal funds rate can not go lower stateside but the base rate in Europe has plenty of room on the downside.

The yield on the 2 year note declined 3 basis points to 74 basis points. The yield on the 3 year note dropped 3 basis points to 0.92 percent. The yield on the 5 year note edged higher by a basis point to 1.46 percent. The yield on the 10 year note dropped 2 basis points to 2.08 percent. The Long Bond was the star of the day as its yield declined 5 basis points to 2.58 percent.

Federal Reserve MBS purchase: The Federal Reserve announced the asset managers who will guide the Fed’s purchase of $500 billion of MBS. The purchases will begin early in January and will conclude by the end of June. Here is a link to the FAQ on the topic at the Fed website.

There is one humorous question and response. The question asks if the purchases will expose the Fed to losses. In the answer the central bank states that credit losses are not a problem as FNMA and Freddie Mac guarantee principal and interest. Huh?

Swaps and agencies: Agency spreads are unchanged to 2 basis points wider in the 5 year and 10 year sectors. The level of trading activity is very light.Two year swap spreads are 1 ½ basis points wider at 69 ½ basis points. Five year spreads are ¾ basis points tighter at 61 ½ basis points. Ten year spreads are 1 ¼ basis points tighter at 38 ¾ basis points. Thirty year spreads are wider by 5 basis points at 11.

Corporate bonds are firmer once again as the march of buyers continues. Trading volumes remain light, since many are in year-end mode. Participants uniformly report that the flow of business is skewed to the buy side and selling is infrequent. As I mentioned yesterday, some participants expect a heavy slate of issuance as 2008 fades into financial oblivion. One salesman noted that he has clients with a pile of cash and their dream is to invest it as the new issue come to market in January.

That will be an important test for the market and will provide some real world data points to observe if credit market rehabilitation is truly underway.

Here are several examples of the move in spreads on quality corporate bonds:

The Budweiser 2018s issue was trading T + 510 about two weeks ago. That paper is 410 bid today.

IBM has several issues in the 9 year and 10 year part of the curve which before the rally traded T + 370 ish. That paper is mostly 275 bid now.

Con Edison has a 2018 issue which traded at T+ 445 a week ago. That bond is now 385 bid.

There are quality accounts looking for solid investment grade bonds and spreads are marching tighter.

Once again, in the interest of honesty and full disclosure I am long the EFT LQD. I also own some Wells Fargo (WFC) paper in 2013 and some GE paper in 2012. Very small amounts on each, and each is in the Across the Curve hold to maturity portfolio.

I also own some PSY. That is not for the faint of heart. I averaged into that one and I have a tiny profit.