Bond Expert: Friday Outlook

Prices of Treasury coupon securities have registered modest gains in overseas trading as the markets greet the new trading year quietly. Economic data released in the overnight session suggest ongoing economic weakness around the globe. Manufacturing appears particularly weak as the New Year beckons.

In Australia manufacturing contracted for the seventh month in a row. The index increased to 33.7 in November but remains mired well below the 50 level which indicates contraction.

Likewise manufacturing contracted in China for a fifth consecutive. The index rose here, too, but at 41.2 remains well below 50.

In Europe the Purchasing Managers Survey tumbled to 33.9 in December from 35.6 in November. That is the weakest level for this series since its inception in 1998.

Mortgage approvals in the UK fell to the lowest level since 1999 and HBOS reported that home prices declined at an annual rate of 18.9 percent in December.

The cascade of manufacturing surveys will continue in the US with the Survey data set for release at 1000AM New York time. The consensus anticipates a decline to 35.5 from 36.2 the prior month.

Stock markets around the globe are opening sharply higher in spite of the data. Investors seem ready to position for an economic rebound in response to the actions of central banks and in anticipation of dramatic action by the Obama Administration when it assumes power in a couple of weeks.

Yields on the 2 year note dropped 2 basis points to 0.74 percent. The yield on the 3 year note dropped 3 basis points to 0.94 percent. The yield on the 5 year note tumbled 5 basis points to 1.50. The yield on the 10 year note edged lower by 2 basis points to 2.19 percent and the Long Bond dropped one basis point to 2.67 percent.

The yield spread between the 2 year note and the 10 year note was unchanged at 145 basis points.

Treasury supply

One of the leading surprises for the market in calendar year 2009, I think, will be the vexations and perturbations resulting from the heavy schedule of issuance by the US Treasury. Some of that supply will be evident next week. On December 31 the Treasury announced that it will auction $8 billion of 10 year TIPS.

On Monday January 5 the Treasury will announce auctions of 3 year notes and 10 year notes. Last month the auction total for the three year note was $28 billion and the size of the 10 year note was $16 billion.

I think that the size of the 3 year note will remain the same at $28 billion . I expect that Treasury will reduce the size of the 10 year note to $12 billion.

Why less issuance in the 10 year sector? The 10 year note was originally auctioned in November with a size of $20 billion. The Treasury reopened the issue last month for 16 billion. The issue will be reopened again this time and another $16 billion auction would make for an unwieldy issue of $52 billion.

And how would you like to be around in November 2018 when that matures?