Bond Expert Friday Wrap: Crowded Trade

Prices of Treasury coupon securities are posting bizarre and random price changes in a session characterized by volatility and conflicting crosscurrents.

The yield on the 2 year note is unchanged at 0.91 percent. The yield on the 3 year note is a basis point lower at 1.26 percent. The yield on the 5 year note climbed a basis point to 1.80 percent. The yield on the 10 year note edged higher by 2 basis points to 276 percent. The yield on the Long Bond declined 3 basis points to 3.62 percent. Very random. Maybe reader and commenter Greg, who predicted illiquidity would triumph, is onto something.

The market opened firm on the back of a story that the ECB is contemplating purchasing corporate bonds. The yield on the 10 year note dropped to 2.71 percent before hitting a wall.

Why did the market sell off subsequently?

I have heard various explanations. There was selling by mortgage originators as well as some rate lock selling.

I think that there is another more important short term factor which guided prices lower. Speculators ( myself included) had concluded yesterday that it was safe to be long after the auction. There was a window of opportunity for price improvement as the Treasury was on the sidelines and the Federal Reserve was a buyer. Month end is nigh and that should bring extenssion and buyers.

Alas (a word I have not heard since the days of Sister Mary Consolata in the 6th grade) the trade was very crowded and sowed the seeds for the selloff. Day traders and speculators are natural liquidators. Their positions must always head towards flat. So when speculators are net short, they buy. And when net long, as they were, today they liquidate to get closer to even.

I think that many day traders were long and the failure of the market to continue grinding higher impelled those traders to sell that which they owned or something else as a hedge. That selling engendered more selling, which knocked the market from its perch.

Against that background, the Long Bond has been a stellar performer. The 10 year/30 year spread is about 6 basis points flatter on the day. There is a reason for that.

When the Fed purchased 7 year sector paper it bought $7.5 billion of paper. Likewise today its purchases in the 3 year sector totaled $7.5 billion. On Monday the Desk will purchase the long end of the Treasury market and some traders believe that they might buy $7.5 billion in the long end.

I very much doubt that the hope will become reality. As a practical matter there is not as much paper available in the long end. It would be quite a feat to buy that paper and it would move the market if they did.

Additionally, the central bank stated that while they would buy across the curve and TIPS, too, they would concentrate on the 2 year/10 year sector.

I think they do that by buying significantly less in the long end end and disappointing the happy holders of that paper.

The 2 year/10 year spread is 2 basis points wider at 185 basis points.

The 2 year/5 year/30 year spread is (very cheap) at 93 basis points.

Agency Market

It was a very quiet day in the agency market today. There was very little involvement from clients.

Two year spreads are about a basis point snugger on the day. Five year spreads and 10 year spreads are somewhere between unchanged and a basis point wider.

Agency traders are occupying themselves discussing the timing of the next purchase of agencies by the Federal Reserve. Last week they announced on Friday that they would buy on Monday.

That led to a conversation about the Treasury buyback by the Desk. As I mentioned in an earlier post, the Fed has concentrated its Treasury purchases in the on the run active issues. I noted that 75 percent of the Fed purchase today was the active 3 year note. Additionally, I just took note that they also bought nearly $ 1billion of the 3 year note, the 1 3/8 February 2012. So about 90 percent of the Fed purchase was active issue or the recently active issue.

The agency trader with whom I spoke noted that there has been a rush to issue FDIC paper before quarter end as a rule change will make issuance after that date somewhat more expensive. My trader source suspects that there is so much congestion in the sector from that FDIC issuance that the Fed just wanted to unclog the pipes to give dealers space for more issuance.

One last point. In the agency market the Fed purposely shuns the on the run issues. They only buy the off the runs which clog dealers shelves. With limited balance sheet dealers may be light on off the run Treasuries into quarter end.

It will be interesting to see if this purchase pattern resumes in purchases made after quarter end.

MBS and Swaps

Mortgages are about 4 ticks tighter to Treasuries today. Down in coupon was the way to go as the premiums lagged on a bout of profit taking.

Cash CMBS is 5 basis points to 25 basis points wider and the CMBX is 20 basis points to 50 basis points wider. A trader with whom I spoke noted that some of the Fed programs have created a bit of a collateral squeeze and cash bonds have ( and he thinks will) outperformed the Index.

Swap spreads are tighter across the curve today. Two year spreads are 4 basis points tighter at 54 3/4. Five year spreads are 1 1/2 basis points tighter at 50 3/4. Ten year spreads are 1 basis point tighter at 18 3/4. I misspoke above as the 30 year spread is wider by 5/8 basis point at NEGATIVE 31 3/8.

Comments

[pickaroonwyo:]

Seems anybody can write a financial blog these days. Seeking Alpha is polluted with mediocrity. Thanks for your fine analyses which certainly differentiates you from the crowd.

Mar 28 09:50 AM

[smsti:]

Put it simply:

Dealers buy U.S. government paper and quickly sell it back.

Count on Wall Street to figure out a way to make a quick buck in a down market. The big banks and brokerage houses that deal directly with the Federal Reserve were avid buyers of Treasury securities in auctions last week, but they were even more avid sellers of those bonds to the central bank.

"What appears to be happening is the 16 primary dealers that were responsible for helping underwrite the auctions are now long with the hope of quickly selling the bonds at a higher price to the Fed before the next supply infusion comes in a few weeks," said Josh Stiles, senior bond strategist at IDEAglobal.

(www.forbes.com/2009/03...)

Mar 28 12:17 PM

[ed233:]

By no means do I purport to have any great knowledge into treasury securities. It is the government that buys their instruments when they cannot go out into the general market to sell those instruments because there is greater skepticism by market participants(eg. China). Presumably the US fed would run into a similar problem as we witnessed recently in the UK. So the US fed or some agency of the government buys treasuries(ie. buys from themselves) to in effect print more money. The interesting thing is that surely there is going to be a pattern develop whereby astute traders can anticipate the action of the Fed. Knowing in advance which instruments will be purchased by the fed(eg. 2 year notes vrs 10 year notes) could be a very profitable move. So while the US keeps injecting billions of dollars in this manner of printing money, traders will take advantage of their moves and this it seems to me will eventually create greater volatility until finally those who were thinking they were in a safe haven owining treasuries become the victums caught in the jaws of the snake. I would appreciate anybody's comments.

Mar 29 10:32 AM