Bond Expert: Thursday Wrap

Prices of treasury coupon securities are plummeting once more amidst violent convexity induced volatility.

It has been an interesting day as I think this move caught many flatfooted. I think many posited a quiet pre employment position squaring session. For much of the day trading volumes have been light and belied the shifting tectonic plates below the market.

Later in the day the level of activity has quickened as the market penetrated key levels. While the convexity types have been flailing all day like a newborn baby, that activity has picked up steam over the last hour and several sources cited servicer hedging as the proximate cause of the carnage.

I hesitate to say this, and it is probably the death knell for the bear market in bonds, but it is difficult to envision any scenario tomorrow in which the market can rally. One has consistently been paid this year to short the supply and cover back later. There has been no reward for buying early. I think that we will see higher yields into the refunding next week and surely a steeper yield curve.

We are in a new age and that new era is governed by supply. There is no refuge from it. It just keeps coming, and until there is some sign that the fiscal situation in the US is a road to rehabilitation, the treasury market will remain a cold lonely venue.

The yield on the 2 year note has remained relatively stable relative to its peers as it has risen just 4 basis points to 0.95 percent. The carnage in the three year note is a little worse but not truly painful as the yield on that security has climbed 7 basis points to 1.51 percent. As we trek into the territory of the 5 year note the market's trials and tribulations become self evident as the yield on that once pristine instrument climbed 14 basis points to 2.56 percent. The yield on the 7 year note rose 17 basis points to 3.32 percent. The 10 year note is the ugly duckling as its yield soared 19 basis points to 3.73 percent. The yield on the still investment grade Long Bond increased 16 basis points to 4.60 percent.

The 2 year/10 year spread is at a record 278 basis points.

The 10 year/30 year spread narrowed to 87 basis points from 91 basis points earlier today.

Agency spreads are mixed. Two year paper is wider by about 2 basis points. Five year and 10 year paper is better by 2 basis points to 3 basis points.

The Federal Reserve will conduct a buyback tomorrow in the June 2011 sector through May 2013 sector.

Corporate Bonds

Corporate bond spreads had paused in their relentless and inexorable push tighter but that pause proved to be fleeting. The market firmed and spreads are unchanged to 5 basis points tighter.

Issuance was heavy but it did not derail the train or upset the apple cart (if I may mix metaphors). The largest offering of the day is from Express Scripts (ESRX) which is offering $2.5 billion in 3 year, 5 year, and 10 year bonds.

Most of the other issuers were smaller and nondescript in name. In general investors are greeting the issuance with open arms as it is patently obvious that it is virtually impossible for spreads to ever widen again. We are obviously at the dawn of some corporate bond New Age in which life and work will be filled with sweetness and light.

MBS, Swaps and Some Vol

(2:43PM ET) Swap spreads led the market lower today. There was paying by servicers as well as rate locking by corporate issuers. Regarding the convexity crowd, participants reiterate that we are at rate levels at which small movements in yields induce hedging activity and then the process becomes self fulfilling prophecy as the first round of paying / selling begets another round of hedging from another group of disgruntled spread product owners.

Two year spreads are 6 basis points wider at 47 1/4. Three year spreads are 5 basis points wider at 55 1/4. Five year spreads are 3 1/2 basis points wider at 49 1/2. Seven year spreads are 2 basis points wider at 228. Ten year spreads have leaked 3 1/4 basis points wider at 32. Thirty year spreads are 5 basis points wider at NEGATIVE 16.

Mortgages lagged swaps by 4 ticks. As I mentioned in an earlier post, though, the higher coupon significantly outperformed the 4s and 4 1/2s and performance improves as you hike up the coupon stack.

The three month / ten year ATM straddle is 658 mid.

Comments

[Macro_Man:]

John, you are much closer to the truth than you think. We are getting very close to the highs on yields. It is very hard to guess when we get a massive rally in US Treasuries. Could be a day, days, weeks or months. But within 4 months we are going to see the mother of all short squeezes on Treasuries.

I bought back my covered call on TLT. Been selling covered calls on my TLT positions to mitigate my losses. Sold first one at 95, sold and bought back at 93, sold and bought back at 91. Happy to hold here. Perhaps another month or two of pain. Will keep mitigating losses by trading covered calls. Just want to make sure I ride TLT all the way up when that happens

Jun 04 04:40 PM

[popey:]

The sooner the bond market collapses the better. Then we might get some fiscal responsibility.

Jun 04 04:55 PM

[igggy:]

I don't understand why the corporate bond market is so stable when the treasuries are falling apart. It's not like corporate bonds can avoid the carnage of higher interest rates. What am I missing?

I agree with Macro_Man, the moment the stock market drops, we'll have a huge rally in treasuries. I wouldn't be surprised if we revisit 3% yields on the long bond. But what do I know? I started shorting the long bond last October which was pretty dumb in hindsight.

Jun 04 05:14 PM

[JohnAl:]

Commenters are ignoring this important sentence from Mr. Jansen's report; "We are in a new age and that new era is governed by supply."

The sheer amount of debt to be financed is SO great that there is no longer safety in long bonds.

There will be stops and starts, but the trend for the long bond is down.

Jun 04 06:21 PM

[InnocentsAb...:]

Possibly because, in a still fragile credit market, many corporate bonds are still behaving like equities. So -- if the equity markets really recover, bonds will be back to behaving like bonds.


On Jun 04 05:14 PM igggy wrote:

> I don't understand why the corporate bond market is so stable when
> the treasuries are falling apart. It's not like corporate bonds can
> avoid the carnage of higher interest rates. What am I missing?<br/>
>
> I agree with Macro_Man, the moment the stock market drops, we'll
> have a huge rally in treasuries. I wouldn't be surprised if we revisit
> 3% yields on the long bond. But what do I know? I started shorting
> the long bond last October which was pretty dumb in hindsight.

Jun 04 07:35 PM