Bond Expert: Friday Wrap

Prices of Treasury coupon securities have capped off a wild and volatile week with a dramatic plunge and a gigantic twist of the yield curve. There are many countervailing forces at work here.

The headline print on the labor data was significantly better than that which paid prognosticators and pundits pitifully prophesied. With that report, traders took a club to the market and it sold off sharply in early trading.

The yield curve has flattened significantly as the payroll report prompted discussions about Federal Reserve policy and the possibility that the Federal Reserve might unwind some of the emergency liquidity provisions sooner rather than later.

I believe that such speculation is misplaced, misguided and flat out wrong. I recounted in an earlier posting the musings of a friend of the blog that the Fed will typically not raise rates at the end of an ease cycle until the economy has produced some period of robust job growth. That is certainly not the case at present time.

The unemployment rate is rising (I know that it is a lagging indicator, but it is an important public marker) and initial claims have yet to fall significantly. In addition the monthly labor report needs to show a gain in the vicinity of 150K just to hold the rate steady.

If the Federal Reserve were to even hint at tightening the political reaction and the market reaction would be severe. In fact I think the Federal Reserve and the Administration is experiencing some serious angst over the recent rise in rates as if it persists it will serve to dampen the putative recovery.

I know it is different this time but I think the shock to the global financial system has been so severe that regulators and policy makers all over the globe will keep the spigots open for a very long time.

I think the price action today is more about position management and management of trading profits. The yield curve trade (the steepening trade) has been an easy trade and was widely owned. The price action today reflects the reality that the trade was crowded. I think that long term holders chose to exit those positions to lock in profits and I think that there was a coterie of traders who put the trade on at less than propitious levels who exited quickly when it turned violently against them.

I understand the reaction but think it will reverse quickly. The treasury will auction quite a few 10 year notes and quite a few Long Bonds next week. It makes no sense to flatten the 2 year/30 year spread 25 basis points in advance of the supply. Likewise, the 2 year/10 year spread is flatter by more than 20 basis points.

I believe that with a weekend to reflect on the data traders will reintroduce a steepening bias next week.

How about some yield levels? The yield on the 2 year note has rocketed 37 basis points to 1.32 percent. The yield yield on the 3 year note catapulted 34 basis points to 1.86 percent. The yield on the 5 year note soared 26 basis points to 2.85 percent. The yield on the 10 year climbed 13 basis points to 3.84 percent. The Long Bond is the relative value winner of the day as its yield edged higher by 6 basis points to 4.64 percent.

The 2 year/10 year spread is 252 basis points after trading at 278 basis points in advance of the data.

The 2year/5 year/30 year spread is 26 basis points.

FNMA 5s outperformed swaps by about 4 basis points.

The 3month 10 year at the money straddle is 692 basis points mid.

Two year swap spreads are 3/4 basis point wider at 49. Three year spreads are 4 basis points wider at 60 3/4. Five year spreads are 1/2 basis point tighter at 50 1/2. Seven year spreads are 1 basis point wider at 32. Ten year spreads are3 3/4 basis points wider at 37 1/2. Thirty year spreads are 1 1/2 basis points wider at NEGATIVE 13.

Corporate Bonds

Corporate bond spreads are about 5 basis points tighter on the day. One veteran salesman commented that they would be even tighter if more bonds were trading but the level of activity has shriveled.

Market participants expect another heavy week of issuance next week. One reported rate locking activity yesterday and expected that to lead to issuance.

Here is an anecdote which summarizes the demand for new issues. The three tranche ExpressScripts (ESRX) deal from yesterday is about 75 basis points tighter in each piece.

I believe the deal totaled $2.5 billion and one source reports the book was over $13 billion.

Comments

[Macro_Man:]

I agree with you 100%. There is no way the Fed is going to be tightening for quite some time!

Jun 05 04:14 PM

[PCScipio:]

"[P]aid prognosticators and pundits pitifully prophesied...." Oh, John!

Jun 05 05:11 PM

[gniappe:]

The fed isn't likely to increase rates anytime soon, but whether or not the market tightens rates is something else altogether. It depends in large part on foreign demand. The treasury auction next week might give us some indication. I like TBT on pullbacks. So if the auction goes over well, we should see yields drop in the short term giving us a great opportunity to short longer term treasuries.

Jun 05 06:52 PM

[User 426530:]

If the fed were to boost short term rates 50-75 bps, the longer- term treasury rates would decline, the dollar would firm and commodity prices would tank. Probably be good for the economy overall.

Jun 05 06:55 PM

[y1531y:]

The oil price has doubled from low 30s few months agao, it will show on the next month inflation number. Fed will be in hot water sooner than expected. We cannot cure recession by printing money, it will cause inflation plus recession or hyperinflation. It happened in the 80s when inflation and long treasury rates were both at 14%.

Jun 06 08:57 AM

[MarkitWacha:]

Bernanke told the Congress he wouldn't continue to print money to finance their Treasury offerings for the deficit.

I hope he puts the squeeze play on CONGRESS. Those fools need to experience the joy of unemployment.


On Jun 06 08:57 AM y1531y wrote:

> The oil price has doubled from low 30s few months agao, it will show
> on the next month inflation number. Fed will be in hot water sooner
> than expected. We cannot cure recession by printing money, it will
> cause inflation plus recession or hyperinflation. It happened in
> the 80s when inflation and long treasury rates were both at 14%.
>

Jun 06 09:42 AM

[Thucydides:]

How is the 2/5/30 spread calculated?

Jun 06 10:42 AM

[John Jansen:]

Butterfly trade explained

acrossthecurve.com/?p=923

Jun 06 11:05 AM