Bond Expert: Thursday Wrap

Prices of Treasury coupon securities plummeted today as the intersection of supply and economics and convexity led to waves of selling which pushed the market significantly lower in price.

The yield on the 2 year note climbed 9 basis points to 1.25 percent. The yield on the 3 year note jumped 11 basis points to 1.87 percent. The yield on the 5 year note soared 15 basis points to 2.83 percent. Someone shot the 7 year note from a cannon as its yield climbed 16 basis points to 3.49 percent. The yield on the 10 year note increased 13 basis points to 3.82 percent. The yield on the Long Bond climbed 9 basis points to 4.60 percent.

One can see the effect of supply on the belly of the curve. The 2 year/5 year/30 year spread closed at 19 basis points. I believe it was 34 basis points yesterday. During the carnage when the 10 year note traded to 4 percent, I think the narrowest I ever observed that spread was at 17 basis points.

The 2 year/5 year spread widened by about 7 basis points while the 5 year/30 year spread narrowed 6 basis points. The 2 year benefits from central bank buying, which the ZIRP motivates. There is a clientèle for that issue. There is no similar sponsorship for the belly, and consequently it trades as though there is a neverending torrent of issuance from the Treasury (which there is).

Consider this simple bit of arithmetic. The Treasury announced $104 billion today in the 2 year, 5 year and 7 year sectors. Two weeks from today the Treasury will announce 3 year notes and 10 year notes and Long Bonds. That batch of paper will be in the vicinity of $65 billion. That means that each month in coupons the government issues a shade less than $170 billion of securities ($169 billion to be precise). Keeping with the $170 billion theme because the multiplication is easier, that is $2.040 trillion bonds in a twelve month period.

If the economy is recovering, then I am wondering who will have any interest in buying that debt.

Economic data today caused sweaty palms for bond bulls as the Philadelphia Fed index registered significant improvement. Initial jobless claims were also economy-friendly. That confluence of data prompted specs to sell and that selling begat more selling from convexity geeks.

The supply from the Treasury at $104 billion is the largest bond offering in the history of humanity and speculators took that as a cue to pile on.

There is an interesting feature to the bidding process this month. June 30th is quarter end and many dealers will operate with balance sheet constraints on that date. They will certainly buy the new issues but I think the balance sheet shackles will temper demand.

It will also make the rolls wider than they should be as there will be diminished appetite for the new issues. The rolls are closing (chronologically) at 6 basis points, 5 basis points and 4 1/2 basis points.

In the world of corporate bonds, early weakness met buying and that sector is closing unchanged.

MBS, Swaps and Vol

Swap spreads widened sharply today as the rising tide of Treasury yields brought in paying by money managers, servicers and originators. Two year spreads are 8 basis points wider at 50 1/4. Five year spreads are 6 wider at 43 3/4. Seven year spreads are 5 basis points wider at 24 1/2. Ten year spreads are 6 1/4 basis points wider at 25 3/4. Thirty year spreads are less inverted by 7 1/4 at NEGATIVE 18 1/2.

The selling eviscerated the current coupon mortgage as it lagged battered swaps by about 1/2 point.

Volatility increased with the three month 10 year ATM straddle trading at 673 basis points today.

Comments

[LKofScotland:]

Terrible combination of supply and what it's being spent on. Worst part is if you agree with Obama on the need for health care reform its so clearly DOA it's like "why bother." This spending gives profligacy new meaning. Worst part? It's for the LEAST deserving and MOST corrupt. I cannot fathom how a DEMOCRATIC government became "this." This regime is like the so called "Chinese communists" only without the work ethic. Again, not all taxes are created equal. Uncle Sam collects INCOME taxes which is obviously a HUGE problem right now. If you're collecting PROPERTY taxes as your main source of revenue, well, let's just say that's why the Warren Buffets of this world are more than willing to pile into municipal debt. It's SAFER government debt. I think it would be interesting to see if certain states decide that maybe they should start issuing their own currencies instead of relying on the worthless us dollar since what all the states will be doing soon is sending money to "the center" never to see it again. That includes, obviously, resource rich states like Wyoming, North Dakota and most importantly Alaska.

Jun 18 09:46 PM