Bond Expert: Tuesday Wrap

Prices of Treasury coupon securities (mostly) are surging today as wobbly equities provide the impetus for a breakout rally. It really is not just the weakness in equities which has pushed yields lower but a confluence of several factors.

First some levels, and then some reasons. The 2 year note is the redheaded stepchild of the day as its yield has increased 2 basis points to 0.96 percent. In spite of the $35 billion 3 year note auction, the yield on that instrument slipped a basis point to 1.44 percent. The yield on the 5 year note dropped 4 basis points to 2.34 percent. The yield on the 7 year note declined 7 basis points to 3.06 percent. The yield on the 10 year note dropped 6 basis points to 3.44 percent. The yield on the Long Bond declined 6 basis points to 4.30 percent.

The 2 year/10 year spread has narrowed to 248 basis points. That traded yesterday at 260 basis points.

The 2 year/5 year/30 year butterfly is now 58 basis points. It began trading this morning at 52 basis points.

In talking to market participants, many cite the old adage that the market will move in the direction which causes the most pain to the greatest number of people. I commented somewhat on this earlier in the day as well as yesterday. The curve steepening trade was crowded. On Thursday and again yesterday, real investors and speculators were piling into every form of curve steepening trade.

That position has worked since the treasury has moved to this new gargantuan issuance cycle. Well now it seems as though the markets have adjusted and the adjustment is colliding with some salutary fundamental news.

Sources reported today that many of those same traders who had established curve steepening positions were now busily unwinding those positions. I have heard of unwinds of 2 year/10 year and 5 year/30 year positions as well as 2 year/5 year trades. Steepeners all and those tickets, ripped up and deposited in the recycle bin.

The employment report changed some perceptions and has precipitated continued end user buying. The labor report pushed equities over the edge and has added to the bid for less risky assets.

There is also a seasonal factor at work here. In each of the last four years, bonds registered their yield peaks in June . So that seasonal factor is at work here, too. I think you can add to that, the old saw in equities about selling in May and walking away. (Someone told me that 885 was the 200 day moving average and a breach of that level is rather negative for equities.)

For those who follow charts, we are at some interesting levels on the 10 year note. This 3.46 percent to 3.44 percent level is one area of resistance. One technician explains that we traded 3.464 two days ago as we traded 3.454 level on June 29. On May 29 the 10 year peaked at 3.446 before the projectile vomiting began which pushed the yield to 4 percent.

The next key level is 3.39 percent, which was the previous yield peak in May. If we can break that level the next target is 3.23 percent. That is a 50 percent retracement of the post QE announcement in March low yield of 2.45 percent and the 4 percent peak in early June.

Swaps, MBS and Vol

Swap spreads are mixed. Two year spreads are tighter by 3/4 basis point at 38. Three year spreads are 1/4 basis point wider at 49 1/2. Five year spreads are unchanged at 42. Seven year spreads are 1/4 basis point wider at 19 1/4. Ten year spreads are 1 basis point tighter at the same 19 1/4. Thirty year spreads are 2 basis points tighter at NEGATIVE 19 1/2.

Lower coupon mortgages are unchanged to swaps, while higher coupons are a couple of ticks tighter. Speeds have slowed and that has supported the UIC trade.

The three month ATM 10 year swaption straddle is down to 633. Vol is very directional currently and investors are protected against lower rates. Consequently vol will stay soft as the market improves.

Corporate Bonds

Corporate bond spreads remain little changed in muted trading.

Barclays (BCS) priced $2.5 billion 5 year notes at T+ 2 7/8. The issue is 10 basis points tighter in the gray market.

Poland priced $2 billion 10 year notes at T+290. I have not been able to find a quote on that one.