Bond Expert: Thursday Wrap

Prices of treasury coupon securities posted solid gains today as the market bounced following the sharp rise in rates yesterday. Market participants reported robust buying overnight by Japanese investors as well as broad-based Asian buying in the belly of the curve during stateside trading. I have also heard of leveraged account selling of the 3 year sector as well as real money vacating the 30 year sector in favor of the 10 year sector.

How do we account for the strength of the Treasury market in the face of another solid performance by the stock market? I think that the answer is that we moved too far, too fast. It took one month for the market to move from 4.00 percent 10 year notes to about 3.25 percent 10 year notes. In just three days we retraced nearly 50 percent of that move. In a period of no supply (there is an announcement next Thursday of 2 year, 5 year and 7 year auctions the following week), that is just too much of a move in such a narrow time frame.

The stock market has been the bete noire of the bond market, and if the equity jockeys remain giddy, it will be instructive to see if the high yields of yesterday can hold.

The yield on the two year note declined 4 basis points to 0.97 percent. The yield on the three year note slipped 5 basis points to 1.54 percent. The yield on the five year note dropped 7 basis points to 2.44 percent. The yield on the seven year note fell 6 basis points to 3.12 percent. The yield on the ten year note declined 5 basis points to 3.56 percent. The yield on the thirty year bond edged lower by 5 basis points to 4.44 percent.

The 2 year/10 year spread is a basis point narrower at 259 basis points.

The 2 year/5 year/30 year spread is 53 basis points.

The 10 year/30 year spread is 88 basis points. It opened at 90 basis points this morning and traded as wide as 92.5 basis points yesterday.

As an aside, I wrote yesterday about the minutes of the June FOMC meeting, and the statement in that report that it was unlikely that the System would ever have a reason to sell the long term assets which they have so graciously acquired the last several months.

I want to add two points on that topic. It is not unusual for the Federal Reserve to refrain from selling coupons from its own account. I have made this statement to several friends and former colleagues: In the last three decades I do not believe that the Federal Reserve has ever intervened in the market and sold coupon securities from its System Open Market Account.

They have at times sold coupons on behalf of foreign clients but to the best of my knowledge they have never done so on their own behalf.

Indeed, when seasonal reserve flows would produce a surfeit of reserve in the backing system (for instance following the Christmas shopping season) they would counter that flow by selling T-bills and as best I can recall, they always sold very short dated bills. If anyone has evidence that I am off base here, please let me know.

As part of the buyback program, the Federal Reserve has bought a chunky amount of short Treasuries and short agencies. I think that these purchases provide a self fulfilling exit strategy as the Desk can unobtrusively mature them and not reinvest the proceeds. That can be done with little fanfare and without leaving a significant footprint in the market.

Swaps and MBS and Vol and Agencies

(3:32 pm ET) Swap spreads are tighter across the yield curve today. Participants report receiving by speculators, real money and mortgage clients.

Two year spreads are 1 1/2 basis points narrower at 44 1/2. Five year spreads are 1/2 basis point tighter at 48. Ten year spreads are 2 1/4 basis points narrower at 22 1/4. Thirty year spreads are 2 1/2 basis points more inverted at NEGATIVE 21.

Mortgages are about 2 ticks tighter to swaps.

The three month/10 ATM swaption straddle is trading 640 mid.

Agency spreads are 2 basis points tighter in the 2 year through 5 year sector and as much as 3 basis points narrower in the 10 year sector.

The Open Market Desk will intervene in the market tomorrow and purchase agency paper with maturities from Jan 2016 through July 2032.

One trader (agency) with whom I spoke has observed robust buying in the 3 year sector by money managers. He also notes that when the market was at its lows yesterday, some insurance company money sought refuge in the 10 year sector.

Comments

[PCScipio:]

Thanks, as always, Mr. J for your pithy wrap.

Jul 16 05:15 PM

[BigJake:]

Mr. J? Is that kind of like Dr. J, but for bond investing?

Jul 16 08:07 PM

[shine4u:]

I got lost in the sauce, but the Fed seems to cook the books.
I love your request that if wrong, please let you know.
Your is a attitude one can admire.

Jul 17 10:45 AM