Bond Expert: Tuesday Outlook

Prices of Treasury coupon securities drifted lower in overnight trading as strengthening equity markets and supply weighed on sentiment. Investor appetite for risk has returned and the $/Euro is flirting with the $1.48 level.

The yield on the 2 year note is unchanged at 0.98 percent. The yield on the 3 year note has increased a basis point to 1.55 percent. The yield on the 5 year note has increased a basis point to 2.46 percent. The yield on the 7 year note increased a basis point to 3.11 percent. The parallel shift continues with the yield on the 10 year rising a basis point to 3.49 percent. The Long Bond broke ranks and its yield increased 2 basis points to 4.25 percent.

The 10 year/30 year spread widened a basis point to 76 basis points.

The 2 year/10 year spread leaked wider by a basis point to 251 basis points.

The 2 year/5 year/30 year spread is unchanged at 31 basis points.

The dealer community will have an opportunity to risk its scarce capital today when the Treasury offers the world $43 billion 2 year notes at 100PM. Two year notes generally come and go with little fanfare and often times the street uses the issue as an anchor to balance short sales out the curve. I suspect that will be the case today also.

There are a couple of small negatives to consider, however. The trade of being long from the end is quite crowded, and at some point the appetite for front end paper might become sated, at which point the auction process would become quite sloppy.

David Ader of CRT points out that our Japanese friends are on holiday and will not return until the 7 year note auction on Thursday. He suggests that there are not too many data points for the following observation but he notes that in the past when Japanese investors were not bidding, foreign participation dropped by 25 percent.

Additionally, the System Open Market Account (SOMA) owns a shade less than $2 billion of the maturing note. I wrote yesterday about the influx of reserves into the system which will occur as the Treasury addresses debt ceiling issues. If the Fed wishes to address that problem it could soak up some of the surfeit of reserves by failing to roll over its holdings of the maturing issue.

It would only be a small amount relative to what will be flooding the market, but it would signal their institutional concern.

As I write that, I am not sure that I have ever observed the Open Market Desk not rolling over its coupon holdings. They do that often in the bill world, but if memory serves me well it is not something that they have done in notes or bonds.

There are a couple of data points in the world of economics today.

The FHFA Home Price Index should post another monthly gain of 0.5 percent.

The Richmond Fed index should climb to 16 from 14.