Bond Expert: Friday Wrap

Prices of Treasury coupon securities put in a most bifurcated performance today with benchmark issue maturing in 5 years or less languishing whilst the gaggle of bonds with longer maturities loved life and lurched higher.

There were a variety of reasons for the significant curve flattening.

Federal Reserve Governor Warsh kindled the flame with his Op Ed piece in the Wall Street Journal. His comments engendered fears of a FOMC embarking on a regime of higher rates sooner rather than later. I still think that the timing of the piece is very odd as it was so close to the meeting at which they reiterated the mantra that financing would remain low for the infamous “extended period”.

Whatever the case, his comments made some portfolio managers nervous and sparked movement into the long end from the front end.

There is still a significant cadre of funds locked in money funds which has begun to flow into the intermediate part of the curve. Bloomberg carries a story which notes that $295 billion has fled money market funds for various and sundry bond fund havens this year. If those flows continue, the curve will continue to flatten and bonds will trade at unlikely levels.

In a previous post I noted that exotic option hedging had contributed to the demand for the long end of the Treasury market. One interesting aspect of that article is that the author noted the animus with which the new Japanese administration views currency market intervention. The author thought that the yen could drift towards the 75 level.

I would differ and suggest that it would not drift there. If it continues to slide it will be more of a cascade as opposed to a drift.

Economic data provided a fundamental backdrop for the rally.New Home Sales and Durable goods were weaker than expected and had some participants questioning the durability of the barely nascent recovery. The data hammered home the point that the economy remains quite fragile and is rather tenuous without the activist intervention of the government.

And the price action this week is rather encouraging. We briefly flirted with the 3.50 percent level in the 10 year note and once again higher yields seduced buyers. The market sliced through the Brobdingnagian $112 billion of supply this week and has not looked back. As we speak, each issue trades at a profit and the happy holders will enter the weekend with a bounce in their step and the wind at their back.

It certainly feels as though the market will once more assault the 3.25 percent level on the 10 year note. Previous attempts to breach that level have ended in ignominious defeat. I have a feeling that it will end differently this time but only time will tell.

The yield on the 2 year note climbed 4 basis points to 0.98 percent. The yield on the 3 year note increased 2 basis points to 1.46 percent. The yield on the 5 year note was unchanged at 2.36 percent. The yield on the 7 year note dropped 4 basis points to 2.98 percent. The yield on the 10 year note fell 6 basis points to 3.32 percent. The yield on the Long Bond plunged 8 basis points to 4.09 percent.

The 10 year/30 year spread narrowed 3 basis points to 77.

The 2 year/10 year spread collapsed by 10 basis poiints to 2.34 percent. Someone sent me a chart which (I apologize) I cannot reproduce here but it demonstrates huge resistance on that spread at the 234 level.

The 5 year note gave up a small amount of ground against the wings as my 2 year/5 year/30 year spread is at 35 basis points.

The upcoming week is a week replete with data points. We receive the Chicago Purchasing Managers Survey as well as the ISM survey. And Friday brings the important labor report.

However, there is a dearth of high profile data on Monday and amidst that relatively clean slate, trading desks will see reduced staffing as our Jewish friends observe Yom Kippur.

In a thin market it might be easy to push the market higher.