Bond Expert: Wednesday Wrap

Prices of Treasury coupon securities tumbled today and the longer the maturity of the debt instrument the harder was the fall.

Several factors combined to frustrate and flummox fixed income investors.

The mania for risk assets remains intact as evidenced by the rush to the equity markets. The self congratulatory meanderings of some of the TV talking heads is amusing as I would suspect that one would have been far better off these last 10 years in nearly any combination of Treasury securities. And the performance would be ever more impressive when one adjusts for the relative risks of each market.

The decline of the US dollar lingers in the background and at some point, if unchallenged, will be the cause of the next debacle. In terms of the quotidian flows, the weakness in the dollar is beneficial as those exporters with appreciating currencies intervene to support the dollar. Those dollars find their way back into the Treasury market.

In a larger sense, however, the continued and long run debasement of our currency is not an inducement for foreign investors to continue to view the US as safe sanctuary for their funds. I have a feeling that the purchase of the belly of the US curve with intervention money could prove to be the financial equivalent of holding a lighted stick of dynamite in the hand.

One day traders will walk in and find out that sentiment has done a volte face and all of a sudden a declining US dollar is not such a great deal. When that epiphany happens, there will be a mad dash for the exits.

I think that the release of the minutes of the September FOMC meeting contributed to the weakness in the market and the steepening of the yield curve. As one salesman put it,”the minutes had no fangs”. The minutes repeated the tools which Chairman Bernanke mentioned in his recent speech but made no mention of when or under which circumstances that the FOMC might employ the tools.

The minutes also dwelled on concerns regarding an increase in inflationary expectations and the need to curb those expectations. It spoke of a need to communicate the FOMC’s seriousness in that regard.

My observation is that the recent spate of Fedspeak is a coordinated effort by the Committee to convey a hawkish stance. Unfortunately, the market demands action and not just words.

In that regard the Treasury yield curve has manifested a marked propensity to steepen. The 2 year /10 year spread traded last week at 226 basis points. Today it is approaching 250 basis points. That is investors fleeing the long end with a vengeance.

I would suggest that the steepening of the yield curve will continue -- or maybe, to put it another way, that any appreciable flattening of the yield curve is unlikely. Let me explain.

The minutes communicate the idea clearly (to me) that the FOMC will remain on hold for a very long time. The Committee sees little chance of inflation and is quite concerned about the labor market. Against that background, they will not be raising rates. Without the Federal Reserve raising rates aggressively it is unlikely that we can have a protracted round of curve flattening.

The aforementioned scenario is the so called bear flattener. I view the bullish flattener as unlikely also.That would happen with the 10 year note piercing the 3.00 percent level once again. That does not appear to be a good bet either. Without a second round of contraction in the economy I believe that the weight of supply will tend to keep the curve steep.

Additionally, the bulk of the intervention money gets invested in the one zero to three year part of the Treasury curve. That flow of funds will cause the curve to stay steep,too.

Wow, I sure did ramble here this evening. My apologies.

Here are some current (358PM NY time) levels. The yield on the 2 year note has climbed 3 basis points to 0.93 basis points. The yield on the 3 year note has also adjusted higher by 3 basis points and rests at 1.47 percent. The yield on the 5 year note increased 5 basis points to 2.34 percent. The yield on the 7 year note is flirting with 3 percent -- it climbed 7 basis points to 2.99 percent. The yield on the 10 year note climbed 7 basis points to 3.42 percent. The yield on the 30 year bond also climbed 7 basis points and sits at 4.27 percent.

The 10 year/30 spread is unchanged at 84 basis points.

The 2 year/10 year spread is 5 basis points wider at 249 basis points.

Comments

[F. Bradeen:]

Please. Keep rambling.

Oct 14 05:07 PM