Bond Expert: Tuesday Outlook

Includes: BIV, IEV, TLO
by: John Jansen

Prices of Treasury coupon securities have advanced in overnight trading and have produced a truly parallel shift in the yield curve. Each of the benchmark issues shed a basis point in yield.

The overnight session was not one with a single data point to move the market.

The Australian central bank released its minutes and they were hawkish. Given the extent of the the rate increase in that country and subsequent hawkish comments from officials, the tone of the minutes should not have been surprising.

European finance ministers met and afterwards pontificated about exchange rate volatility and uttered platitudes regarding their support for the Obama Administration’s support of a strong dollar.

The dollar is marginally weaker overnight versus the Euro and the yen.

Equity markets are mixed with small gains in Asia and small losses in Europe.

We receive information today on PPI and Housing starts. PPI should be flat and the consensus expects an increase to 610K in Housing starts.

The yield on the 2 year note is 0.95 percent. (As I stated initially, each of the benchmarks have declined a basis point.) The yield on the 3 year note is 1.49 percent. The yield on the 5 year note is 2.33 percent. The yield on the 7 year note is 2.97 percent. The yield on the 10 year note is 3.38 percent. The yield on the Long Bond is 4.19 percent.

The 2 year/10 year spread is 243 basis points.

The 10 year/30 year spread is 81 basis points.

The 2 year/5year/30 year spread is 48 basis points.

The belly of the curve has begun to underperform slightly as the 5 year note has cheapened to 48 versus the wings after being as rich as 56 recently. On Thursday the Treasury will announce about $115 billion of new 2 year notes, 5 year notes and 7 year notes. That is a significant duration drop in the belly and should lead to additional underperformance as we approach the bidding process.

There is some Fedspeak today with Plosser and Warsh speaking. Warsh is the gentleman who wrote the WSJ op ed piece immediately after the last FOMC meeting in which he suggested that higher rates would be required before it seemed that they were necessary. It was that article which has prompted the recent round of speculation regarding the timing of the Fed’s withdrawal of liquidity.

For now I suspect that the market is trapped in a range. We approached the 3.50 percent level and buyers emerged. We witnessed a brief surge down to 3.10 percent and participants firmly rejected those levels. For now I would be content to take a shot selling the market if we trade into the 3.20s.

Regarding the curve. I think a flattening trade is in order as the supply impends. David Ader made an interesting point in his morning piece today. He noted that the statement by the Federal Reserve bank of New York regarding repos and that they would not necessarily happen soon should have caused the curve to steepen, all other things being equal. That the curve flattened, albeit slightly, is instructive.

One corporate bond trader reports early demand for that product has spreads tighter by 3 basis point to 5 basis points already this morning. The trader cites stock market gains and favorable earnings.