Bond Expert: Tuesday Outlook

Includes: IEF, IEI, SHY, TIP, TLH, TLT
by: John Jansen

Prices of Treasury coupon securities have posted very modest gains in overnight trading and have retracted some of the rocky ground over which they trod yesterday as the market careened into a ditch. There was very little news overnight and the focus of the market this day will be pricing the largest tranche of 2 year notes ever issued ($44 billion).

The yield on the 2 year note declined 2 basis points to 1.01 basis points. (The forward roll into the WI is 6ish so the new issue is trading around 1.07 basis points.) The yield on the 3 year note slipped 2 basis points to 1.58 percent. The yield on the 5 year note declined a basis point to 2.48 percent. The yield on the 7 year note edged lower by 2 basis points to 3.14 percent. The yield on the 10 yield note declined one basis point to 3.54 percent. The yield on the Long Bond is unchanged at 4.36 percent.

The yield curve continues its steepening trend. The 2 year /10 year spread has widened to 253 basis points.

The 2 year/30 year spread opened yesterday at 328 basis points and it is trading this morning at 335 basis points.

The 2year/5year/30 year butterfly is at 41 basis points which is relatively unchanged. At the current level the belly is on the cheap side relative to recent levels.

I think that the belly will continue to cheapen throughout this week as the dealer community makes room for Mr Geithner’s wares ($41 billion 5 year notes and $31 billion 7 year notes).

The $44 billion 2 year note is the problem du jour. On an outright basis the issue has cheapened and with the 6 basis point forward roll is seductive. However, I would be a very cautious bidder. The price action yesterday was an abomination and the violation of the various 100 day moving averages makes me think that there is more downside before this ends.

In addition the steepening of the yield curve has made the 2 year note rich to the long end. I would expect that at these levels prudent accounts would be fleeing the 2 year for the rich pickups available into 7 year notes and 10 year notes.

We receive reports on housing via Case Shiller today as well as a report on consumer confidence. Case Shiller should manifest continued improvement as housing rises from the abyss of the last 2 years (nearly three now). And confidence should post a small gain, too.