Bond Trader: Thursday Wrap

 |  Includes: IEF, IEI, TLO
by: John Jansen

Prices of Treasury coupon securities have posted modest gains today but have retreated from their best levels as the 10 year note flirted with the 3.30 level which has acted as a barrier in the recent past.

I do not speak to often of the T-bill market but yields in that market continue to collapse. In one recent conversation, a market participant noted that bill yields are negative out to February. There are a couple of factors at work here. There is a massive wall of liquidity, a pile of cash which needs a home. That is driving yields lower.

Typically as the year end approaches, clients tend to unwind profitable trades and reduce balance sheets. I think that some of that deleveraging process has created new piles of cash and that money needs a place to park.

Others are preparing to beautify their balance sheet by having some pristine government paper on the books over year end. Some of that trade has begun as investors purchase paper which will carry them into 2010.

In that regard, the flight to this short paper has resulted in lower yields on the 2 year note. At one point today that benchmark traded as low as 0.678 percent. It is caught up in the gravitational field of the short bills and consequently it will trade to even lower yields, I believe.

As I wrote earlier this week, I am a firm believer that the Federal Reserve will remain on hold for all of 2010. Here is a great trade which one can do if he or she buys the proposition that the FOMC will indeed be on hold for the rest of our natural (and maybe supernatural) lives:

If you believe that proposition, that financing will remain at current levels throughout next year, then here is an idea. You can buy the 3 year note at a yield on about 1.25 percent and lock it up on repo to December 31 2010 at 0.25 percent. At that repo rate your breakeven yield on the current three year note on December 31 2010 is 1.85 percent.

If one could lock up the repo at 0 percent then your breakeven is 2.00 percent on December 31 2010.

In my mind that is a very compelling trade and as market participants experience an epiphany regarding the length of ” an extended period” more and more traders will be piling into that trade or some other version thereof.

The yield on the 2 year note has slipped 3 basis points to 0.72 percent. The 3 year note was the relative value star today as the yield on that instrument declined 4 basis points to 1.24 percent. The yield on the 5 year note fell 2 basis points to 2.17 percent. The yield on the 7 year note also declined 2 basis points and rests at 2.88 percent. The yield on the 10 year note slipped a basis point to 3.35 percent. The yield on the Long Bond slipped a basis point to 4.29 percent.

The 10 year/30 year spread is a very wide 94 basis points.

The 2 year/10 year spread is 263 basis points.

The 2yea/5 year /30 year spread is 67 basis points.