Bond Expert: Friday Outlook

by: John Jansen

Prices of Treasury coupon securities are registering, on balance, modest changes in overseas trading. The massive wall of liquidity sloshing through the market has driven short rates lower while the longer maturities are unchanged.

Against that background, the yield on the 2 year note has edged lower by 2 basis points to 0.68 percent. The yield on the 3 year note has declined 3 basis points to 1.20 percent. The yield on the 5 year note has slipped 1 basis point to 2.14 percent. The yield on the 7 year note has also declined a basis point and rests at 2.85 percent. The 10 year note and the Long Bond are unchanged in yield and are currently at 3.33 percent and 4. 28 percent, respectively.

The 2 year/10 year spread is 265 basis points.

The 10 year/30 year spread is 95 basis points. I have been very wrong on that one and would have dusted it off yesterday. I had originally touted that trade when the spread was 91 basis points. I would revisit that flattening trade next week as the auction process unfolds.

The 2 year/5 year / 30 year butterfly is 68 basis points.

I want to reiterate the point that I made yesterday regarding the T bill market and that is that the current plunge of bill rates into negative territory is a technical phenomenon. What are my reasons for drawing that conclusion?

When bills plummeted to negative territory in September 2008, they were following a series of dire events and the near death experience of global capital markets. At that time I wrote that the price action in the money markets was the financial equivalent of the Reign of Terror during the French revolution. Lehman Brothers had failed, Merrill Lynch was in extremis, AIG was receiving massive assistance from the Federal Reserve, FNMA and Freddie Mac had recently become wards of the state.

The single most important factor in the flight to quality of that period was the failure of Lehman Brothers and the subsequent “break of the buck” at a money fund, which led to fear and panic in the populace and a subsequent run on money funds. That, if left unattended, would have toppled the system and led to a 1929 style collapse.

The salient point here is that a series of events occurred and propelled investors to seek safe sanctuary in the T bill market. By any standard, the system was in chaos, and that led to the flight to safety.

We do not have that situation today. There is a simple way to make that point. Some one just sent me the opening Libor levels: three month Libor set at 0.26219 versus 0.26656 yesterday. When the market was in distress last year, that rate was gapping higher. If the current situation was even remotely similar, the Libor rate would not be lower today.

Finally, one can view other credit spreads and while there may be some incipient leakage wider, there is certainly nothing resembling the panic which enveloped the money markets last year.