3-Year Note And Other Miscellany

Includes: SHY
by: John Jansen

The US Treasury will offer the dealer community an opportunity to buy $28 billion of newly-minted 3-year notes today at 100PM. The issue looks cheap on a relative value basis. The WI roll is about 4.25 basis points and that prices the new three-year at just north of 48 basis points to the 2-year note. That is the wide end of that spread. The wide is about 50. In addition the WI trades at around 92 basis points and that is the back end of the range on that issue. As recently as May 28th the current benchmark traded at 72 basis points.

There are conflicting flows in the sector in which overseas clients have been active. I have heard of central bank buying in the sector but there has also been some chunky selling of the 3 1/2 year to 4 1/2 year sector by non-official accounts.

Some participants with whom I have spoken have focused this morning on a WSJ story which states that inflation may become a problem sooner rather than later and that the Fed will be too slow in addressing it. If you believe that story you probably do not want to own anything but if this is just another iteration of traders getting irrationally exuberant on the bear side then I think this three-year note is a safe sanctuary for short-term to intermediate horizon traders.

Separately, one seasoned veteran made the cogent point that the most important marker is corporate bond spreads. He opined that the MBS market is dysfunctional because of Fed purchases while the corporate market is clean and that is where so many investors have placed overweights. I agree with him and think that when the bond market finally cracks the crack will be in corporate bond spreads as that is what investors own.For now that has not happened as investors still crave any yield in paper with even a modicum of credit quality.