Bond Expert: Tuesday Wrap

Prices of Treasury coupon securities have dropped sharply today as economic data and a generalized malaise regarding the level of interest rates weighed on sentiment. It was also a day in which selling begat more selling which then brought in more sellers. (For the record I am beginning this closing piece a little early today so the closing levels might be out of whack with reality later.) At the moment, the yield on the 2 year note has jumped a chunky 7 basis points and sits at 1.83 percent. The yield on the benchmark 5 year note has climbed by 8 basis points to 2.67 percent. The benchmark 10 year Treasury note is at 3.58 percent as its yield has moved higher by 7 basis points. The yield on the Long Bond is 8 basis points above yesterday’s close at 4.43 percent. The shift in the yield curve is parallel as the 2 year/10 year spread is unchanged at 175 basis points.

Economic data today established a less than friendly backdrop for those who ply their trade in the interest rate markets. PPI jumped 1.1 percent in March and that left the YoY gain at 6.9 percent. The tacticians at the central bank engage in some mental gymnastic and lean on the ex food and energy component for broad guidance. By that metric inflation was reasonably well contained in March as it rose just 0.2 percent. The YoY level of so called core PPI is 2.7 percent. This is the data for finished goods PPI.

If you thought that there might be some improvement in the next few months,think again as there is an inflation train in the tunnel, bearing down on you full throttle. Economists at JPMorgan in a note to customers highlight that there is quite a bit of inflation in the pipeline.At the intermediate level core PPI gained 1.1 percent in March ,and, more significantly has increased at an annual rate of 10.7 percent in the first three months of the year. The same economists at the House of Morgan note that PPI at the core crude level soared 3.5 percent in March. The annualized rate for the first three months of 2008 for PPI at the core crude level is a Weimar Republic like 52.6 percent. ( I want the wheelbarrow concession on the South Shore of Long Island.)

The Empire manufacturing level which tracks industrial activity in the New York region jumped from -22 to 0.6 (consensus -17) . That caused consternation amongst those who hoped that the economy was in free fall.

The jump in rates today sprang from developments in other markets. Mortgage spreads have widened by 2 basis points to 3 basis points versus swaps. Hedge funds,originators and servicers have all been active sellers. Domestic client buying has been very limited and the only buying stems from the hearty appetites of foreign investors.

Swap spreads are 3 basis points to 4 basis points wider in the 2 year through 5 year sector and about 2 basis points wider in the 10 year sector. The Wachovia debacle yesterday was a watershed as it convinced some participants that all of the financial stress has not been wrung out of the system yet.(One former colleague argues vociferously that the underlying problems have not been solved or mitigated. They have only been term funded by the Federal Reserve System,which is a sage observation.) Anyway,the Wachovia mess in concert with the GE warning on Friday sparked paying. Some of the paying was from MBS types micromanaging duration. The sogginess in the swap market became self fulfilling as higher swap rates engendered selling from players who had entered positions shortly after the Bear Stearns solution.Those trades have turned ugly and traders with less than optimal entry levels are jettisoning those positions.

In the Treasury market clients were actually better buyers. An aggreagation of comments from several traders suggests that central banks had a healthy appetite for paper in the 2 year/10 year sector. There was some selling of the back end by retail and several large corporate deals weighed on sentiment,too.

Much of the activity in the bond market derives from activity and perceptions about the stock market. Intel reports after the close today and in the fragile financial world Merrill Lynch,Citibank and JPMorgan report later in the week.