Bond Expert: Monday Wrap

Prices of Treasury coupon securities posted bifurcated results today with most of the list showing small losses and the Long Bond manifesting modest gains. The benchmark 2 year note yield increased 3 basis points to 2.17 percent. The yield on the 5 year note also climbed 3 basis points and rests at 2.93 percent. The 10 year note yield is unchanged at 3.71 percent and the yield on the 30 year bond has slipped 2 basis points to 4.48 percent. The 2year/10 year spread has narrowed to 154 basis points.

The entire yield curve from 2s through 30s continues to flatten. Supply motivates that trade as the Treasury is flooding the market with short end supply this week via 5 year TIPS, 5 year notes and 2year notes. I have not checked the veracity of this so caveat emptor but several folks with whom I speak suggested that this 2 year note is a candidate for the Guiness Book of records as the largest 2 year note ever issued. That supply adds to the residue of heavy sales of short coupons by the Open Market Desk as the Federal Reserve sterilized some of their recent activities.

The back end gains support from a heavy supply of corporate issuance as the issuers lift hedges and /or receive in swaps at the time of issuance. JPMorgan sold a very large perpetual tranche last week and Citi is offering $6billion today. Merrill Lynch is active ,too, as they offer preferred shares with a juicy 8.625 percent coupon. Most of the financial company paper probably gets swapped back to Libor and that generated a strong bid in the back end.

There was unusual bit of trading which I can not explain. The 10 year note contract and the bond contract have outperformed the nearby on the run instruments by about a basis point today. That does not sound like much but it did occur in an environment in which the yield curve is flattening. The futures contracts represent shorter durations than the cash securities and should have lagged cash today. I think that it probably represents short covering as many traders prefer the contracts for positioning. One doom and gloom friend suggests that the trading pattern represents a heightened sense of counterparty risk and many prefer the safety of an exchange to an over the counter name.

Mortgages have outperformed the swap curve by 4 basis points to 5 basis points. The solid buying of the last few days continues and dealers are still friendly to the mortgage basis. Retail clients have not sold and originators have largely been on the sidelines. One dealer noted that the recent buyers have been end users who are not the drive by transitory types and that these investors are not apt to make quick sales. So in spite of the huge rally in MBS it is probably not yet the moment to rush to Treasury paper.

Secondary trading of corporate bonds is finishing with cash bond spreads about unchanged. JPMorgan sold $2.5 billion 5 year notes at T+ 185 basis points. One market source reports that a $750million dollar reverse inquiry drove the transaction. The issue is issue bid currently so there is no groundswell of enthusiasm in the afterglow of that issuance. Citibank is rattling the tin cup and is in the perpetual market today. They are looking to issue with an 8.40 percent coupon. JPM issued a similar structure with an 8 percent coupon last week.

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[Anurag Choudhury]

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