Bond Expert: Monday Wrap

Prices of Treasury coupon securities are posting very modest gains in a lacklustre trading session in which ennui reigned supreme. Most traders and investors have positioned themselves for the Federal Reserve statement on Wednesday and the very light volume is a reflection that today’s market is mostly about professional traders tweaking the margins of their positions.

The yield on the benchmark 2 year note has declined by 5 basis points and it now resides at 2.37 percent. The yield on the 5 year note has declined by 4 basis points to 3.14 percent The yield on the 10 year note also dropped by 4 basis points and it yields 3.83 percent. The Long Bond has seen its yield fall by 3 basis points to 4.56 percent.

The 2 year/10 year spread is finishing the day at 146 basis points after being as wide as 148 basis points earlier in the day. The 2 year /30 year spread also recouped some of its earlier widening. The slight long end improvement resulted from some machinations surrounding the issuance of corporate deals which necessitated the purchase of Treasuries.

Where does the Treasury market head from here and upon what will it fixate? I think that in the short run that the market is fairly priced after the huge adjustment of the last two weeks though there would seem to be other sectors of the market away from Treasuries which offer better value.

I think that the proper strategy now is to assume that the Federal Reserve has probably finished the cycle of ease. They will sit back and observe the impact of the fiscal stimulus package and observe the effects of the actions which they have initiated to lubricate financial markets. They will observe the lagged and indeterminate effects of monetary policy as the system absorbs the effects of the lower funds rate instituted last fall.

Against that background the funds rate will be solidly anchored at 2 percent for a protracted period and in an era of stability which will ensue the best strategy, I think, is to find some quality carry and ride down the yield curve. The swaps market is a fertile field for that endeavor. The 5 year swap rate is 3.91 percent and the 10 year rate is 4.47 percent. I think as participants come to believe that the Fed is through for a while yield buyers will emerge and they will drive spreads tighter.

Regarding future Fed actions, I think it is best to watch consumption. Consumers are troubled by declining home prices, muddled equities, and a soft job market. If you eat corn or rice your wallet is lighter and if you are driving to the store to purchase those commodities, it is an increasingly expensive excursion.

If consumers react by tightening their belts the effects of the slowdown will widen and will bring the Fed back into the game. And given that this is an election year I suspect that demagoguing politicians will chant for more largesse for their constituents.

Comments

[bearfund]

Not only may the Fed be convinced to / convince itself to lower rates further but there could certainly be more "stimulus packages" and other spending on top of the already enormous deficit. Yet more Treasuries on the market plus the possibility of further rate cuts can't possibly be supportive of prices. Prices on March TNX calls suggest that the market agrees. The trader who picked up 4000 42.5 calls at 25 cents must be ecstatic.