Bond Expert: Friday Outlook

Prices of Treasury coupon securities have posted mixed results in overseas trading . The 2 year note rebounded from the debacle which it experienced yesterday as its yield slipped 3 basis points to 2.34 percent.(Late yesterday after I published my closing piece I heard that the pressure in the front end was not so much a result of direct sales of the 2 year note itself but resulted from the unwind of certain derivative market transactions which engendered heavy selling of Eurodollar contracts. Those sales pressured the entire front end of the yield curve.

The yield on the benchmark 5 year note is unchanged at 3.07 percent. The yield on the 10 year note has increased by 2 basis points to 3.77 percent. The yield on the 30 year bond has risen 1 basis point to 4.50 percent. The 2 year/10 year spread has widened to 143 basis points from 138 basis points late yesterday. I will remain a one trick pony and cling tenaciously to the viewpoint that between now and the refunding bidding next week the yield will steepen inexorably and 2year/10year will trade 150 basis points.

The powerful rally in US equity markets yesterday carried over into overseas markets. Gains in Asia and Australia were sharp. Australian equities jumped 2 percent while stocks in China rocketed higher by 4.7 percent. Japanese stocks and Hong Kong stocks posted increases of about 2.0 percent. In Europe most markets are higher but the gains are somewhat subdued with an average increase of 1.0 percent.

Today is the climax of an intense week of economic data and the monthly labor report should bring a swift denouement. The consensus anticipates a decline of 75K and an increase in the unemployment rate to 5.2 percent from 5.1 percent. I think that there is a risk that the decline in employment is more severe as surveys of consumer sentiment manifest angst about the job market and the manufacturing survey also show employment declining.

How will the market react following the release of the report? I think a consensus like number lacking sharp revisions to prior period data will give traders free run to pursue the steepening trade about which I have obsessed. Dealers will feel free to set up for the supply in an orderly way. If the numbers are weaker tha anticipated my first inclination would be to fade any rally after allowing the market to trade a bit. I think the gist of the FOMC announcement the other day is that they are in a reflective mood and wish to see what their recent work has wrought. At some point they might revisit the ease mode but I believe that it will takes a series of weak data to force that posture.

There were a couple of interesting news stories overnight. Bloomberg is posting an item which suggests that Bank of America might not guarantee the debt of Coutrywide when it swallows that troubled lender. The story indicated that B of A might cherry pick the firms best assets and then shovel the liabilities into a new corporation which if I read the story correctly will quickly file for bankruptcy. That would be the first time in this crisis that bondholders would be thrown under the bus.

The Federal Reserve and the Treasury established the template for crisis resolution when they forcefully and purposefully threw the shareholders of Bear Stearns under the bus. In other less severe cases existing shareholders have suffered severe dilution as firms have issues large amounts of new equity at the expense of existing shareholders. If Countrywide bondholders suffer a similar fate it will be a new twist in this story with many subplots.