Bond Expert: Thursday Outlook

Update 11:03 AM:

The Treasury yield curve has manifested a predeliction to steepen this morning. The 2year 10 year yield differential is about 5 basis points wider than at the close yesterday and currently sits at 159 basis points. Similarly, the 2year/30 year spread has steepened by 7 basis points and is at 234 basis points.

Butterfly spreads testify to the rally as 2/5/10 has moved 3 basis points favor of the 5 year and 2/5/30 has moved 5 basis points in favor of the 5 year.

There has been central bank buying in the 10 year sector.

Hedge funds purportedly have been unwinding long MBS/short Treasury trades. That has caused MBS to underperform swaps and Treasuries. MBS also lags as vol has moved higher and as Dollar prices of the underlying mortgage bonds increase.

I suspect that much of the sharply higher prices on the Treasury curve is the price action forcing burned shorts to scramble for cover. Many(myself included) expected cheaper prices at 100PM at the auction. The shorts are in job preservation mode and are covering now.

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Prices of Treasury coupon securities have registered modest gains in overnight trading . The yield on the benchmark 2 year note has declined by 3 basis points to 2.29 percent. The yield on the 5 year note has slipped by 2 basis points to 3.07 percent. The yield on the newly minted 10 year note had fallen by 1 basis point to 3.87 percent. The Yield on the Long Bond is virtually unchanged. The 2year/10 year spread has narrowed to 148 basis points.

The bidding process for the 10 year note yesterday represented a dream fulfilled for the underwriters. The absolute yield level of nearly 3.94 percent was the highest yield in the last three months and the spread to the 2 year note at about 153 basis points was the recent wide for that spread. Subsequent equity market turmoil ignited a bond market rally and one can observe the improvement(post auction) in the yield on the benchmark 10 year as well as the tightening of the spread versus the 10 year note.

The Treasury will complete the refunding process at 100PM New York time today when it offers $6billion of Long Bonds. The auction in reality is a reopening of the current 30year . The size of the auction is smallish at $6billion but I would not be lulled into complacency by the size. The market has rallied since yesterday and on an outright basis the issue has lost some of its lustre . Additionally, the appetite of the street for risk taking has diminished and I do not believe that dealers will buy this on the fly without indications that demand from end users is enthusiastic. There has been healthy competition from the corporate bond market the last several days as corporate Treasurers have beeen issuing at a breakneck pace. Many of those issues priced very cheaply and offer nearly instant profits for buyers. Additionally, the recent sharp jump in foood and energy prices will heighten inflation fears and dampen demand for the issue.

Equity markets around the world have declined in concert with the sharp declines in the US yesterday.Japan declined by 1.0 percent and Hong Kong was lower by 0.6 percent. Most European exchanges have dropped by about 0.5 percent thus far. Futures market trading currently indicates that US equity markets will open with a modest rebound following the sharp drop yesterday.

It is a light economic calendar today with the initial claims data leading the parade. The consensus anticipated a small decline to 375K from 380K in the prior week.

Today the market will also have an opportunity to observe consumer behavior at department stores as the monthly same store sales data are available. Analysts expect strong sales dats but point out that it is a result of the early Easter holiday. One analyst I read suggested that March was unserstated and the data which will be available today regarding April is overstated.

Have a great day.