Bond Expert: Wednesday Wrap

Prices of Treasury coupon securities took a roller coaster ride Wednesday and are finishing the session with mixed results. The yield on the benchmark 2 year note is 4 basis points higher and is closing at 2.51 percent. The high yield on the issue was 2.59 percent. The yield on the benchmark 5 year note jumped 3 basis points to 3.20 percent. The high yield on this issue today was 3.27 percent. The benchmark 10 year note closed unchanged at about 3.92 percent and the high yield on this issue was 3.97 percent. The 30 year bond closed 2 basis points lower in yield at 4.62 percent. The high yield on this issue was 4.67 percent. The high yields were attained early in New York trading prior to the release of the CPI report.The 2year/10 year spread is closing the day at 141 basis points.

Dealers report that it was a very active trading day with tremendous two way flow. One dealer noted chunky buying of benchmark 2 year through 10 year paper by central banks. The same dealer noted that the central banks were also active buyers of spread product. Another trader said he could not characterize the flow thematically but said that end users were as active as they have been in some time. He observed a very large seller of the 5 year note, a substantial buyer of long principals and a chunky buyer of 2 year notes.

The Federal Reserve Bank of New York was actively involved in the sterilization game today as they sold $2.5 billion of coupons in 2013, 2014 and 2015.

Yields in the Treasury market have moved dramatically higher since the middle of March when they touched very low levels in response to the fear which had gripped the markets as Bear Stearns vaporized. The yield on the 2 year note is about 130 basis points higher and the yield on the 5year note is about 95 basis points higher. The yield on the benchmark 10 year note has jumped about 60 basis points.

As those yields were ludicrously low it seems to me that current yield levels are beginning to look attractive and especially so when viewed in light of the economic fundamentals. Private sector job growth has vanished and manufacturing jobs continue to evaporate. Consumer confidence is at multi decade lows. High oil prices and high food prices shrink the funds that consumers have to spend on discretionary items.

The genesis of the current set of economic woes and associated credit crunch was the sharp drop in the price of houses. Economic indicators which measure the health of that segment of the economy lead to the conclusion that the housing slump will be protracted. There is no recovery lurking around the corner.

The financial system has recovered significantly but Chairman Bernanke averred the other day that stresses remain and the system is not functioning normally.

Against that background, it is hard to understand how the market is beginning to price in higher short term rates six months hence. There has certainly been a sentiment shift which holds that the economy is not as weak as many had believed it would be and that we will not fall into some steep recession. Even if one accepts that argument, I think it would be folly to assume or believe that the economy will quickly return to trend growth. I believe that growth will be sub par for quite some time as we pay for the earlier excesses. Growth is far more likely to average 1 percent or so over the next two years rather than anything close to 3 percent. In that case the funds rate will be anchored at 2 percent for a long time and the muddled growth picture will alleviate worrisome inflation pressures.

And if that is the case yields close to these make some real sense. More on that Thursday morning.

Comments

[baynetin4hd]

Best guess on direction of 30yr mortgages ??