Bond Expert: Wednesday Wrap

Includes: LEH, RBS, XLF
by: John Jansen

Prices of treasury coupon securities have posted mixed results today with several benchmark issues gaining while the Long Bond languished. The yield on the benchmark 2 year note has dropped by 11 basis points to 2.82 percent. The yield on the benchmark 5 year note has declined by 8 basis points to 3.48 percent. The yield on the 10 yield note has dropped 2 basis points to 4.08 percent. The lackadaisical Long Bond experienced a one basis point jump its yield to 4.71 percent.The 2 year 10 year spread has widened to 126 basis points. Yesterday morning following the Bernanke speech and in sympathy with the turmoil in European curves, that spread had been as narrow as 114 basis points.

Until President Trichet stirred the pot with his rate hike comments last week, the spread has traded between 130 basis points and just shy of 160 basis points. I suspect that the market will test that 130 basis point level as a part of the supply process ($11billion 10 years to underwrite tomorrow) and it will be informative to see if the spread can remain above that level without a supply consideration.

The 2year/5 year/30 year spread is 57 basis points. At the high yield levels on Tuesday morning that spread was 48 basis points.

Traders report substantial buying in the front end of the curve today. One trader who is a regular source for these afternoon musings noted that he had even seen (unusually) pension fund buying in the very front end.

This trader had an interesting thought on the configuration of the yield curve in an environment of stagflation and no Fed tightening. If the Fed does not tighten the 2 year note will benefit from its (relative) cheapness to the funds rate. The Long Bond will benefit because it is issued less frequently by the Treasury and because many accounts who buy are long term holders.

He argues that the belly of the curve (the region inhabited by the 5 year note and the 10 year note) will suffer because of the heavier pace of supply from the Treasury in that sector as well as from the lack of demand which would ensue from convexity players if the Fed chooses to stand still. So in that environment clients should favor the barbell of owning the wings and shunning the belly.

Swap spreads tightened by about 3 ½ basis points today in the 5year and 10 year portions of the curve. As I noted earlier today, the active paying which Trichet’s comments inaugurated has ceased . There was some receiving by dealers today who were busy hedging mortgage risk. There was chunky buying of mortgages and that product outperformed swaps by 2 ½ basis points.

Finally, financial stocks cratered again today. Lehman (LEH) raised new capital recently at $28 per share and the stock is closing at $23.75. I am doing this from memory ( and I killed a lot of brain cells in the 60s) and I believe that back in March following the bailout of Bear Stearns, Lehman stock briefly traded down around$20 but quickly rallied back to the $40 neighborhood. The declines of the last several days are ominous. In addition I note that the XLF dropped by nearly 3 percent.

I would be remiss if I did not mention UK bank stocks as Royal Bank of Scotland (NYSE:RBS) and Halifax Bank of Scotland [HBOS] each suffered significant declines today and traded well through levels at which the companies recently raised equity capital.