Bond Expert: Tuesday Outlook

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Prices of Treasury coupon securities have edged higher in overnight trading as higher energy prices, slowing growth and the tribulations of the financial sector weigh on sentiment. In particular, the profit warning by UPS after the close of US trading buttressed the view that growth in the US is slowing.

There was also a rumor that Israel had attacked Iran and that led to some volatile movements in equities.The yield on the benchmark 2 year note has declined by 2 basis points to 2.92 percent. The yield on the 5 year note has dropped 3 basis points to 3.60 percent. The yield on the benchmark 10 year note has dropped by a basis point to 4.15 percent and the yield on the Long Bond is lower by 1 basis point. The 2 year/10 year spread has reversed some of the supply induced flattening which transpired yesterday and sits at 123 basis points.

The Treasury will auction $30 billion 2 year notes today. This is a tough one as the issue has cheapened significantly on the curve and the forward roll is cheap. Yesterday afternoon I posited that a diminished appetite for risk in conjunction with quarter end and the FOMC meeting would motivate the dealers to shoot the taxpayers in the big toe on this one. I am not so sure of that now.

The evidence of weakness in the economy mounts. That weakness has been reflected in the significant movement lower in equity prices. In particular, financial stocks have been battered and bruised. In the last three months I note that the XLF as well as the KRE has each declined by about 20 percent.

The slide in housing prices has not ended and if one examines the component pieces of Case /Schiller the fall in prices is accelerating in some metropolitan areas. The latest iteration of this report is scheduled for release this morning.

The labor market has shed workers, albeit at a moderate pace, this year. When the Labor Department reports on payrolls for June it will be another month of losses. It is unlikely that the FOMC will offer an overly hawkish assessment with job growth consistently negative.

I think the dealer community will bite the bullet and buy today’s auction on the screws. If they are wrong, they can always play defense by selling the 5 year note which the Treasury will auction on Thursday.

And once again in the interest of full disclosure, I am long SHY.