Bond Expert: Tuesday Wrap

Prices of treasury coupon securities have dropped sharply following the release of the statement by the FOMC following the conclusion of its meeting. There was nothing in the statement which precipitated the drop in bond prices. In my opinion, prices fell as the street contemplates the bidding process for the refunding auctions which begin tomorrow with the sale of $17 billion in 10 year notes. The process will conclude the following day as the Treasury sells $10 billion 30 year bonds.There was no set up by the street for this refunding. Last Friday traders and risk managers confronted the monthly employment report and prudence would dictate baby positions only for that report. Trading was incredibly light following the news Friday and remained that way again yesterday. The FOMC meeting intervened and would have restrained traders from placing big bets.

With that process complete, traders will offer the market down and hit bids until they discover a level which brings in buyers. Until that level is discovered, the orgy of selling will continue unabated until the bond auction has been completed on Thursday.

Against that background, prices are lower and the sectors of the curve which the Treasury supply has infected are steeper. The yield on the benchmark 2 year note has gained 2 basis points to 2.55 percent. The yields on each of the other active issues have jumped 5 basis points. The yield on the 5 year note has closed at 3.29 percent. The yield on the 10 year note is once again above 4.00 percent and is closing at 4.02 percent. The yield on the long Bond is $.63 percent.

The 2year /10 year spread is 147 basis points and the 2 year/5 year/30 year butterfly is about 60 basis points.

The FOMC was noncommittal in its public statement. The Committee noted the deleterious effects of the housing debacle, the higher cost of energy and the credit crunch. They also noted that the risk of inflation remained significant.

They no longer said as they did in June that the downside risks had diminished.

They will weigh the risks as the incoming data clarifies the situation.
I worked years ago with Ian Morris and I always enjoy his commentary. He wrote about some specific risks which Committee members failed to mention in its commentary and which endanger outlook for growth in the near term.

Corporate bond spreads remain wide. The rate on 30 year conventional mortgages is rising. The jumbo/conventional spread is rising. House prices are still falling. Tax rebates have failed to significantly boost consumption. Consumer confidence is at generational lows.

I would add that since the FOMC last spoke, foreign economies have turned very soft.

In that regard, I spoke today with a research analyst at a large money manager whose purview is foreign exchange. She noted that there is huge support for the Euro at the $1.5280/$1.5300 level. If the Euro does not hold that level, it will probably trade back into the old range of $1.45 to 1.50.

She noted that the dollar had probably bottomed against the pound, the Aussie dollar and against the Scandinavian currencies. She suggested that the process of bottoming against the Euro has just begun. The Fed likely to hold rates steady for a very long time while the weakness in Europe will have the ECB dropping rates sooner rather than later.

Comments

[whidbey:]

So, as usual the Treasury will offer the yield curve up to do what is required to hang its paper. To hell with bond investors who happen to hold anything, too late, they are just a memory. Such behaviors are compelled, of course, but the market remembers; some day the foreigners will not buy and the local yokels will be much loved again, if they ever were. What are we doing?

2008 Aug 05 08:31 PM