Bond Expert: Monday Wrap

by: John Jansen

Prices of Treasury coupon securities surged today as the credit crunch hovers and associated economic weakness hangs over the market like a funeral pall draped over a casket. It is sad and depressing and good news is hard to find. The day opened with the news that there would not be a Korean based deus ex machina for Lehman Brothers (LEH). The strange euphoria which this shabby story generated faded quickly.

During the day the depth of the problem resonated with word that JPMorgan (NYSE:JPM) in an SEC filing has acknowledged that it had lost $1.2 billion in write downs on FNMA (FNM) and Freddie Mac (FRE) preferred stock. If they are down that much what is the fate of regional banks with less capital and a far larger (percentage) holding than JPM.

Economic data was less than friendly. Existing home sales were greater than expected but the headline masked weakness as inventories of unsold homes ballooned and selling prices decreased.

Stock market weakness also benefited the bond market, as for a large chunk of the day the Dow was down over 200 points and erased the gains of Friday.

The Chicago Federal Reserve publishes a national economic activity index. I have never observed it before but several investors mentioned it today. It was weak in July and continued a series of very weak readings which suggest recession. The Chicago Fed noted that housing, consumption and employment led the weakness.

There is also a not seasonally adjusted Dallas Federal reserve Manufacturing Index which jumped to -18 from -27 but remains at a very weak level.

Russia stirred the geopolitical mix by recognizing the breakaway Georgian provinces that precipitated its “incursion”. That is a great bit of semantics ala Kissinger and Nixon. Since Georgia is the hub through which much European energy passes the hug of the Russian bear in this instance is a bit uncomfortable.

Volumes were extremely light today and several traders reported less activity than visited the markets on Friday.

The Treasury was not deterred and announced $32 billion 2 year notes for auction Wednesday and $22billion 5 year notes for auction Thursday. The 2 year roll was 4 basis points and the 5 year roll was 2 ¾ basis points.

Against that backdrop yields plummeted. The yield on the benchmark 2 year note dropped 9 basis points to 2.31 percent. The yield on the benchmark 5 year note tumbled 11 basis points to 3.03 percent. The yield on the 10 year note dropped 9 basis points to 3.78 percent and the yield on the Long Bond fell 7 basis points to 4.39 percent.

The 2 year /10 year spread remained unchanged at 146 basis points.

The 2 year /5 year/30 year spread moved 6 basis points in favor of the belly to 64 basis points from 58 basis points.

The 10 year TIPS spread is back to a very narrow 215 basis points which means that buyers of TIPS expect that inflation will average 2.15 percent for the next 10 years. I will book that bet!

Agency spreads are a tad better than they were when I reported earlier in the day. They are now about 1 basis point to 2 basis points wider on the day.

Mortgages were weak most of the day but recovered late. They are about even to treasuries and 3 ticks to 4 ticks better than swaps. They had been 4 ticks to 6 ticks wider to swaps at the worst levels of the day. Participants reported apathy ennui and originator selling. I am unable to locate the late day buying which tightened spreads.