Bond Expert: Wednesday Wrap

Prices of Treasury coupon securities are posting modest gains today but have done so in the face of a supply onslaught from Hank Paulson and his minions. The uptick in prices also comes in the face of a stronger than expected durable goods report this morning.The yield on the benchmark 2 year note has slipped 3 basis points to 2.29 percent. The yield on the 5 year note dropped 2 basis points to 3.02 percent. The yield on the 10 year note is lower by a basis point and rests at 3.77 percent and the Long Bond is dramatically unchanged at 4.38 percent.

The Treasury did auction $32 billion 2 year notes today at a yield of 2.33 percent. That was about a one basis point concession to levels prevailing in the market at auction time. The indirect bidding was right in line with the recent history and was about 28 percent of the total.

The curve has steepened today. The 2 year/ 10 year spread has widened to about 147 basis points. Why would the curve do that on the day of a $32 billion auction? There is an old adage which says the market will always take the course which causes the most pain. (The market quote for that adage is a little more pungent and a little more descriptive but this is a family blog.) When I viewed the market last Thursday it appeared that the easy trade for this week was to be short the curve. There was tons of short end supply and natural buyers of the back end with the extension at month end.

Alas, everyone piled into the same trade and now they are all scrambling to exit. There is month end as well as quarter end for several dealers. There is international turmoil with Russia seeking to reestablish a more forceful hegemony in its region. FNMA and Freddie Mac are still fraught with problems. Those factors have also created a bid for short dated assets. In fact one month bill yields dropped about 15 basis points today, too.

Dealers reported solid buying before and after the auction and most of it concentrated in Treasury paper. I heard of robust demand for coupons out to 5 years and some extension trades in the 5 year/10 year sector. One dealer noted a chunky hot money buyer of 4 year following the auction.

I spoke to a Long Bond trader who has doubts about the extent of the month end bid. He noted that the current Long Bond trades cheap to everything around it and has lagged its neighbors by a tick or so this week. He thought that if there was a duration bid that many would have parked in the most liquid instrument and that searched for a permanent home later.

Mortgages are 1 ½ ticks cheaper to swaps after being tighter earlier. As one salesman noted, there was no active selling but they got left behind in the treasury rally.

Swaps are tighter by ¼ basis point to 1 ¼ basis points on the 2year/10 year part of the swap curve.

Comments

[GKM:]

So based on this, this is the scary scenario I had been expecting. The smart and fast money is going into paper in preparation for the coming deflation. This has been helpful John to know that the trades I've been planning to put on are the right ones. It also goes to affirm that generally the obvious trades are obviously wrong.

2008 Aug 27 05:33 PM

[whidbey:]

When the market is thin, and at the end of a season, anything can happen as the kinks are pulled out. We must wait to see what the movers and the shakers think about their book. Frankly, I am fearful we are bottoming in the equities and dollar, that means bonds may be attractive for a while. Isn't that disgusting?

2008 Aug 27 08:07 PM