Bond Expert: Tuesday Wrap

by: John Jansen

Prices of Treasury coupon securities have surged today as a variety of fundamental and technical factors have combined to drive prices higher. In a sense, that sentence is a bit of a cop out because as I traveled the investment grade bond universe today I was unable to isolate one solid reason for the rally.

The collapse in commodity prices is certainly an important factor in pushing bond yields lower. Rising energy prices were the bete noir of bond investors and central bankers. The collapse of energy prices, if maintained, will produce some very friendly YOY headline inflation comparisons in Q4 2008 and Q1 2009. That will alleviate pressure on central banks to tighten and given the fragile state of most of the large industrial economies it might even provide cover for ease. One salesman friend whom I often quote here makes the point that Libor close to 2.80 is not accommodative and central bankers will want to guide that rate lower as year end approaches.

Against that background, some investors might have reacted to the drop in the prices paid component of the ISM as it slipped to 77 from 88 the preceding month.

There was an unsubstantiated rumor of a SWF fund selling commodities and buying Treasury debt. In that regard, the futures contract performed better than cash today and that would lend some credence to that story. If someone had been long commodities and short bonds the cleanest short would be the futures contract.

Fitch lowered the ratings on the preferred stock of FNMA and Freddie Mac. That is old news but refocuses investors on the precarious state of those companies and the problems which will accompany their demise.

There was another body of thought which said that the price action was a short squeeze and a response to the breach of resistance on the 10 year note
at the 3.76 percent level.

I did hear of some buying activity which pushed yields lower. Central banks bought the belly of the Treasury curve. Money managers and hedge funds bought mortgages. In the swap market there was an eclectic group of receivers.

Benchmark Treasury yields declined sharply and the yield curve steepened. The yield on the 2 year note slipped 11 basis points to 2.26. The yield on the 5 year note has the subterranean homesick blues as it also dropped by 11 basis points and fell below 3.00 percent to yield 2.99 percent. The yield on the benchmark 10 year note dropped 8 basis points to 3.73 percent and the yield on the Long Bond fell 7 basis points to 4.35 percent.

The yield spread between the 2year note and the 10 year note widened by 3 basis points to 147 basis points.

The 2 year/5 year/30 year butterfly is 63 basis points.

Spread closes:

Swap spreads widened to benchmark Treasury debt today. There was some receiving but it did not keep pace with the buying of Treasuries. So swap spreads lagged Treasury debt by 2 1/2 basis points in the 2 year sector, 2 3/4 basis points in the 5 year sector and 1 3/4 basis points in the 10 year.

Mortgage spreads were about a tick wider to Treasuries after being as much as 12 ticks wider. Money managers and hot money bought the wide levels.

Agency spreads were unchanged. Freddie (FRE) announced $3billion 2year notes which will price tomorrow. They also reopened a 5 year note for $1 billion and the issue stopped 2 basis points through the market.