Bond Expert: Historic Day Wraps

Prices of Treasury coupon securities are closing with modest gains, but that belies the wild rollercoaster ride which those securities have taken in the last 24 hours. Sentiment regarding Treasury debt had shifted to the very negative as the rescue package was detrimental to treasuries in a variety of ways. The bottom line belief as the day began was that there would be sellers of risk averse assets to purchase riskier assets. So Treasury debt had a quite soggy tone early.

Always expect the unexpected is a fine mantra to follow even in the bond market. The unexpected result was that the massive buying of mortgages unleashed a convexity event which had mortgage servicers scrambling for duration. Analysts at Credit Suisse have concluded that the gap higher in mortgage prices since Friday has created the need to buy the equivalent of $250 billion of 10 year swaps to hedge that risk.

That buying began slowly but picked up pace as the day wore on. Traders report outright buying and receiving in most of the investment grade asset classes.

The yield on the benchmark 2 year note has finished lower on the day by 2 basis points and rests at 2.50 percent. The yield on the benchmark 5 year note is closing 3 basis points lower at 2.95 percent. The yield on the benchmark 10 year note is lower by 4 basis points at 3.66 percent and the yield on the Long Bond has also slipped 4 basis points to 4.26 percent.

The 2 year/10 year spread is tighter by 2 basis points at 137 basis points.

The 2 year/5 year/30 year butterfly is 65 basis points. In overnight trading when the 2 year note traded at 2.52 percent that spread was 50 basis points.

Mortgages outperformed swaps by about one point in price or about 30 basis points in yield. One salesman made the interesting point that the refi wave,if it happens might be curtailed, because so many of the homes which might be eligible to refi based on the movement in the market, will not be able to do so because the loans in question exceed the value of the house. That will leave lenders with the choice of an unhappy homeowner with negative equity or a happy homeowner after they write down a piece of the loan.

Swap spreads are 8 basis points tighter in the 2 year sector and 11 basis points tighter in the 5 year sector. In the 10 year sector spreads are tighter by about 9 basis points.

Agency close

Agency debt is closing the day dramatically tighter as the rescue package prompted buying from investors and also moved the street to mark prices higher. Two year sector paper closed 35 better than Friday levels, 5 year sector paper is tighter by 30 basis points and 10 year paper is better by 30 basis points.Traders continue to report illiquid and volatile markets.

Freddie Mac (FRE) auctioned three month bills and six month bills today. The three month bill came at 2.10 percent which is down from 2.57 percent last week. The six month bill came at 2.35 percent which was down from 2.85 percent.

One issue which bedeviled the agency markets today was the CDS issue. Apparently, the act of placing the GSEs into conservatorship has triggered a technical default event. I have not found anyone who could explain the ramifications of that clearly to me so that I could recount the tale here.

One gentleman suggested that the default would benefit 5 year agencies. Another demurred and argued that much of the settlement would occur in cash and would not require purchase and delivery of securities.

Corporate bonds

Corporate bond spreads participated in the orgy of spread tightening today but the thrill began to fade as the day progressed. Financials were 20 basis points tighter in very early trading and they are closing about 10 basis points tighter. Industrial names tightened by about 10 basis points early and are now about 5 basis points better.

One salesman suggested that volume was light and that most of the tightening consisted of movement of the offered side of the quote.

The IG 10 is finishing at 136 after meandering in a narrow range throughout the day.

There was a smattering of new issuance activity from Barrick Gold (ABX) and Agrium (AGU). One salesman noted that the Barrick deal would price at about a 50 basis point spread to outstanding debt.

Comments

[MarvinMBA:]

Its going to be tougher for the Treasury to fund the debt...the load will become unbearable and there are not enough investors out there that will accept the petty interest rate...there is suppose to be an inflation premium but that seems to have evaporated...what we have now is a combination of high inflation, low interest rates and questionable energy supply/prices as well as a potential Iran problem which includes now Russia. It might turn out the only thing of value will be your brain and its ability to survive under extreme challange and physical adversity going forward.

2008 Sep 08 05:43 PM

[Reinko:]

Now after this perfect weekend where Frannie was capable of hooking herself on the mouth of the US Treasury I can only say this:

Maturing Treasury coupon securities, or bonds, can only be replaced by new 'coupon securities'.

Most folks inside the USA do not understand how much house prices will decline further and so even more folks do not understand the future price tag on tax payers.

Yet replacing old bonds for new ones is well understood: If there is no other way for replacement it is called a 'Ponzi scheme'.

The USA folks are blessed because the Chinese, Japanese and Indian folks do not know what a so called 'Ponzi scheme' is.

Therefore US bonds will live forever, do you agree or disagree with me???

And what about Federal Agency debt? Will that joke seize to exist or will the Europeans cat copy that wisdom in the future decades?

2008 Sep 08 06:39 PM

[madasiwannabe:]

Today's bond and T-bill action was not in line with the global sentiment. Everyone else around the globe understands, now that Uncle Sam is in the mortgage business, America is floating paper it will be hard pressed to cover if the housing market and economy don't start looking up fast. USA has a very bad debt to income ratio...

The effect of the strengthing dollar is a big economic negative right now. Our only economic bright spot (exports) is getting killed. I wonder who's running up the American peso.

Seems kind of strange the Chinese markets are falling while the rest of the globe is going up. Dollar up and Chinese goods down helps their products dominate the global stage though. Could it be they are manipulating the markets like they did the yen? Couldn't be, Hank just gave them insider info so they could pull out of the GSE's before the big investor mugging.

2008 Sep 08 07:22 PM

[Rumpole:]

On the CDS issue, I'm wondering who's going to have to pay out on the default? Might it be MBIA or the like or perhaps a few banks? I figure this could be the beginning of the feared CDS default tsunami.

2008 Sep 09 02:45 PM