Bond Expert: Thursday Wrap

Prices of Treasury coupon securities, on balance, moved lower today as the seemingly imminent resolution of the issues surrounding the bailout bill appear to have been surmounted. All is well in the commonweal and an atmosphere of comity, collegiality and concord reigns in Washington DC. We will see how long that lasts.

Anyway, prospect of an agreement lessened the flight to quality bid for treasury paper and the front end of the Treasury curb suffered. The yield on the 2 year note jumped 15 basis points to 2.14 percent. The yield on the 5 year note climbed 11 basis points to 3.03 percent. The yield on benchmark 10 year note rose just 3 basis points to 3.84 percent. The Long Bond bucked that trend as its yield slipped 1 basis point lower to 4.40 percent.

The Treasury auctioned $24 billion 5 year notes today and awarded those notes at a yield of 3.129 percent. That was a mini travesty for the already strapped taxpayer as the auction coincided with news reports that agreement had been reached on the thorny issues on the bailout. So in the uncertain environment which prevailed, bidders headed for the hills and a sloppy auction ensued.

The result of the Treasury auction with a so-called 5 basis point “tail” is another manifestation of the illiquidity which has plagued the treasury market. One veteran off-the-run bond trader (any bond which is not an active recently issued benchmark issue) recounted a trade from yesterday which he said epitomized the truly unruly market. Someone had necessity to buy an old 10 year that matures in August 2013 and to simultaneously (and you must pronounce that like a Brit with the short I sound) sell the old 5 year piece of paper in February 2013. The issues are just six months apart so there is not much curve risk. The trader reported that $400 million of the swap traded. The issue which was sold declined by 6/32 and the issue which was bought rose by 8/32. In the old days that would have traded with no concession to maybe 2/32 at the most. In this case, the spread moves 14/32. That is not the type of price action that will encourage risk-taking.

The money market remains stressed, though three month Libor is expected to set at approximately the same level or slightly lower tomorrow. The trader with whom I speak on this topic suggests that there is no indication of improvement and thinks that end of quarter window dressing will exacerbate matters the next couple of days. He thinks that we will need to get into the first week of October before we will have a true glimpse of the state of that market.

Swap spreads are tighter by 18 basis points in the 2 year sector, 11 ½ basis points in the 5 year sector and 5 ¾ basis points in the 10 year sector.

Mortgages were better bid most of the day. In spite of the curve flattening, higher coupons outperformed lower coupons. One trader reports that the only factor that matters is the last buy or sell.

Today is the 25th of the month and that is the day of the monthly remittance reports, which participants pore over to discern the state of the mortgage market. In particular, they examine the status of the loans which comprise the ABX index.

One participant noted that the salient points of the reports today revolve around speeds and severities.

Speeds are very slow. Bond holders will be slow to receive payments and since the loan is outstanding longer, the chance of default is greater.

Severity, which measures what one realizes after liquidations, is also rising.