Bond Expert: Tuesday Wrap

Prices of Treasury coupon securities plummeted today (though most of the drop occurred in the overseas session) as the domestic market had an initial opportunity to respond to the historic actions of the Bush Administration which has commanded a recapitalization of the banking system. The yield on the 2 year note has jumped 19 basis points to 1.76 percent. The yield on the benchmark 5 year note has increased by 20 basis points to 2.95 percent. The yield on the 10 year note has ratcheted up by 15 basis points t 4.01 percent. The yield on the Long Bond has edged higher by 13 basis points to 4.21 percent.The 2year/10 year spread has flattened one basis point to 225 basis points. That spread has spent the full day widening as in my opening note this morning the spread was about 212 basis points.

The 2 year/5 year/30 year butterfly spread is finishing the day at 7 basis points. One week ago that spread was 56 basis points which means that the 5 year note has underperformed the wings by 49 basis points in the last week.

Treasury bill rates have increased but the increase is not consistent with the news that the Treasury will backstop the entire financial system. Intuitively, I had thought that the bills would take a drubbing today but the increase in bill rates is minimal.

Why is that so? The cause is the low cost of funding. The central banks have positioned the system with so much liquidity that repo trades between 0 and 10 cents. If you own the three month bill at 25 basis points and fund it at 10 basis points, there is positive carry. The six month bill trades at 1.05 and the year bill changes hands at 1.30 percent. So there is a reasonable amount of positive carry and until such time as that dissipates it will be difficult to blow up bill rates.

Market participants wanted to talk about supply today and the effect of that supply on the yield curve. Treasury issuance will be gargantuan in the months ahead. Most participants believe that the November refunding will bring with it the return of the three year note. Others look for the 10 year cycle to increase from eight auctions each year to a monthly cycle. And I spoke to another analyst who sees the return of the seven year note on a quarterly basis. All of that supply will weigh on the market and pressure the longer maturities.

There is an additional and more powerful case for the steepening trade and that is that the thrust of Fed policy will be supportive of the front end. By the end of this year the funds rate will probably be 1 percent and central banks are likely to keep the system awash in funding.

Consequently, the anticipation of FOMC ease, in concert with heavy supply from the Treasury, makes the steepening trade a popular choice.

Swap spreads have narrowed by 18 basis points in the 2 year sector and 7 basis points in the 5 year sector. Ten year spreads are unchanged and 30 year spreads are wider by 3 basis points. Speculators busied themselves receiving in the short end while servicers paid in the long end.

Mortgages got clobbered versus swaps. FNMA 5s are wider by a point and FNMA 5 1/2s are wider by about ¾ point. That is against swaps on each.

Plain vanilla mortgages suffered from the edict over the weekend from Central Planning to the GSEs which mandated that the GSEs scoop up Alt A and subprime paper. In so doing, they have left the street to buy a bunch of paper that FNMA and Freddie Mac would have purchased previously.

Comments

[Ishortyou:]

looks like speculation is already starting the bond market.

2008 Oct 14 07:58 PM