Bond Expert: Wednesday Wrap

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Includes: FMCC, FNMA, SPTL
by: John Jansen

Prices of Treasury coupon securities traversed a pretty narrow range today and are closing with small mixed ( and random changes). The ADP guesstimate of job losses boosted prices initially but in non Long Bond parts of the yield curve that bid faded.

The yield on the 2 year note climbed 2 basis points to 0.82 percent.The yield on the 3 year note also climbed 2 basis points and rests at 1.14 percent. The yield on the 5 year note slipped a basis point and it is finishing the day at 1.65 percent. The 10 year note is unchanged at 2.66 percent. The 30 year bond is the relative value super star as its yield dropped 3 basis points to 3.50 percent.

The 2 year/5 year/30 year butterfly is 102 basis points after opening at 98 basis points.

The 2 year/10 year spread narrowed 2 basis points to 184 basis points.

I am not sure why the bond outperformed the list. My best guess is that with a 3 year and 10 year announcement imminent (like tomorrow) traders are playing the supply game and using the Bond as an anchor against the issuance of 3 year and 10 year paper next week.

The Federal Reserve announced a buyback schedule for the period beginning April 6. On that day they will target the 2019 through 2026 sector. That is prime off the run territory and should their action should relieve the dealers of some burdensome inventory.

Spreads in that sector had not changed in the moments immediately following the announcement.

Tomorrow the market braces for the initial jobless claims report which with the Labor data available on Friday is unlikely to move the market.

The ECB will announce the result of its meeting early tomorrow and there are some anticipating some form of quantitative ease from that group which often views the world through a Weimar Republic mirror.

MBS, Swaps, and some volume

Mortgages trade in a very narrow dollar price range once again and are about a tick better versus swaps.

Two year swap spreads have narrowed 2 1/2 basis points to 56. Five year spreads have widened 1 3/4 basis points to 56. Seven year spreads have widened 1 1/4 basis points to 31 1/4. Ten year spreads have widened 1 1/4 basis points to 20 1/2. Thirty year spreads have widened 2 basis points to NEGATIVE 28 1/2.

There is some interesting stuff going on in the market for volatility.

There was a long discussion on the blog a week or so ago about the impact of the Federal Reserve quantitative ease on the market. It seems to me that it is sucking the short-dated volatility out of the market place.

I spoke to some participants who follow that topic and it was an interesting chat. One trader ( I promised him that he would be the ever ubiquitous 'a trader said') said that his shop is busying itself by selling 25 basis point out of the money calls and 25 basis point out puts on the swap rate (Payors and receiver swaptions). They do this on expirations of one month to three months across the vol surface.

Another more interesting development is the interest in high strike payors. That is essentially a put on the swap rate. It is a bearish bet on interest rates.

One participant noted that with rates this low, the only trade for 2 years for now (or so it seems) is to protect against higher rates. So an eclectic group of clients is buying payors with strikes from 5 percent to 6 percent on 10 year swap rates. That rate is currently about 2.90 percent.

The buyers are seeking expirations on the options of 2 years to 5 years.

Agency market

Agency spreads have moved tighter across the yield curve today. Two year spreads are three basis points tighter at 60 basis points. Five year spreads are 2 basis points tighter at 83 basis points. Ten year spreads are 2 1/2 basis points tighter at 88 1/2.

Fannie Mae (FNM) announced a new 3 year note today. The hobbled GSE did not put a definitive size on the offering but participants expect something in the neighborhood of $4 billion to $5 billion. Price talk is T+ 75 . At that level it is 5 basis points cheap to a Freddie (FRE) issue one month shorter.

The deal saw substantial interest from end users and is considered a blowout. Pricing should be tomorrow.

Why did spreads narrow today?

One dealer suggested there is a residue of shorts from the month end buying and Federal Reserve money drop of yesterday. Those factors leave the street propping the bid side.

Separately, recent issuance has been smaller and both of the GSEs have taken pain to alert the investing public that they would not regularly issue mega sized deals.

Finally, agency paper is not full faith and credit but there is still an aura of safety and security which surrounds much of it. So in many minds it is almost guaranteed. I think if you couple that mind set with a nascent stirring in macro confidence, then a 60 basis point spread to the 2 year note (which nearly doubles its yield) is attractive.