Bond Expert: Tuesday Outlook

Includes: IEF, IEI, SHV, SHY, TLH, TLT
by: John Jansen

Prices of Treasury coupon securities are posting modest gains in overnight trading. In Germany the ZEW survey of investor confidence fell more than expected. Separately, Fitch noted that amongst the large industrial nations the UK is most likely to face the ignominy and and infamy of a credit downgrade.

The yield on the 2 year note has slipped a basis point to 0.84 percent. The yield on the newly minted 3 year note has declined 2 basis points to 1.39 percent. The yield on the 5 year note edged lower by 2 basis points to 2.27 percent. The yield on the 7 year note declined 3 basis points and fell below 3.00 and landed at 2.97 percent. The yield on the 10 year note dropped 3 basis points to 3.46 percent. The yield on the Long Bond declined 2 basis points to 4.38 percent.

The 2 year/10 year spread has narrowed to 262 basis points. Recall that the spread had spiked to 270 basis points on Friday.

The 10 year/30 year spread remains very steep at 92 basis points.

Finally, the belly of the yield curve continues to improve and the 2 year/5 year/30 year spread which I chronicle here regularly is now 68 basis points. I do not have access to historical data but I believe that when yields were at their highs back in June that spread was single digits and flirting with zero.

The focus of the day is the auction of $25 billion 10 year notes. The issue is very cheap to the 2 year note at 262 basis points (notwithstanding the flattening from 270 basis points on Friday) and is also on the very wide end of where it trades versus 5 year notes with that spread at nearly 120 basis points.

David Ader makes the point that seasonals favor buying the 10 year note. In the period from 1990 through 2008, the yield on the 10 year note has declined on average between 11 basis points and 27 basis points between the November refunding and year end. Similarly, the 2 year/10 year spread has had a tendency to flatten between 14 basis points and 20 basis points between the November refunding and year end.

Outright yields do matter to me and I would much prefer owning the issue at 3.50 percent or cheaper. Mr. Ader notes and I would concur that as the market grinds toward 3.40 percent on the 10 year note, sellers will emerge. I would imagine that some arbs hold the 10 year/30 year steepener and I would suspect that if the market does grind towards 3.40 that those arbs would happily lift a leg and wait to cover their bond short in the 30 year auction on Thursday.

I am borrowing rather liberally from Mr. Ader this morning and I thank him. He also linked to a Wall Street Journal blog which demonstrates the extent to which banks are not lending and the extent to which they are buying Government securities. If you wonder where all the buying is coming from, that is one chunky source.

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