Bond Expert: Thursday Outlook

by: John Jansen

Prices of Treasury coupon securities have posted sharp losses in overseas trading as the recent rout continues full force. The yield on the benchmark 2 year note has climbed 11 basis points to 2.73 percent. (That is a bit misleading as the auction yesterday provides a new benchmark issue and the roll from the April to the May issue is worth close to 5 basis points.) The yield on the current 5 year note has jumped 5 basis points to 3.42 percent. The yield on the 10 year note has risen by 4 basis points to 4.06 percent (and sits right on that Fibonacci fault line which I noted in my recap late yesterday).

The yield on the Long Bond is 2 basis points higher at 4.72 percent. The 2 year/10 year spread (somewhat distorted by the aforementioned roll) has narrowed to 133 basis points. That would be a significant support level as the spread traded there early in May following the release of the April Labor data and represented a propitious level to establish spread widening positions ahead of the refunding auctions. As the auction process unfolded, that spread widened to 158 basis points, generously greasing the bonus pools of bond trading firms.

The trading environment is much different today and I suspect that this level is unlikely to hold.The rout in bond prices has not been confined to the US but has a pandemic feel about it. Reuters reports that 2 year yields are at levels which prevailed last August and JGB yields are at 10 month highs. Investors are fleeing risk averse assets as the credit crunch fades and there is a developing sentiment that central banks will ratchet up the war on inflation rendering the current rate structure inadequate.

The Treasury market braces for another round of supply today with the auction of $19 billion 5 year notes. The issue has cheapened significantly on the curve. If I am correctly reading the compilation of data provided by the good folks at the Kidder Reports, it appears that the 5 year note has cheapened against 2s and 30s by 10 basis points in the last several days as it has moved from about 74 rich to about 64 rich to the wings of the butterfly. That might be a reason to cover shorts but that does not provide a rationale for establishing a long position.

With rates breaking out of their recent range (to the high side) it is a good bet that corporate treasurers will accelerate issuance and that the crazed, clamoring crowd of convexity players will need to sell something or pay fixed in swaps to peel off unwanted duration. That does not bode well for the belly of the curve. I would look for the street to lean on the market until the 1:00PM New York time auction.

There is some noteworthy economic data today. Participants will get the first revision of the previously issued GDP data and while the pace of growth is expected to remain anemic at 0.9 percent that is a somewhat better rate than the originally reported 0.6 percent level.

It is Thursday so that means initial claims. They have been hovering in the 375K area and the consensus expects 370k today. Economists at UBS report that the relationship between weekly claims and job losses has changed. Previously the 4 week moving average of claims had to breach the 400K level to bring forth job losses. With the 4 week average in the 370s this time, the economy has been shedding jobs at a rate of about 65k per month this year. The same economists note that while claims have not risen much the continuing claims series remains elevated.

UBS expects that the economy will have shed another 75K workers in May and expect the unemployment rate to climb 0.2 percent to 5.2 percent.