Bond Expert: Thursday Wrap

by: John Jansen

Prices of Treasury coupon securities took a wild ride today as convexity selling and supply from the US taxpayers darkened sentiment. The yield on the benchmark 2 year note has climbed 3 basis points to 2.69 percent. The yield on the benchmark 5 year note has climbed 8 basis points and it currently yields 3.42 percent. The yield on the benchmark 10 year has jumped by 7 basis points and it yields 4.08 percent. The Long Bond yields 4.76 percent and its yield is higher by 7 basis points, too.The 2 year /10 year spread is finishing the day at about 139 basis points but that comes after it traded as narrow as 131 ½ basis points very early in New York time.

The Treasury did auction $19 billion 5 year notes, and it was a less than festive result for taxpaying Americans but a victory for the bonus pools of the dealers. The issue came with a 2 ½ basis point tail and the auction award was about the cheapest point of the day. One trader noted that the 2 year /5 year /30 year butterfly which I spoke of earlier today came at 53 basis points and was the cheapest level for the 5 year versus the wings since last September. That butterfly has improved dramatically since the auction and currently trades around 60.

Following the release of the auction results, an eclectic group of buyers emerged. Central banks nibbled in the 10 year sector and arbs busied themselves booking profits on yield curve flattening trades. Tomorrow is month end and there is a modest extension to the Index tomorrow. So, while some profitable flatteners are being undone as we speak, the extension of the index tomorrow should keep the longest maturities better bid.

Last week I wrote about the power of positive carry and the ride down the yield curve. That thought process applies again now and if an investor is the slightest bit bullish and makes a compelling case for owning the 2 year note. That issue traded today in the repo market at 1 5/8 to September 30. That positive carry is worth a little over 20 basis points. The configuration of the curve is such that the ride down the yield curve is worth nearly 15 basis points. That means that if you buy the 2 year note today at a yield of 2.75 percent you would be a winner on September 30 as long as the yield on the issue is less than 3.10 percent. It also means that if you are shorting the current 2 year note outright or as part of some arbitrage strategy that you had better be right and very quickly.

Mortgages are closing about 2 ticks wider to swaps after being nearly 8 ticks wider.