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Thursday, May 21, 2009


Bond Market Ramble

The Treasury market has cratered. The 10 year note has returned to the 3.30 percent level. Why did we crater?I think I have a solid answer(s) but wish I had thought this through earlier.

In the purest trading sense today is Friday. The treasury just announced $ 101 billion of new supply which will trade next week.

Dealers, as is their custom, establish outright shorts and hedged shorts, to prepare for the bidding process. Certainly much of that process happens in advance of the auctions but the announcement is often a catalyst.

Today it is a special catalyst as tomorrow is a short working day before the holiday and Monday is a holiday. If you wish to have a starter kit short in place one had better get working on it as there is only scant time before the bidding begins next week.

So I think that the short week/ auction supply dynamic is driving much of this.

I also think that there is also disappointment about the buybacks. Today the Desk bought $7 odd billion of nearly $ 45 billion offered. That I  am sure leaves many holders of securities unhappy with their plight.

Dealers report reasonable client flows with hot money selling across the curve and central banks taking aim at the 5 year sector.

The yield curve has broken to new wide levels. As I compose this the 2 year/10 year spread is 244 basis points. The recent wide earlier this week was 239.

For the historians in the room the record wide was in August 2003 at 273 basis points.

The record wide on the 2year/30 year spread was 369 basis points in October 1992. That was interesting as the bond market was experiencing a flight to quality rally as equities cratered in response to the epiphany which revealed that William Jefferson Clinton would soon be elected President (and begin a second long national nightmare which continues even until this day).

Anyway markets suffered anxiety at the thought of a Democratic President and lived without the knowledge that he would usher in a Golden Age.

The 2year note yielded 3.60 percent and the Long Bond yielded 7.29 percent.

One little bond market factoid here: the 3.60 level was the low yield on the 2 year note for the next nine years and it took the horrific and tragic events of September 11 to push 2 year yields through that levels.

Finally, there is a bit of a reflation trade going on here,too. breakeven spreads in 10 year TIPS are now nearly 170 basis points and have moved quickly from 160 to this new level. I do not have the capacity to chart that but if you can you will see that spread breaking out.

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