Across the Curve

Opening Comments October 9 2008

Prices of Treasury securities registered bifurcated results in the overnight trading session. Those results indicate a significant reduction in the fear factor as the yield curve has shifted significantly in the process.The yield on the 2 year note has jumped by 18 basis points to 1.72 percent. The yield on the 5 year note has climbed 14 basis points to 2.77 percent. The yield on the 10 year note has jumped 8 basis points to 3.72 percent . The yield on the Long Bond has defied gravity and has actually declined 6 basis points and rests under 4.00 percent at 3.99 percent.

Some of the strength in the Long Bond derives from trades in the swap market. Desks which trade exotic options on swaps faced significant exposure to trades in the swap market in which the curve between the 30 year swap rate and the 10 year swap rate inverted. Hedging of that exposure has compelled receiving in the long end of the swaps market and the pressure from the hedging of those positions has percolated into the Treasury market.

I am writing this at 6:15AM New York time and my regular sources have not arrived at their work stations yet. I heard this last evening as I prepared my closing commentary yesterday and only alluded to it there. When the trading day begins I will develop some follow up commentary.

The shift in the yield curve is dramatic. The 2year/10 year curve flattened 10 basis points to 200 basis points.

The flooding of the belly of the curve with new supply has battered the 5 year note. The move in the 2 year /5 year/30 year butterfly which it is my custom to follow here is noteworthy. On Tuesday evening that spread closed at negative 56 basis points. As I write this morning the spread is minus 17 basis points. The 5 year note has underperformed the wings of that butterfly by 39 basis points.

Equity markets in Europe have recovered with most indices gaining 1.00 percent to 1.50 percent.

Trading in the futures markets indicates that US stocks will open with sharp gains.

Libor has not set yet but I did receive one missive which suggests that it will set 20 basis points to 30 basis points higher. Additionally, the very wide quote for a Federal Funds opening level is 5.00 percent to 7.00 percent.

It is a light data day here in the States and the initial claims report will capture the attention of participants. The consensus forecasts a decline to 475K from 497K last week.

The Treasury will hold the final two auctions of reopened 10 year paper today. I think that the spread movement in the 5 year note incorporates that supply factor so there should not be any surprise curve shifts in the yield curve today.

Have a great day.