Prices of Treasury coupon securities slumped and sagged again today as the penurious debt managers at the Treasury replenished their barren coffers. Today was the final leg of a three part issuance cycle which raised the amazing sum of $94 billion.
This auction went well. There was a small tail of about 2.3 basis points. At 100PM the issue was trading in the screens at 2.725 and the auction yield was 2.748. A small tail but when viewed in context of issuance this week an acceptable result.
The indirect bidding category, which folklore holds is a proxy for central bank interest, won nearly 39 percent of the auction.
In spite of that result and in spite of economic data this morning which borders on calamitous the bond market can not get out of its own way. Tomorrow brings month end and a substantial index extension and even with that the market sits within a basis point of cycle lows.
In that regard, I think that the markets have a serious auction and supply problem. David Ader, an analyst at Greenwich Capital, in a piece he wrote this morning talks about the rolling concession which the Treasury market requires to accommodate the issuance.
He notes that the concession building makes the charts look weak and that engenders more selling.
I would like to expand on his thought and suggest that the Treasury market faces the type of risk aversion premium which has inflicted itself upon other sectors of the fixed income world. So, FNMA sold $15 billion 2 year notes today at a 5 basis point concession. That is substantially narrower than they had paid in the last several months but is substantially wider than they would have paid in the heyday of Franklin Raines when new issue concessions were generally in the vicinity of a basis point.
Similarly, corporate bond issuers rarely paid more than a nickel concession to fund themselves. Once again the concessions have narrowed but the fact is the concessions of 25 basis points to 50 basis points are still common place.
I think that an era of unheard of concessions for Treasury issuance is possible too. The funding needs of the Treasury are prodigious and given the details of the budget released today it will only increase in the near term. The wholesale market ( primary dealers) has shrunk in size and the amount of balance sheet available to those in the market has contracted, too. I think that it is only a matter of time until demand slackens and the Treasury faces 10 basis point and 15 basis point tails on a regular basis (A tail is the number of basis points between the level at which the issue was trading in the brokers market and the level at which the auction stops.)
It has happened in other markets and it seems only logical to me that it should happen in this market also. If that pattern were to develop. I think it would force the hand of the Federal Reserve and would hasten their entry into the market as a buyer of Treasuries.
As an aside I would offer an interesting historical footnote from my days at the Open Market Desk of the Federal Reserve Bank of New York.
In March 1981 the Treasury sold a 2 year note with a 12 5/8 coupon. In the prelude to the auction, the Federal Reserve had entered the market and provided reserves to the system. The street thought that the Federal Reserve was sending a signal for lower rates but thoroughly misinterpreted an action under the still new Volcker policy of managing non borrowed reserves and not interest rates.
The issue went so far underwater that you needed Jaques Costeau and his underwater apparatus to find it.
The following month the street wanted to exact a pound of flesh from the Fed and the Treasury for the huge losses it suffered on the prior month’s 2 year note. The coupon on the April 1981 2 year note was 14 ½ per cent, an increase of nearly 200 basis points from the prior month. More telling and germane to this very lengthy story is that the New York Federal Reserve District did not receive enough bids to cover the auction.
Almost all of the important and large players were located in the caverns of lower Manhattan and when their bids were tallied we could generally calculate reasonably well the auction average without the bids from the other eleven districts. (This is long before we entered the computer age and it would generally take 45 minutes to release a result.) I can still remember the terror in the voice of the Treasury official on the other end of the phone when I told him the auction had not been covered in New York. If memory serves me well the auction average was 14.49 percent and it tailed back to 14.61 percent. (It was a different bidding process in those days.) Anyway, I think it is possible that the process might once again become very ugly for the Treasury but on a regular basis.
I will publish this very lengthy piece and then a separate sheet with some closing yields.