Across the Curve

Bond Market Close June 01 2009

Prices of  Treasury coupon securities tumbled today as the rally on Friday proved literally ephemeral. The price declines were significant and stemmed from a confluence of events.

In my previous posting I have described the wreckage in the swaps market. The hedging activity which took place in that venue weighed on the Treasury market and contributed to the slide.

I also believe that we are seeing a reversal of the flight to quality. Investors had piled into risk averse government bonds and they are now fleeing them for equities and investment grade corporate bonds. The change of heart could not come at a worse time as it collides with the massive financing  needs of the US Government.

So at the very moment  when supply is cresting, demand is slumping, and slumping badly.

In that connection, there is much chatter in the market place regarding the next move by the Federal Reserve in the QE chess game. Many expect the central bank will rescue market at the next FOMC meeting by taking up the cudgels at that meeting and announcing the purchase of more Treasuries.

That presents an interesting Catch 22 circumstance as those purchases scare off prospective buyers who fear the inflationary impact of those very purchases.

The bottom line is that supply never recedes. The Treasury auctioned $ 101 billion of bonds last week and will announce on Thursday that they will sell something on the order of $ 65 billion next week.

The market is giving testimony that it will take higher yields and a steeper yield curve to accomplish that feat.

The 2 year note was the super star on the yield curve this day. Its yield climbed just 5 basis points to 0.96 percent. The yield on the 3 year note rose 8 basis points to 1.48 percent. The yield on the 5 year note jumped 19 basis points to 2.53 percent. The yield on the  7 year note soared 21 basis points to 3.27 percent. The yield on the 10 year note had its own little mini interest cycle as the yield catapulted 24 basis points to 3.70 percent. The yield on the 30 year bond increased 21 basis points to 4.55 percent.

The 2year/10 year spread widened 19 basis points to 274 basis points which is a whisker away from the record 275 basis points reached last week.

The 5 year note continues to crater versus the wings of the curve as it rests at 44 basis points. I had clocked it this morning at 57 basis points.

The breakeven on the 10 year TIPS is 195 basis points.

The corporate bond market refuses to crack. Trading volume was light but spreads are better by 10 basis points to 20 basis points.