Closing Comments July 31 2008

July 31st, 2008 4:40 pm | by John Jansen |

Prices of Treasury coupon securities surged today, as investors responded to weaker than expected economic data by driving bond yields lower. The main focus was the GDP data and the initial claims data.GDP was less than anticipated and prior periods were revised down with Q4 2007 showing outright contraction.

The initial claims data and the continuing claims series spiked higher and point to pervasively weak conditions at the current time. The Labor Department noted that a new emergency claim program might have distorted the data and it might take several weeks for the noise to clear from the data.

Economists at UBS note that the continuing claims series jumped 185K and since that series lags the initial claims data by a week it is harder to dismiss that jump in that series.

The yield on the benchmark 2 year note has dropped 12 basis points and rests at 2.51 percent. The yield on the benchmark 5 year note has dropped a like amount and currently sits at 3.24 percent. The yield on the benchmark 10 year note fell 9 basis points to 3.95 percent. The yield on the Long Bond dropped 6 basis points to 4.58 percent.

The 2year/10 year spread has widened to 144 basis points.

The 2year/5year/30year butterfly has moved to 61 basis points. On July 23 that spread closed at 42 basis points as the market underwrote 2 year and 5 year supply. It has outperformed the wings by 19 basis points.

There was a smattering of month end buying today as well as buying from investors short their various benchmarks. (One benchmark, an important one, is keeping your seat.) One Long Bond trader who is a regular contributor to the conversation noted that clients are short and that he did see active buying today. He also believes that the strong rally today has “defanged” the impact of the labor report tomorrow.

I would disagree and believe that a weak number tomorrow will bring lower yields and strong participation from investors. I would posit the view that the employment data tomorrow is an inhibiting factor today and has actually led to some restraint. Bond friendly data tomorrow will be a seductive glass of wine  which dissolves the restraint and inhibition investors experienced today.

Mortgages are finishing about 2 ticks wider to Treasuries.

Corporate bond spreads are about unchanged. The IG 10 is closing 131/132. That is a stellar performance in the face of the 200 point decline in equities and indicates, to me, that there is a substantial short in the index.

I had a long conversation with a seasoned corporate bond salesman with a flair for the dramatic. He says that in that market “apathy, illiquidity and dislocation reigns supreme”.

He offers an example via a trade which he has been unable to print. An investor can sell the IBM 4 ¾ bond due 11/29/12 and extend to the IBM 7 ½ of 06/15/13 for a pickup of 50 basis points. The shorter issue is $1.4 billion and the longer issue is $550million. There is some step up in coupon and there is some credit curve.

But the Treasury yield curve between the 2 year note and the 5 year note is about 73 basis points. In this case you get 50 basis points for a 6 ½ month extension. That is a dislocation.

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