Closing Comments October 8 2008

October 8th, 2008 4:29 pm | by John Jansen |

Prices of Treasury coupon securities gyrated about today and moved sharply lower as Hank Paulson and his minions flooded the belly of the Treasury curve with securities. (I wrote about this in an earlier piece entitled “Is Doctor Heimlich in the Room”.) The Treasury chose to announce the reopening of four issues and to sell the first of those issues within one hour of the announcement. The street was unable to effectively set up for the auctions and so the auctions were sloppy and as I recorded in the earlier piece the cost to the taxpayer was substantial.But wait, as there is an opposing view which springs from either a Machiavellian impulse or finds its antecedents in the belief that shots rang out from the grassy knoll on that Friday in Dallas. Everyone loves a conspiracy and this one holds that this was the Treasury’s way of firing a shot across the bow of those who choose to hold expensive issues for the sole purpose of deriving positive carry in the repo market. The folks who derive profit from that strategy will think twice before they invest in expensive paper as they will not know when the Treasury will pounce again.

The Treasury seeks to move investors and traders into risky assets and out of the safe sanctuary of the Treasury market. Hoarding of Treasury paper is an activity that should be discouraged and the forceful move by the Treasury today seriously punished speculators who had employed this strategy.

So goes that theory. We will never know if it is true but it was offered by an agency trader who is a friend of the blog.

Each of the issues which the Treasury pumped into the market was expensive on the yield curve, and expensive to such an extent, that end users probably would not buy them.

Here are two examples of how much some of this stuff moved following the announcement. I speak to a trader who was short the May 2015 issue and long May 2014 and May 2016 against it. He closed that spread last night at -25. The spread is closing today at + 15 for a shift of some 40 basis points. My friend has happily closed his position.

Similarly, the February 2018 issue which the Treasury will sell tomorrow closed 12 basis points rich to the benchmark 10 year. The supply announcement cheapened that issue by 8 basis points and it is closing 4 basis points through the 10 year.

Yields on benchmark issues jumped dramatically today and the 5 year and 10 year sectors cratered.

The yield on the benchmark 2 year note climbed 16 basis points to 1.61 percent. The yield on the 5 year note suffered ignominious defeat as it soared 23 basis points. The yield on the benchmark 10 year issue rose 18 basis points to 3.69 percent. The Long Bond was the best relative performer as its yield rose just 7 basis points to 4.10 percent.

The 2year/10 year spread steepened 2 basis points to 204 basis points.

The 2year/5 year/30 year butterfly is 39 basis points after closing yesterday at 55 basis points.

Mortgages are a basis point wider to swaps.

Swap spreads are a basis point wider in the 2year sector and 2 ½ basis points tighter in the 5 year sector. Ten year sector spreads narrowed by nearly 8 basis points and 30 year spreads tightened nearly 15 basis points.

There is some interesting stuff playing out in the 30 year sector of the swap curve. There has been chunky receiving in the 30 year sector by pension fund accounts that need duration. Separately, there were certain trades in exotic derivatives, which have gone sour, and has necessitated receiving in the 30 year sector by options desks hedging flattening exposure.

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  1. 3 Responses to “Closing Comments October 8 2008”

  2. By Don on Oct 8, 2008 | Reply

    I would assume that it is in the interest of the Treasury to maintain low rates in order to keep down the cost of borrowing, as the need to borrow increases as supply increases, to cover cost of Fed purchases of assets off banks, CP, etc.

    So . . . would it not be advantageous to encourage hoarding of Ts since what prevails now is a circle jerk – in which Fed loans to banks in exchange for MBS, etc., and said banks then turn around and buy more Ts., to keep the loaning in full play, and thus also supporting the Fed balance sheet to enable the Fed to continue loan programs?

  3. By maynardGkeynes on Oct 8, 2008 | Reply

    Considered in the context of today’s short rate cuts, this clearly is an effort to further steepen the yield curve to increase bank margins and profits. It also gives the FED room to provide stimulus later on when they reach the zero bound on short rates, by re-buying up the long end and flattening the curve.. It’s a bit of a perverse logic, but in this environment, they can probably get away with just about anything. .

  4. By GreenAB on Oct 9, 2008 | Reply

    thanks for the inside john!

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