Closing Comments October 23 2008

October 23rd, 2008 4:56 pm | by John Jansen |

Prices of Treasury coupon securities posted bifurcated results today with shorter maturities losing ground while longer dated maturities were unchanged or sharply higher in price.I think that the by word of the day is illiquidity and it remains a constant refrain from the traders with whom I speak.

The 30 year swap spread traded negative today for most of the day. That means that the receiver on a swap is willing to accept several basis points less in yield on the fixed leg of a 30 year swap than he could have earned on the 30 year Treasury Bond. That is nuts!

The story is that there are still bad positions in exotic derivative trades and the dynamic hedging of those positions has forced huge receiving in 30 year swaps. There has also been receiving by some pension funds.

The 30 year Treasury benefits from that flow because the swap trader will often turn to the Treasury market to hedge the duration risk created by the swap market transaction. That leaves the trader long Treasuries versus swaps and that position can be unwound over time.

The 30 year bond yield dropped 12 ½ basis points today and the yield on the 10 year note dropped 8 ½ basis points. (These yield changes are based upon one trader’s 300PM marks and might be different from what I will post here later because I use Bloomberg levels.) On that basis the curve flattened 4 basis points.

However, the same trader noted that the Bond Contract which captures the 20 year part of the Treasury curve actually declined in yield by 17 basis points and outperformed both the 10 year and the 30 year cash securities.

That performance by the bond contract is indicative of forced unwinds and is a manifestation that economics and fundamentals have taken a backseat to finding room on the balance sheet.

One more example someone shared with me is located on the short end of the curve. There is a note which matures on January 15 2010 and another note which matures January 31 2010. They are essentially the same maturity. You can sell the January 15 and buy the January 31 and pick up 15 basis points of yield.
So I hope that you can see that it is a circus in the once rational and highly liquid treasury market. As many traders have said to me, it is the last trade that governs price changes. That will be the case until confidence is restored and arbs can warehouse positions. In the meantime, relative value types shall proceed with caution.

Using Bloomberg levels the yield on the 2 year note has climbed 2 basis points to 1.52 percent. The yield on the 5 year note is higher by 3 basis points to 2.56 percent. The yield on the 10 year note is unchanged at 3.60 percent and the yield on the Long Bond fell 6 basis points to 4.00 percent.

The 2year/10 year spread narrowed 2 basis points to 208 basis points.

Mortgages lagged swaps by 12 ticks.

Two year swaps widened 6 basis points to 115 basis points. Five year swaps widened a basis point to 97 ½ and ten year swaps widened 1 basis point to 42 basis points. Thirty year swap spreads narrowed 4 ¼ basis points to close at NEGATIVE 1 ½.

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  1. 6 Responses to “Closing Comments October 23 2008”

  2. By jd on Oct 23, 2008 | Reply

    re: swap spread at -1 1/2 pts:
    i am new to this segment of finance- why is that nuts? could it be due to counterparty risk? lack of balance sheet room? etc?
    help me here…thanks

  3. By s on Oct 23, 2008 | Reply

    JJ

    Can you discuss this whole fail issue and the article pon bloomberg (Alea) and jesse cafe touch on it. The later claims that the fails are being done deliberately by the prim dealers so as to not pay the finance cost – kind of a free float (naked shorting kind of thing). Is it that people are buying treas and simply not allowing them to be lent out, hence the repo is special? Would love a good expalanation..

  4. By darkmatter on Oct 24, 2008 | Reply

    i would like to know how you would have positioned last week. and i would like to know how you would have fared this week.

    i love your commentary but i think we are at a point where “what worked before” is not working now.

    how long this can continue is anyone’s guess.

    but if we continue to see “things that have not happened before” and we see them every week, in some cases every day, then what are the “knowns” we are going to have to give up to face the markets today.

  5. By Mark on Oct 24, 2008 | Reply

    John,

    Just read this, care to comment?

    http://www.ft.com/cms/s/0/3b8ebf34-a14e-11dd-82fd-000077b07658.html

  6. By Alex on Oct 24, 2008 | Reply

    Volvo Cuts Truck Market Outlook After Demand Slumps

    Volvo AB, the world’s second-largest maker of heavy trucks, cut its industry growth outlook for this year after curtailing production as demand slows and some customers struggle to finance the purchase of new equipment.

    Volvo said it received 115 order bookings for heavy trucks in Europe in the quarter, down from 41,970 trucks a year earlier.

  7. By John Jansen on Oct 24, 2008 | Reply

    I was long 10 year Treasury and mistakenly sold them out in the 3.90s.

    I realized the error of my ways and I am short the stock market with the S and P around 925. That trades looks pretty good right now.

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