Closing Comments January 5 2009

January 5th, 2009 5:41 pm | by John Jansen |

Prices of Treasury coupon securities registered very bifurcated results as the first fully staffed trading session of the new year produced a rout in the long end. Investors returned from the holidays with the animal spirits racing and poured money from risk free assets into riskier fixed income assets.The yield on the 2 year note declined 2 basis points to 0.80 percent. The yield on the 3 year declined a basis point to 1.07 percent. The yield on the 5 year note glided ever so slightly higher by 4 basis points at 1.69 percent. The yield on the 10 year note jumped 11 basis points and the yield on the Long Bond catapulted 24 basis points and sliced right through the 3.00 percent level to finish at 3.03 percent.

The 2 year/10 year spread widened 13 basis points to 168 basis points.

The 2 year/5 year /30 year spread closed the day at 45 basis points after opening at 27 basis points.

The flight from risk averse assets into riskier and less liquid paper manifested it self in the Treasury market. I have chronicled here over the last couple of months the story of several off the run bonds which had become extremely cheap on the curve or had recounted instances of off the run issues which had had produced strange relationships.

As an example the 8 1/8 August 2019 bond has traded as much as 70 basis points cheap to the 10 year note. The 10 year note is a November 2018 maturity and there is no reason why one should pick up 70 basis points for a three month extension. That spread narrowed 6 basis points today and has narrowed over the last several days to 57 basis points.

Then there is the story of the August 2023 bond and the November 2024 bond. The yield curve is positively sloped in which case rolling back on the curve should cause one to give up Not so in the relationship between these bonds. That spread had been such that you could sell the 2024 and roll backwards to 2023 and pick 36 basis points. That spread is 28 basis points today.

If the Fed is serious about keeping the funds rate at zero (and they are) then these and numerous other anomalies along the Treasury curve will correct as yield hogs scour the curve for incremental value.

Money managers continue to buy MBS and paper is closing about ½ point tighter to Treasuries.

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  1. 6 Responses to “Closing Comments January 5 2009”

  2. By paul on Jan 5, 2009 | Reply

    hey john, do you think the trend out of treasuries will continue? is this the start of a possible pop in the treasury bubble (if you believe there is a bubble)?

  3. By mxq on Jan 5, 2009 | Reply

    alea pointed out a good article in ft about this…,s01=1.html

    in short: “Investors who purchase long-dated Treasuries at current prices are betting that a determined man with the dollar printing press will fail in his battle against deflation.”

  4. By alex on Jan 5, 2009 | Reply

    I took this from the Alea blog, thought readers here might be interested;

    Another bubble is brewing – bonds
    By Edward Chancellor

    Published: January 4 2009 18:27 | Last updated: January 4 2009 18:27

    Central bankers around the world have promised to pay more attention to the dangers posed by asset price bubbles. Yet they seem unable to refrain from inflating new ones. The recent surge in the market for US government bonds has several characteristics of a classic bubble.

    A bubble is defined by extreme overvaluation. Ten-year Treasuries with yields at half-century lows meet this description. The current yield of little more than 2 per cent provides no protection against the return of inflation any time over the next decade. In normal times, there would be no argument that Treasuries are overpriced. These are not normal times, however.

    Madoff drama sounds a death knell – Dec-21Annus horribilis for the star investors – Dec-14The dysfunctional Mr Market family – Dec-07Equity aversion good news for bonds – Nov-30Why it’s crucial to invest debt wisely – Nov-23Poor performing CTAs in the spotlight – Nov-09Another essential attribute of a bubble is that it should be sold with a great story. A decade ago, overblown expectations for internet commerce fuelled the technology boom.

    Today’s great hype is deflation. Tales of global recession and collapsing financial markets are embroidered with lurid narratives from the 1930s and Japan in the 1990s. This bubble is motivated by fear rather than greed. Investors are seeking to protect themselves against deflation and declining stock markets by blindly acquiring “risk-free” government bonds.

    The behaviour of institutional investors also contributes to the bond bubble. Pension funds, insurers and others have sold off toxic securitised triple-A rated bonds and replaced them with Treasuries. Government bonds are also attractive for diversification purposes since they have held up while just about everything else in their investment portfolios has collapsed. Many of the more sophisticated bond bulls are playing a “greater fool” game. Like dotcom speculators of the late 1990s, they know there is a danger the market will sell off at some time in the future. Nevertheless, they are staying for the ride and hope to bail out before it is too late.

    A common feature of great bubbles is that they enjoy the support of the authorities. In 1720, the public acquired shares in the South Sea Company secure in the knowledge that the bubble was promoted by the government of the day.

    Today’s bond buyers place their faith in Ben Bernanke. The Fed chairman has long made it clear he sees low long-term rates as a tool for combating deflation. In December, the Fed announced it was considering purchasing government bonds. Just as the “Greenspan put” emboldened stock speculators a decade ago, the “Bernanke put” has placed an apparent floor under the market for Treasuries.

    The deflation story that drives the current bond bubble is more plausible than the dotcom pipe-dreams of yesteryear. Deflation is sparked by a combination of bank losses and tighter lending standards, increasing risk aversion and a rise in the demand for money, falling household consumption and higher savings, together with mounting unemployment and a widening output gap. All these conditions pertain today. If this crisis were left to its own devices, the result would likely be a pronounced and prolonged decline in the price level as occurred in the early 1930s.

    However, the authorities are not standing by idly. Instead, the Fed is bolstering the credit markets in numerous ways and has cut short-term rates to near zero. Some $7,200bn (£4,930bn, €5,150bn) has been pledged to support the US financial system, of which $2,600bn has already been spent. Although bank lending is currently stagnant, the monetary base climbed by 775 per cent in the year to November.

    Broader monetary aggregates are also expanding. The St Louis Fed’s MZM measure climbed 11.2 per cent over the past year. Nor is there evidence of widespread deflation in the economy. Although, the consumer price index has started to fall, only transportation has showed a pronounced decline. There is also the fiscal response to consider. Morgan Stanley projects that in 2009 the gross US fiscal deficit, including asset purchases from the private sector, will exceed 10 per cent of GDP.

    Mr Bernanke gained his moniker “Helicopter Ben” after his famous November 2002 speech in which he outlined the various ways by which the authorities could combat deflation. “The US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices of those goods and services,” stated the former Princeton economist and future Fed chairman.

    “We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” Investors who purchase long-dated Treasuries at current prices are betting that a determined man with the dollar printing press will fail in his battle against deflation.

    Edward Chancellor is a member of GMO’s asset allocation team

  5. By Joe on Jan 5, 2009 | Reply

    Isn’t it interesting how a “pivot point” is forming in treasuries. In TIPS, all TIPS under 8 years rose today. Everything longer got annihilated.

    What’s my point? Buying something that is going up (following a trend) isn’t a bubble; buying something that has become overvalued just because it is going up is a bubble. It appears the market is starting to get a grip on how long this mess will take to play out: less than a decade. T-notes that far out are in a bubble.

    It seems the media, like lemmings, all figured this out simultaneously. (Maybe they read each other. Bloomberg and Barron’s also had bond bubble articles today.)

    My summation of what the lemmings, err.. reporters, are finally realizing (I’m such a simpleton): beating this alleged deflation is easy: do not confuse forced asset sales with deflation.

    Forced asset sales are everywhere, from billion dollar hedge funds selling silos full of grain to meet redemptions, to my local market that yesterday told me all ice cream is now 70% off.

  6. By Al on Jan 6, 2009 | Reply

    Forced asset sales or no forced asset sales, now it does not matter, the outcome is going to be the same- depression. And for some people it’s already here.
    No jobs, no incomes, and no spending. Only Divine intervention could help out here, probably.

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