Bond Market Close and a Reminiscence

February 26th, 2009 5:50 pm | by John Jansen |

Prices of Treasury coupon securities slumped and sagged again today as the penurious debt managers at the Treasury replenished their barren coffers. Today was the final leg of a three part issuance cycle which raised the amazing sum of $94 billion.


This auction went well. There was a small tail of about 2.3 basis points. At 100PM the issue was trading in the screens at 2.725 and the auction yield was 2.748. A small tail but when viewed in context of issuance this week an acceptable result.


The indirect bidding category, which folklore holds is a proxy for central bank interest, won nearly 39 percent of the auction.


In spite of that result and in spite of economic data this morning which borders on calamitous the bond market can not get out of its own way. Tomorrow brings month end and a substantial index extension and even with that the market sits within a basis point of cycle lows.


In that regard, I think that the markets have a serious auction and supply problem. David Ader, an analyst at Greenwich Capital, in a piece he wrote this morning talks about the rolling concession which the Treasury market requires to accommodate the issuance.


He notes that the concession building makes the charts look weak and that engenders more selling.


I would like to expand on his thought and suggest that the Treasury market faces the type of risk aversion premium which has inflicted itself upon other sectors of the fixed income world. So, FNMA sold $15 billion 2 year notes today at a 5 basis point concession. That is substantially narrower than they had paid in the last several months but is substantially wider than they would have paid in the heyday of Franklin Raines when new issue concessions were generally in the vicinity of a basis point.


Similarly, corporate bond issuers rarely paid more than a nickel concession to fund themselves. Once again the concessions have narrowed but the fact is the concessions of 25 basis points to 50 basis points are still common place.


I think that an era of unheard of concessions for Treasury issuance is possible too. The funding needs of the Treasury are prodigious and given the details of the budget released today it will only increase in the near term. The wholesale market ( primary dealers) has shrunk in size and the amount of balance sheet available to those in the market has contracted, too.  I think that it is only a matter of time until demand slackens and the Treasury faces 10 basis point and 15 basis point tails on a regular basis (A tail is the number of basis points between the level at which the issue was trading in the brokers market and the level at which the auction stops.)


It has happened in other markets and it seems only logical to me that it should happen in this market also. If that pattern were to develop. I think it would force the hand of the Federal Reserve and would hasten their entry into the market as a buyer of Treasuries.


As an aside I would offer an interesting historical footnote from my days at the Open Market Desk of the Federal Reserve Bank of New York.


In March 1981 the Treasury sold a 2 year note with a 12 5/8 coupon. In the prelude to the auction, the Federal Reserve had entered the market and provided reserves to the system. The street thought that the Federal Reserve was sending a signal for lower rates but thoroughly misinterpreted an action under the still new Volcker policy of managing non borrowed reserves and not interest rates.


The issue went so far underwater that you needed Jaques Costeau and his underwater apparatus to find it.


The following month the street wanted to exact a pound of flesh from the Fed and the Treasury for the huge losses it suffered on the prior month’s 2 year note. The coupon on the April 1981 2 year note was 14 ½ per cent, an increase of nearly 200 basis points from the prior month. More telling and germane to this very lengthy story is that the New York Federal Reserve District did not receive enough bids to cover the auction.


Almost all of the important and large players were located in the caverns of lower Manhattan and when their bids were tallied we could generally calculate reasonably well the auction average without the bids from the other eleven districts. (This is long before we entered the computer age and it would generally take 45 minutes to release a result.)  I can still remember the terror in the voice of the Treasury official on the other end of the phone when I told him the auction had not been covered in New York. If memory serves me well the auction average was 14.49 percent and it tailed back to 14.61 percent. (It was a different bidding process in those days.) Anyway, I think it is possible that the process might once again become very ugly for the Treasury but on a regular basis.


I will publish this very lengthy piece and then a separate sheet with some closing yields.



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  1. 14 Responses to “Bond Market Close and a Reminiscence”

  2. By Alex on Feb 26, 2009 | Reply

    “The issue went so far underwater that you needed Jaques Costeau and his underwater apparatus to find it.”

    That’s got to be one of your funniest quips yet!

  3. By Bman on Feb 26, 2009 | Reply

    John, great story. I remember some pretty big tails on 7-yr auctions back in the 90’s, but nothing like that. Also, David Ader is a good man – spoke with, and followed him quite a bit.

  4. By TA on Feb 26, 2009 | Reply

    Great story. I guess supply does matter despite continued weakness in equities and the worst econ climate in decades. With yields looking like they want to push higher, oversold levels in equities, and continuing Yen weakness, it will be interesting to see if the market can hold here.

  5. By Steve on Feb 26, 2009 | Reply

    If the Fed must, at some point, step in and supply limitless dollars to begin buying all those treasuries, who pockets all that interest? The Fed? It’s member banks? Who is going to become a billionaire from this?

    And it also raises another question that nags my mind: Who would be willing to lend such gargantuan amounts to the U.S. government? Other governments and central banks? And why? I have serious doubts that private funds would want to take on this risk, especially with such unrealistically-low interest rates.

    I read in a Bloomberg article a few months ago that the interest alone on the Federal debt for last fiscal year was $400 billion, if memory serves me correctly. That amount must, at some point, become a mushroom cloud as not only the quantity of debt is increasing in a parabolic pattern, but the rising interest rates are also going to begin to demand an increasingly painful pound of flesh. We saw that somewhat today, as interest rates on treasuries rose to nearly the highest rates since the Fed engaged its verbal intervention when it announced its intent to buy longer-term treasuries.

    What’s the difference between the Fed printing limitless amounts of Dollars and flooding the world with them, versus the Fed printing endless amounts of Dollars and using them to buy treasuries? The only difference I see with quantitative easing is that we have limitless dollars combined with artificially-low interest rates, which is precisely the scenario that contributed most to this imbroglio in the first place. The potential for inflation is obvious, but in a debt deflation environment, one can only wonder! The Fed claims that inflation won’t be a problem, since they aren’t flooding the world with money. They are flooding the world with debt instead!? Will the consequences be different?

    Where will all that money go next? What will be the next bubble?

    I have been asking myself this question for months now, because as an investor, the answer would tell me where next to put my money.

    I was listening to an economist the other day, and he raised the question of what has happened to all those trillions of dollars lost in the stock and housing markets. He said that all that money wasn’t real. He said that it was all just credit. As that credit deflates in value, it would appear to me that all asset classes that were artificially inflated by easy money and easy credit would also experience price deflation as well, despite the best efforts of politicians.

    One scenario that I see is that in this debt deflation, those who have deleveraged and eliminated debt will be in an advantageous position to profit during the coming turmoil because they will have cash to buy cheap assets.

    What other scenarios do the rest of you see unfolding? I’m curiously interested in gathering other perspectives on where this might lead.

    Please forgive the long-winded comment, John.

  6. By Dr.Dan on Feb 26, 2009 | Reply

    Wonderful post Steve and Good Questions as well.

    You said “all that money wasn’t real. He said that it was all just credit”

    Perhaps you could explain more on this. What do you classify as “real money” ? Just cash ?

  7. By Dr.Dan on Feb 26, 2009 | Reply

    From Bloomberg :

    “Yields are headed higher,” Cheong said in an interview. “More issuance will be needed to support the economy.

    Is this the reasoning in the above statement ?


  8. By Rajesh on Feb 26, 2009 | Reply

    I have proposed that the Federal Reserve announce interest rate ceilings for selected Treasury notes. This will reassure bond buyers that the market will not suddenly collapse; that the Federal Reserves is standing by to support prices. If done correctly, the Treasury would get lower interest rates for its borrowings without the Federal Reserve actually buying any securities.

    They would also announce a policy to sell back into private hands any securities that they bought as a result of this policy when rates fall by a certain amount. This would reduce the volatility of Treasury rates.

  9. By Gregor on Feb 27, 2009 | Reply

    I can already hear the maniacal, laughing voice of Vincent Price hovering over future UST auctions.

  10. By Dr.Dan on Feb 27, 2009 | Reply

    I would recommend china buying these and owning Indonesia 🙂

    Look at the yield T+9% ? for a soverign debt !

    Indonesia, Southeast Asia’s biggest economy, sold $3 billion of bonds in the largest dollar debt fundraising by a developing nation this year after offering more than double the premium over U.S. Treasuries it paid in June.

    Indonesia sold $2 billion of 10-year notes to yield 11.75 percent, or 8.759 percentage points more than similar-maturity U.S. Treasuries, according to Barclays Plc, which along with UBS AG arranged the sale. It also sold $1 billion of five-year notes to yield 10.5 percent, 8.474 points above U.S. government debt.

  11. By Dr.Dan on Feb 27, 2009 | Reply

    Indian GDP disappoints but probably is the fastest growing economy in the world

    India’s economy grew a slower than expected 5.3 per cent in the December quarter from a year earlier, slowing sharply from the previous
    quarter’s 7.6 per cent as the global economic crisis cut demand and exports.

  12. By Dr.Dan on Feb 27, 2009 | Reply

    table showing the extent to which
    investors now hold Treasuries and the amount of new Treasuries that these players would have to
    buy if everyone bought the new supply according to their current ownership share.

    would love to see such a table . Any one has got any links pls ?

  13. By K T Cat on Feb 27, 2009 | Reply


    What’s the difference between the Fed printing limitless amounts of Dollars and flooding the world with them, versus the Fed printing endless amounts of Dollars and using them to buy treasuries?

    The difference is in who spends those dollars. If the Fed is buying Treasuries, then the money is spent by the Federal government. I don’t know who spends the money if they flood the world with dollars. That all depends on who gets those dollars.

  14. By TA on Feb 27, 2009 | Reply

    Steve-great post. In regards to your first question. Were the Fed to purchase Treasuries, they would go on the Fed Balance Sheet as an asset along with their other assets (Gold, Agency MBS etc). Hence the Fed would retai the rights to the interest. As long as the Fed BS is in a positive carry situation (assets > liabilities) they usually pass the carry along to congress (seniorage).

    Re: question 2, while many are not “willing” many (most?) don’t have a choice. In a deflationary environment, safety, income, and duration are crucial (see ML/BofA’s economist Dave Rosenberg for more).

  15. By TA on Feb 27, 2009 | Reply

    Dr Dan-Check out Brad Setser’s Blog. I think you will find your answer there:

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