Bond Market Open May 28, 2009

May 28th, 2009 7:03 am | by John Jansen |

Prices of Treasury coupon securities have actually posted solid gains in overseas trading. I do not observe any particular news story which might have prompted the advance but believe that the recent bond market rout has left the market at levels which at least some found enticing or interesting.

The yield on the 2 year note slipped 2 basis points to 0.95 percent. The yield on the 3 year note fell 2 basis points also to 1.48 percent. The belly of the curve had taken the most severe pounding during the recent assault on the sensibilities of bond investors and it has sen the biggest rebound overnight.

The yield on the 5 year note declined 5 basis points to 2.41 percent. The yield on the 7 year note dropped 5 basis points to 3.18 percent. The yield on the 10 year note slid 6 basis points to 3.68 percent. The yield on the still investment grade 30 year bond dropped 4 basis points to 4.59 percent.

The 2year/10 year spread flattened 4 basis points to 273 basis points which means it is resting comfortably at what had been until yesterday 30 year wide levels on that spread.

The 2year/5year/30 year spread is still quite narrow at 72 basis points.

Whither the bond market from here?

There is an auction today of $ 26 billion 7 year notes. The bond market rout of the last several days has seriously damaged the collective psyche of the rentier class. It probably has bureaucrats and apparatchiks in officialdom scratching their heads to discern some solution.

Quantitative ease via purchase of Treasury securities by the central bank is an abject failure. Prior to the announcement of QE the 10 year nottte traded around 3 percent. It experienced a fleeting rally into the 2.40s and subsequently cratered and traded in the 3.70s yeaterday.

A more pressing concern is the mortgage market which broke down yesterday and precipitated the rout elsewhere as portfolio managers who had believed in the efficacy of the Fed’s efforts and had eschewed hedging extension risk did so yesterday with a vengeance.

We have had a massive rout and as I mentioned in an earlier post the massive convexity selling we observed yesterday often signals that the trend is over for awhile. Those who had not hedged have done so and new players own bonds at new (cheap ) prices.

The problem which confronts market participants is that the market has shown itself to be bigger than the concerted action of the Federal Reserve. The Federal Reserve cannot command the market Canute like.

We may stabilize for awhile but the fundamentals of monetary policy and fiscal policy have not been addressed . Until America addresses those issues bond prices will remain under pressure.

At some point the market will force a serious discussion sharp cuts in entitlement spending or more interestingly tax increases to alleviate the problem.

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  1. 12 Responses to “Bond Market Open May 28, 2009”

  2. By Alex on May 28, 2009 | Reply

    Thanks for the tip on convexity selling.

    I like the Canute reference.

  3. By BL on May 28, 2009 | Reply

    The Bloombergers often speak of a return of the “bond vigilantes” — are these creatures of mythology, or are they going to come riding over the horizon shortly?


  4. By bsetser on May 28, 2009 | Reply

    john — if the issue is current not future supply, cuts in future entitlement spending won’t help. social security is still generating a cash flow surplus that is reducing the government’s current borrowing need; lots of entitlement reforms discussed in the past (notably some proposals for private accounts, which reduce soc. sec. inflows w/o cutting current benefits) would have had an upfront budget costs.

    of course if the market is really focused on the world after 2015 not borrowing needs from now til 2015, then entitlement reforms could help, as medical cost growth really will start to hurt and the rest of the government will have to start repaying the money it borrowed from the social security system.

  5. By Stuart on May 28, 2009 | Reply

    So much supply on its way. We’re going to drown in a tsunami of treasuries, so why pay up, especially on the long end.

  6. By martino on May 28, 2009 | Reply

    “We have had a massive rout and as I mentioned in an earlier post the massive convexity selling we observed yesterday often signals that the trend is over for awhile. Those who had not hedged have done so and new players own bonds at new (cheap ) prices.”

    John, pls, could you explain me this logic? I don’t know what is a “convexity selling” and consequently I probably don’t understand rightly which trend is over.Thank you


  7. By Kevin Mackey on May 28, 2009 | Reply

    We are probably going to have to see all of the measures outlines go into effect. With our major lenders shifting into the lower end of the curve, thus indicating their unwillingness to extend their financing longer into the future, we are going to have to continue to entice this crowd to roll over their investments. As time moves on, these countries, mainly China, will (should) have been able to build up some semblance of an internal infrastructure that makes them less dependent on American consumerism. If they have no incentive to park their funds in an indebted country that is debasing their currency, why would they? This then increases the need for internal financing via tax increases, money printing, and spending reductions. When this hits, however, is the biggest uncertainty, for which it seems our politicians are happy to wait, especially if it comes after a new election cycle.

  8. By Bman on May 28, 2009 | Reply

    Bingo. Efforts right now are on Government Sachs, A.I.G.overnment, and Government Motors – of which we all now own a piece of.

  9. By daveinSV on May 28, 2009 | Reply

    In the news today–discussion about implementing a national VAT tax.

  10. By RG on May 28, 2009 | Reply


    Let me echo the request from Martino. For the newbies to your column and bond trading, some sort of reference for many of the concepts that you comment on every day would be helpful. Thanks.

  11. By Greg on May 28, 2009 | Reply

    Brad Setser —

    You follow government numbers pretty closely, so you may know the details of this better than the rest of us:

    When are Social Security and Medicare supposed to go cashflow negative?

    I had heard medicare goes negative later this year or early next?

    And assuming baby boomers do not opt for early retirement in this recession, Social Security goes cashflow negative sometime between 2015 and 2020?

    BTW — I would appreciate it if experts like yourself would stop talking about a social security trust fund. Its an accounting entry and nothing more. An IOU from yourself to yourself is not an asset; and IOU from the government (Congress) to the government (Social Security) is not an asset.

    If the trust fund was not there (which it isn’t), we have to raise taxes, cut spending elsewhere and/or sell debt to pay the benefits.

    If we pretend the trust fund is real, we have to raise taxes, cut spending elsewhere, and/or sell new debt — exactly the position we are in with no “fund”

    There is no trust fund, and if America is going to get itself out of its mess, we need to stop playing along with all the accounting scams of government

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