Fixed Income Economics
April 6, 2009 Provided by MF Global
Treasury Market Commentary
The Treasury curve saw a substantial steepening move Monday in a slow start to what should be quiet, holiday-shortened week as the front end was supported by a stock market sell off -- though more substantial weakness through much of the day was largely reversed in a late recovery -- while the rest of the market came under pressure ahead of the latest biweekly flood of supply and perhaps some disappointment at another relatively small Fed buying operation at the long end. This week’s total issuance in 10-year TIPS, 3’s, and 10’s at $59 billion over the next three days will be far smaller than the record $98 billion flood of 2’s, 5’s, and 7’s a couple weeks ago, but will clearly still be substantial. And with only two Fed buying operations this week, the first of which Monday was at the long end and was again much smaller than purchases further in on the curve, that offset to the new issuance this week will be relatively small. On the positive side, with Treasuries being weighed on by supply primarily, mortgages rallied and substantially outperformed, posting modest gains on the day. There were no economic data releases Monday and very little the rest of the week either, with focus on Thursday’s release of monthly chain store reports and the trade balance.
At 3:00, 2’s-30’s was 6 bp steeper on small gains at the front end and moderate losses at the back end (which were more substantial relative to Friday’s late level after a decent move higher after the futures close that ended last week’s trading). The 2-year yield fell 2 bp to 0.96%, while the 3-year yield rose 1 bp to 1.36%, 5-year 1.5 bp to 1.90%, 7-year 2 bp to 2.55%, 10-year 3 bp to 2.94%, and 30-year 4 bp to 3.75%. The market had been doing a lot better through most of the day with help from the weakness in risk markets but saw a long end led sell off in the afternoon. Even with the 10-year TIPS reopening kicking off this week’s auctions on Tuesday and commodity prices seeing broad weakness, TIPS surprisingly substantially outperformed. The 5-year TIPS yield fell 7 bp to 0.91% and 10-year 2 bp to 1.49%, while the 20-year rose 2 bp to 2.20%. That moved the benchmark 10-year inflation breakeven back up to within a couple bp of the six-month high of 1.48% hit a week and a half ago. Current coupon 4% mortgages rallied a few ticks to significantly outperform Treasuries and more so compared to a widening in swap spreads and rise in volatility.
Risk markets mostly traded down Monday and helped support the shorter end of the Treasury market, though bigger losses through much of the day were partly reversed by a late rebound. The S&P 500 lost 0.8% led by a 3% drop in financials, though this represented a decent recovery from midday losses that peaked at 2.3%. Credit did better. The investment grade CDX index saw a recovery from small losses as stocks rallied, ending little changed near 189 bp, while the high yield index swung from a modest decline on the day to a small rally. The leveraged loan LCDX index also managed to pare larger midday gains to only a small loss by the close. On the other hand, the subprime ABX market extended its terrible performance seen after a brief, small bounce that followed the announcement of the Treasury’s toxic asset purchase plan. The AAA ABX index fell to 23.60 from 23.98, very close to the record low hit last week. The commercial mortgage CMBX market saw a bit of weakness Monday, but while off the post-Treasury announcement tights at least continues to manage to show substantial net gains since the plan was introduced, as investors figure this sector will benefit far more than subprime. The AAA CMBX index widened 6 bp to 577 bp on the day, up from the tight of 525 bp hit March 26, but still a good bit better than the 747 bp close on March 20.
The first of the Fed’s two Treasury purchases this week was at the longer end of the curve. Like last week’s long end buying, the operation was much smaller than the others so far at $2.5 billion again. Investors were more prepared for the smaller size this time after significant disappointment last week and there was no negative reaction to the operation initially. Still, the smaller buying may have weighed on the market somewhat in the afternoon as the long end sell off kicked in, as dealers lightened positions they were unable to offload to the Fed. The target maturity range of August 2019 to February 2026 was at the shorter end of the bond sector and buying was heaviest at the shortest end of this range, with a $1.1 billon purchase of the 8/15/19 issue by far the biggest. Substantial buying of around $400 million each was also done of the 8/15/20, 2/15/23, and 8/15/23 issues. The second round of buying this week on Wednesday will be at the short end in the 4/15/10 to 2/28/11 maturity range.
Treasury announced a $35 billion 3-year and $18 billion reopening of the 10-year for auction Wednesday and Thursday. The 3-year size was boosted by $1 billion, a bit less than the $2 billion increase we anticipated, while the 10-year size was unchanged, as expected. Combined with the $6 billion 10-year TIPS reopening on Tuesday that was announced last week, gross coupon issuance this week will be $59 billion, a hefty amount but at least a good bit smaller than the record run of $98 billion in 2’s, 5’s, and 7’s a couple weeks ago. This week’s issuance will refinance $15 billion in maturing issues, so net issuance will be $44 billion. The second round of Fed buying on Wednesday will probably be a lot bigger than Monday’s operation since it is at the short end, so total Fed Treasury coupon buying this week will probably be about $10 billion versus this $44 billion in net issuance.
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