Fixed Income Economics
April 8, 2009 Provided by MF Global
Treasury Market Commentary
The Treasury curve saw a solid bull flattening move Wednesday, as the long end held good gains into the close after a decent morning rally while the short end fell back from morning gains after a smaller than hoped for round of Fed buying in the 1-year to 2-year sector. A solid 3-year auction subsequently helped give the shorter end a lift off the lows in the afternoon, however. At Monday’s close, yields at the longer end had been threatening to move through the levels seen ahead of the Fed’s March Treasury buying plan announcement, but there’s been a decent recovery over the past couple days. TIPS continued to struggle somewhat in relative terms after Tuesday’s sloppy 10-year auction, but otherwise the market is dealing with this week’s run of supply a lot better than it has in recent prior weeks of heavy issuance, which now occur mostly on an every-other-week schedule, though of course this week’s run of $59 billion in coupon supply has been quite a bit less to deal with than the record $98 billion flood a couple weeks ago. Beyond the focus on new supply and Fed purchases, the more notable story in interest rate markets this week continues to be the strong performance of mortgages, which had another great day Wednesday to take rates on current coupons back to the lows since early January hit early last week before some weakness seen over the back half of last week. Mortgage origination activity remains healthy, but it has moderated to the point that it is now starting to be regularly far outpaced by heavy daily Fed buying -- though given that the recent rally in the MBS market will send mortgage rates significantly lower and likely further ramp up refinancing activity, this recent positive market balance might at least temporarily reverse going forward. Meanwhile, risk markets were mixed and had little impact on interest rate market activity. It was also another light day for economic news in this very quiet week for data, though there will be some notable reports out Thursday to wrap up this short week. Wholesale inventories fell a lot more than expected in February, but we took a look at our inventory inflation assumptions and ended up not altering our first quarter GDP estimate much, raising it marginally to -5.9% from -6.0%. The Fed also released the minutes from the March FOMC meeting, at which the sharply ramped mortgage and agency buying plans were announced and the Treasury purchase plan introduced, but there wasn’t anything particularly notable in the content of the minutes to shed new light on the Fed’s thinking.
At 3:00, there was a substantial flattening of the Treasury curve on small short end losses and significant long end gains. The 2-year yield rose 1 bp to 0.94%, while the 3-year yield fell 2 bp to 1.30%, 5-year 3 bp to 1.83%, 7-year 7 bp to 2.43%, 10-year (lagging marginally on the curve ahead of Thursday’s auction) 6 bp to 2.85%, and 30-year 7 bp to 3.66%. TIPS did okay in absolute terms, but except at the long end lagged nominals. The 5-year TIPS yield rose 2 bp to 0.97%, while the 10-year fell 4 bp to 1.52% and 20-year 8 bp to 2.12%. While still towards the upper end of the range seen over the last seven months, the benchmark 10-year inflation breakeven has come in 13 bp to 1.33% since the close ahead of Tuesday’s auction. Mortgages extended what’s been a great week, again significantly outperforming Treasuries, with 4% and 4.5% MBS rallying about 10 ticks to reverse last week’s bout of weakness and bring yields back down towards three-month lows. Agencies performed more in line on the day after strong outperformance earlier in the week, but the pricing of a new $6 billion 2-year issue met very good demand.
It was a mixed day for risk markets that was largely ignored by Treasuries. Stocks were about unchanged at the futures close, but the S&P 500 caught a late bid to end up 1.2%. Credit markets didn’t follow along with this late equity upside, and the investment grade CDX index was trading about unchanged at 190 bp in late trading having closed right near this level for four straight days now. The high yield index, on the other hand, had been seeing a bit of upside through the first couple days of the week, but was also moving back closer to unchanged levels after a half point sell off Wednesday. Meanwhile, the subprime ABX and commercial mortgage CMBX markets extended Tuesday’s sell off. Wednesday’s losses were at least smaller than Tuesday’s, but this was still enough to leave the AAA ABX index (23.10 v. 23.13) and every CMBX index except the AAA (which widened 3 bp for a 54 bp sell off so far this week to 625 bp) at another round of all-time lows. Lack of traction in the TALF is certainly not helping boost sentiment that the Treasury’s other legacy asset purchase plans will work any better. The Fed released the latest results of the monthly TALF allocations Tuesday evening, and the outcome managed to be far worse than the already disappointing initial numbers in March. Only $1.7 billion in TALF loans will be made this month after the weak $4.7 billion in loans that started the program’s monthly distributions in March. At the current average rate of monthly loans over these two months, it would take 26 years to reach the $1 trillion goal for the program. It’s probably too soon to call this program a failure, but it won’t be too long if demand doesn’t start to greatly accelerate in coming months. Perhaps the program will begin to gain some traction when the range of assets covered expands as part of the Treasury’s legacy securities purchase program, with hopes in particular that the coming expansion to include CMBS will prove more interesting to investors than the current focus on consumer ABS. It’s possible that investor disinterest could prove more protracted, however. It was noted in the FOMC minutes that some Fed officials “saw a risk that private firms might be reluctant to borrow from the TALF out of concern about potential future changes in government policies that could affect TALF borrowers.”
The latest Fed coupon pass was another small operation, with just $3 billion in buying of securities maturing between April 2010 and February 2011. This followed Monday’s $2.5 billion operation in August 2019 to February 2026 maturities. The emerging pattern seems to be that the buying is much lighter when it strays outside of the 2-year to 10-year maturity range that the Fed said would be the focus of the operations, as the three rounds of buying in that part of the curve have been $7.5 billion, $7.5 billion, and $6 billion. In Wednesday’s operation, only six of the 25 eligible securities were purchased, with the largest buying in the 11/30/10 ($0.9B), 12/31/10 ($0.8B), and 4/15/120 ($0.6B) issues. The market was nonplussed by how small Wednesday’s buying was, with the short end taking a sizable hit after the results were announced that reversed decent earlier gains. There was an enormous $31 billion in offerings, a new high, against only $3 billion in buying, so clearly dealers had been hoping to unload a lot more paper than the Fed wanted in this maturity range. That wraps up Fed Treasury buying for this week. There will be three more rounds next week, in the 2-year to 3-year range Monday, 4-year to 7-year Tuesday, and TIPS Thursday. Agency buying will probably take place on one of the Treasury off days on Wednesday or Friday, while mortgage purchases continue to steadily run at a heady $6 billion a day or so pace. The Fed did not announce an agency purchase for Thursday, so there will be no agency buying this week. There were two rounds of agency purchases last week, however, so apparently buying was front loaded because of the holiday this week that will result in the 10-year Treasury auction being held early Thursday.
The 3-year note auction results were in line with prior results for this issue since it returned in November, which was good enough to give the market a lift after the results were announced. The $35 billion issue was awarded at 1.385%, close to expectations. The overall bid/cover of 2.42 was close to the average seen since the revival of this issue, and participation by final investors was again solid, with indirect bidders receiving 38.5% and direct bidders another 3.0%. This week’s $59 billion in coupon supply finishes up Thursday with the $18 billion reopening of the 10-year note.
Wholesale inventories plunged 1.5% in February and sales posted a small 0.6% uptick after collapsing at a 31% annual rate during a run of seven straight prior declines. This allowed the inventory/sales ratio to move down to 1.31 after what had been a near vertical run-up from the record low of 1.10 hit in June to an eight-year high of 1.34 reached in January. The majority of the decline in inventories in February was in motor vehicles, as a collapse in production has allowed automakers to make some progress in getting supplies under control even as sales have hit generational lows. Miscellaneous durable goods were the biggest contributor to the small recovery in sales. Machinery sales also rebounded somewhat after a record plunge in January. The drop in wholesale inventories was larger than we expected, but we also made some adjustments to our price assumptions for Q1 inventories. As a result, we didn’t change our Q1 GDP forecast much, raising it marginally to -5.9% from -6.0%. The inventory drag in Q1 is likely to be enormous, on the order of 2.5 percentage points. So even though in absolute terms the continued inventory liquidation in Q2 is likely to be huge, as inventories remain bloated across the economy, it will probably not be as severe as in Q1 and could provide some technical support to Q2 GDP growth numbers.
There’s an early close Thursday ahead of the Good Friday holiday, but all of this week’s small amount of key economic data will be released during the shortened trading session. Most major retailers will report monthly sales results for March. March and April numbers are usually difficult to interpret because of shifts in the timing of Easter -- with a move to a later Easter this year expected to significantly negatively impact March comps -- but underlying results are expected to be soft. The trade deficit for February will also be released and could have meaningful impact on Q1 GDP estimates. We’ll also get what’s likely to be another miserable jobless claims report as we move closer to the survey period for the April employment report.
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