Prices of Treasury coupon securities sagged today and the severest drubbing was in the longer dated securities. Let me record some yield changes and curve shifts and then I will delve into the causes of the price action.
The yield on the 2 year note increased 2 basis points to 0.94 percent. The yield on the 3 year note increased 4 basis points to 1.48 percent. The yield on the 5 year note increased 6 basis points to 2.40 percent. The yield on the 7 year note increased 7 basis points to 3.10 percent. The yield on the 10 year note climbed 6 basis points to 3.54 percent and the yield on the Long Bond also climbed 6 basis points to 4.45 percent.
The 2year/10 year spread widened 4 basis points to 260 basis points.
The 10 year/30 year spread is 91 basis points.
The 2year/5 year /30 year spread is 59 basis points.
So why the soggy bond market and why the steeper yield curve today?
I think that there is a two pronged and somewhat delayed reaction to the Bernanke testimony of yesterday. I think that one can conclude from the testimony that the Federal Reserve is very, very serious about keeping the funds rate at very low levels for an extended period of time. There paramount concern ( and one can argue about whether they are right or wrong) is to jump start the economy and to prevent weak labor markets from initiating a round of Japanese style deflation.
Against that background holders of longer dated assets are feeling some trepidation, pain and angst and have chosen to exit some positions.
The Federal Reserve stance on keeping the funds rate at or near zero is also a positive force for the 2 year and 3 year part of the curve. Currently, the 2year note trades at about negative 25 basis points in the repo market.
Positive carry is a very potent force. Against a Negative 25 basis point repo rate the breakeven yield on the 2 year note a year from now when it has travelled down the curve to the one year point is 2.50 percent. (Someone calculated that for me seat of the pants so it is probably not totally precise.)
The salient point is that with the funds rate at zero for “an extended period” the carry gains are immense and one has lots of wiggle room if he or she guesses wrong.
Foreign central banks have also become traders. Sources report that some of the bigger players view the range on the 10 year note as 3 5/8 to 3 1/4. In the upper 3.40s they are rather indifferent as they follow the advice of Polonius to Laertes and choose to refrain from borrowing or lending. Those clients are on a buyers strike until the 10 year trades in the upper 3.50s which would place it in the back end of their perceived range and make them comfortable buyers.
Separately, another trader felt that the final thrust on the 10 year note was led by servicers with convexity needs and with their appetites sated there is no significant bid from that quarter.
Tomorrow the treasury will announce 20 year TIPS, 2 year notes,, 5year notes and 7 year notes. Estimates are for a package of about $ 110 billion which would be the largest financing package since man learned to walk erect.
The 2year note should be around 5 1/2 basis points. The 5 year roll and the 7 year roll are predicted to be about 3 1/2 basis points.
Have a great evening.