Monday, March 29, 2010

Treasuries – update on the week; potential drivers of the sell-off. $TLT $TBT

         Tresuries sold off hard this week – in the month of Mar alone, 2yr yields have gone from sub-0.8% to nearly ~1.1% as of Thurs before rallying a bit on Fri to close out the week.  The rest of the curve also has been for sale – 10yr yields were up nearly 20bp as of Thurs.  After contracting for the last few weeks, the 2-10 curve widened back out this week (out ~9bp to 2.79% as of Fri). 

         A "good" sell-off?  Recent trends, namely a rising stock market, a stronger dollar, and weaker Treasuries, suggests that Treasuries are selling-off for the "right reasons" (i.e. rising growth expectations and a desire for more risky assets).  If the Treasury weakness was occuring coincindent w/a weaker dollar/rising gold and a sluggish stock market, then budget deficits and inflation could be more of the culprit. 

         Trading color from the TSY desk - Since the results of the 7yr auction hit on Thurs, the flow that we have seen in rates has been almost entirely one-way, w/ real $ buyers coming out of the woodwork from all corners of the globe.  While few seemed to want to buy via the supply process, many seemed comfortable buying after the aucns into qtr-end.  Getting thru Japanese year-end is a relatively important hurdle next week, and as many Japanese investors view the US economic environment right now as similar to their early experience w/ deflation.  We could see more demand to start the quarter, and as such it may be worthwhile to be paring bearish risk and buying the front end for a trade (2s could trade back to 0.95% before attention turns further out the crv) (from B Kinney on the TSY desk). 

         Auctions poorly received this week – there were three coupon auctions this week (2s, 5s, and 7s) and all of them received somewhat tepid demand. 

         Expectations of a more hawkish Fed (impacting more 2s) - despite recent relatively dovish comments from likes of Yellen, Evans, and others, there is a growing sense that the Fed may have to raise sooner rather than later.  There remains talk that the Fed may raise the discount rate again (although Bernanke didn't lay the groundwork for this during his testimony on exit strategies before the House).  Expectations continue to mount ahead of next week's 4/2 BLS report (note the jobs report will be out Fri when US stock markets are closed for Good Friday).  The UCLA Anderson forecast out this said the Fed would be forced to move away from its present 0% rate policy soon.

         Growth optimism (impacting longer yields vs. 2s) - rising optimism re the back half of the year weighing on 10s and 30s. 

         Duration shedding as investors don't want to be locked in @ these rates for as long (related to this was the negative swap spreads seen this week – from BusinessWeek – "The decline in rates to exchange fixed- for floating-rate obligations below comparable maturity Treasury yields indicates demand may be waning for government debt amid record sales"). 

         Concerns that MBS convexity selling about to hit – a combination of higher rates and loan modifications prompting this worry. 

         Fed ending its mortgage buying program this week – it's been a long time since the Fed hasn't dominated the mortgage market.  Part of the selling in TSYs could be an allocation trade as investors are going to start moving back into the MBS market. 

         Anticipation that a stronger yuan (should China move back towards a policy of allowing slight appreciation) will cut back on Chinese demand for TSYs (less need to buy TSYs/dollars to keep its yuan down).

         Budget worries - the HC bill passage this past weekend, along w/improvement in Dems standings in the polls ahead of the Nov elections, raising budget worries.  See Bill Gross' latest market commentary (publioshed on the PIMCO website this week) - " In the U.S. in addition to the 10% of GDP deficits and a growing stock of outstanding debt, an investor must be concerned with future unfunded entitlement commitments which portfolio managers almost always neglect, viewing them as so far off in the future that they don't matter. Yet should it concern an investor in 30-year Treasuries that the Congressional Budget Office estimates that the present value of unfunded future social insurance expenditures (Social Security and Medicare primarily) was $46 trillion as of 2009, a sum four times its current outstanding debt? Of course it should, and that may be a primary reason why 30-year bonds yield 4.6% whereas 2-year debt with the same guarantee yields less than 1%.  The trend promises to get worse, not better. The imminent passage of health care reform represents a continuing litany of entitlement legislation that will add, not subtract, to future deficits and unfunded liabilities"

         Investors continuing to seek out risky assets (this was mentioned by E Beinstein this week) - investors have been reporting that clients shifting some assets out of HG and other conservative fixed income products into equity markets, HY and EM. There are still net inflows into HG accounts but they are slower. This trend is supported by the fund flow data as well. Second, we have been seeing more interest in structured credit as investors search for assets. So far there have been more discussion than transactions, but there have been new risk transactions as well. This is logical given the lack of credit products available across asset classes.

         inflation?  Its not clear that the back-up in yields is due to inflation…..2 of the best market guages for inflation, gold and the TIPS spread, have both trended flat-to-down.  Meanwhile, the dollar has broken out to fresh highs of late.  NEM was actually one of the weakest stocks in the market. 

1 comment:

  1. Treasury sell off was due to the durable goods report last Weds. Look at the 5 day chart at the time of the report and yields haven't looked back