An Historic Day: September 8 2008

Prices of Treasury coupon securities are closing with modest gains but that belies the wild rollercoaster ride which those securities have taken in the last 24 hours. Sentiment regarding Treasury debt had shifted to the very negative as the rescue package was detrimental to treasuries in a variety of ways. The bottom line belief as the day began was that there would be sellers of risk averse assets to purchase riskier assets. So Treasury debt had a quite soggy tone early.Always expect the unexpected is a fine mantra to follow even in the bond market. The unexpected result was that the massive buying of mortgages unleashed a convexity event which had mortgage servicers scrambling for duration. Analysts at Credit Suisse have concluded that the gap higher in mortgage prices since Friday has created the need to buy the equivalent of $250 billion of 10 year swaps to hedge that risk.

That buying began slowly but picked up pace as the day wore on. Traders report outright buying and receiving in most of the investment grade asset classes.

The yield on the benchmark 2 year note has finished lower on the day by 2 basis points and rests at 2.50 percent. The yield on the benchmark 5 year note is closing 3 basis points lower at 2.95 percent. The yield on the benchmark 10 year note is lower by 4 basis points at 3.66 percent and the yield on the Long Bond has also slipped 4 basis points to 4.26 percent.

The 2year/10 year spread is tighter by 2 basis points at 137 basis points.

The 2year/5 year/30 year butterfly is 65 basis points. In overnight trading when the 2 year note traded at 2.52 percent that spread was 50 basis points.

Mortgages outperformed swaps by about one point in price or about 30 basis points in yield. One salesman made the interesting point that the refi wave,if it happens might be curtailed, because so many of the homes which might be eligible to refi based on the movement in the market, will not be able to do so because the loans in question exceed the value of the house. That will leave lenders with the choice of an unhappy homeowner with negative equity or a happy homeowner after they write down a piece of the loan.

Swap spreads are 8 basis points tighter in the 2 year sector and 11 basis points tighter in the 5 year sector. In the 10 year sector spreads are tighter by about 9 basis points.


Originally published at Across the Curve and reproduced here with the author’s permission.