As MG described last night...dealers took home a few more long bonds than they were expecting to be awarded. Today, they are trying to give them back...and the long end of the yield curve is getting punished as a result. I will argue that the steepening yield curve has nothing to do with duration...instead I put the blame solely on ALCOA!!!! (haha note sarcasm please)
The aftermath of yesterday's duration shedding which has carried over into today: LOTS OF REPRICES FOR THE WORSE AND HIGHER MORTGAGE RATES. Sorry dont mean to rub it in your face with the large size bold print, but I think it was necessary evil in the process of accepting the 180degree turn the rates market has taken.
The FN 4.0 is currently -0-25 at 99-26 yielding 4.1233% while the FN 4.5 is trading -0-18 at 101-09 yielding 4.3443%. The secondary market current coupon is 4.244%
Since prices and yields have moved so much today, we decided to zoom out and look at how far we've retraced in the past two days....
BANG BANG BANG
BANG BANG BANG BANG
BANG
Besides BANG BANG BANG, do you notice a theme in the above charts?
We've retraced the entire October rally!
The 10yr loves that 3.36% yield level...more BANG BANG BANG BANG BANG . Check it out...
WHY?
Headlines cite the reason for today's bond market sell off is Bernanke's speech last night. For example:
"Bonds Tumble on Fed Tightening Fears"
"Bonds Fall on Bernanke Interest Rate Outlook"
"Bond Yields Surge as Fed Weighs Rate Hike"
BLAH BLAH BLAH BLAAAAAAAAAAH
Here is what Bernanke said:
"My colleagues at the Federal Reserve and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road."
THIS IS NOTHING NEW!!!
from the September 23, 2009 FOMC statement...
"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. "
OK just for fun lets assume the market is REALLY nervous about a rate hike...the appropriate trade in response to threats of a hike in short term interest rates would be a bear flattener, short term yields would rise faster than long term yields. That's not what is happening today, instead the yield curve is STEEPER. (NOTE: we are willing to say that the bond market likes to use Fed exit talk as an excuse to set flattener trades, we do not believe it is a reality though...see more on that below)
(10s/30s are steeper too)
I'm just gonna get to the point. The sell off is a function of the following chain of events:
After a strong 10yr TSY auction the yield curve FLATTENED OUT as the long end of the curve rallied. This rally extended all the way into the 30yr bond auction which eventually forced long bond short positions to be covered before the auction...consequently no supply concession was priced into the long bond ahead of the auction.
When the auction results were announced, a few accounts learned they were awarded more bonds (duration) than expected (at lower yields than they wanted) because buyers had covered their shorts ahead of the auction. This resulted in a big old "WE DONT WANT ALL THIS DURATION ON OUR BOOKS" selloff. As selling snowballed, the long end of the curve turned illiquid and the floor fell from under the market...all of October's gains were erased. (which is why the curve is steeper).
Now we wait for the market to remember that the Fed cant raise rates until the labor market stop contracting. Now we await bargain buying...
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