Recap, Tuesday Aug. 10, 2010

10 Aug

It was quite an “interesting” day from various perspectives; where do I begin? Firstly, I must eat some crow on yield curve spread trades as I reached a pain point on short 30’s long 2’s…

The Commentary

While the spread has indeed widened off the recent lows (~328bps), the timing of the widening (a couple months ago) was improper. It goes to prove that no matter how much computing/brain power one has behind them, sometimes things don’t work out as expected.

I’m sure you’ve all read the FOMC statement, so I won’t rehash that here. The one thing that is important moving forward is the following release from the NYFRB outlining their plans to keep the Fed’s account at 2 trillion dollars as the MBS’s they purchased from 2009-2010 mature:

The Desk will concentrate its purchases in the 2- to 10-year sector of the nominal Treasury curve, although purchases will occur across the nominal Treasury coupon and TIPS yield curves.  The Desk will typically refrain from purchasing securities for which there is heightened demand or of which the SOMA already holds large concentrations.

Many people were expecting that the Fed would weight their purchases further out on the 30Y curve, but as I pointed out in a recent conversation, most of the issuance in this crisis has concentrated in the short-mid portion of the curve. It does make sense that if one is going to try to clean up the mess on Aisle 7 (which has overrun the entire store), you’d start there. 30Y prices spiked on the FOMC statement, but retreated after the NYFRB released the detailed description of what they plan to buy back. Much like the chart below, I think that 2-10Y will see some marked differences as they delve into Part II of the “cleanup”. The chart below is the MBB-IEF spread. Shaded blue represents the period in which the Fed was actively purchasing MBS’s. The wider this “spread” in ETF land actually represents a tightening of MBS vs. Treasury spreads in the underlying cash market.

After the Fed completed their buybacks, this spread went lower (wider cash spreads) but not significantly. I anticipate that over the coming 12 months the yield spreads in the 2-10y sector will take on a different shape. What shape? I will be the first to admit: I don’t know. We are in uncharted waters now. and it’s clearly evident in some of the spreads out on the long end of the curve:

The highlighted blue area shows the same period when the Fed was purchasing MBS securities. Now that the attention will be shifted to Treasuries, would it be an educated guess to think that the opposite would happen? There’s some critical assumptions that I am making and that is that the Fed will conduct the purchases in a balanced manner. I am also ignoring the fact that there is still another 300bn of fresh supply coming online. I am not sure if they are going to avoid purchasing securities that will be “re-opened” in the next quarter. For me, there’s a lot of unknowns out there.

Indicative Closing Levels For Aug 10, 2010

1Y rate unchanged at 24.9bps
2Y 53.8 -.8 bps, 5Y 147.7 -5.5, 7Y 214.9 -6.3, 10Y 277.7 -5, 30Y 401.6 unchanged
Spreads: 2s5 93.9 -4.7, 2s10 223.9 -4.2, 2s30 347.8 +0.8, 5s10 130 +0.5, 5s30 253.9 +5.5 10s30 123.9 +5
Swap Spreads: 2Y 15.2 -2.2, 5Y 17.3 -0.5, 7Y 6.1 +0.3, 10Y -1.7 unch, 30Y -37.6 -3**

Quick Note:

With relative strength in the USD vs. JPY (85 level), the 30Y Swap spread has been deteriorating back to 2008 levels (the min was on 11/21/2008 at -54, with intraday prints -70) – I’ve written an updated piece on this on the site.

Upcoming Auctions

Tomorrow is the 10Y Auction (24Bn), details here


Fairly quiet today, some of the most active names were actually sold today which pushed (exceptionally low) corporate yields slightly higher. Looking at DTV 2015’s based on the recent news that their competitor, DISH has been losing customers. Another most active name was MS, with the Apr. 2012’s gaining in price to yield 224.6 bps while the FDIC backed paper of MS (Dec. 2011, 3 1/4 cpn) sold off to yield 49bps.

As part of my stinging lesson, I’ve been gleaning some ideas from Eli over at his blog, which you can check out here (Busting Trading Slumps). It’s time that I get back to the basics in some aspects, and ramp up my game in other aspects. You can call the results of July/August my mid-year review if you will.


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