The bond bears were out in force Wednesday and could be back Thursday, as the government auctions billions more in debt.
Stocks drifted quietly lower Wednesday, but the selling action in the Treasury market was fairly dramatic. The government's auction of $42 billion in 5-year notes went poorly, pressuring an already sagging Treasury market and driving yields higher.
Now, traders anticipate the auction Thursday of $32 billion in 7-year notes could also be weak. Weekly jobless claims could also be a factor in Thursday's markets, when the data is released at 8:30 a.m. The other big event is Fed Chairman Ben Bernanke's testimony before the House Financial Services committee on the Fed's exit strategies.
Traders point to no single event as a catalyst behind the move in Treasurys, which were already lower before the afternoon auction. But they all say the more than trillion dollars in new issuance, this year alone, is a big factor, and the costly expectations of the freshly signed health care reform bill generated new concern in the market.
The 10-year Treasury yield Wednesday had its biggest gain in months, jumping 14 basis points to 3.83 percent. Treasury yields move in the opposite direction of prices.
The dollar, meanwhile, was also at the heart of Wednesday's market action. The greenback gained 1.35 percent as the euro went into a serious slump after Fitch downgraded Portugese sovereign debt. The euro broke through its recent lows, finishing at a level of $1.3325. The dollar also jumped 1.1 percent against the yen, as that currency broke a key technical level.
Sovereign issues will again be in focus Thursday as the EU convenes a Brussels summit, expected to include discussion of Greece.
The Treasury's auction Wednesday of $42 billion in 5-year notes was surprisingly weak, and saw a larger than usual amount going to Wall Street's dealers. The participation by indirect bidders, which includes foreign central banks, was only 40 percent, compared to an average 49 percent.
Pimco's Bill Gross, speaking on CNBC, said he's now looking to stocks to be better performers than Treasurys in the next three months. "Let's suggest the economy looks good, that risk assets - whether it's high yield bonds or whether it's stocks - have a decent return relative to the potential of declining bond prices. I'll go with the stock market," he said. Gross also cautioned though that rising interest rates could ultimately threaten the stock market's gains.
Corporates Get Credit
"We have not believed there to be much value in going into Treasury securities and still don't even with the back up we saw today," said Zane Brown, head of fixed income strategy at Lord Abbett.
Brown said corporates are a better place to put money, and he is not alone. Corporate spreads, while little changed Wednesday, have been narrowing as investors continue to pour into high-yield and investment grade corporate debt.
"I think what's happening is people are yield hogs, and what you're seeing is you're getting absolutely nothing in Treasurys and there's very little in municipal debt at the short end and there's very little municipal issuance on top of that and people are hunting for yield. The corporate bond market I think people feel pretty comfortable about," said Joel Levington, director of corporate credit at Brookfield Investment Management.
"You're seeing a lot of issues coming to market with 5-year structures. You're definitely seeing shorter maturities," he said.
The bond market has been on edge this week, as the 10-year swaps rate moved to less than zero for the first time Tuesday. That is a sign of stress to some in the markets, and the same thing happened Wednesday to 7-year swaps. The 30-year swap spreads have been inverted since the height of the financial crisis in fourth quarter, 2008. Swaps are used by corporations to manage cash flows on their debt by turning long term liabilities into short term floating rate liabilities.
"This is an issue of just supply. There's more supply in Treasurys and less supply in corporate and other Libor related instruments. Now you're seeing the relative differential between the two," said Jim Caron, head of interest rate strategy at Morgan Stanley.
"It's a perfectly logical explanation of why the rates are moving.. it was bound to happen. It's almost like the dike has some cracks in it, starts to leak some water. it's a sign that Treasurys are weighty and cumbersome and starting to weigh on the market," Caron said.
Higher Rates Ahead
Caron says don't be surprised to see Treasury rates move higher. "We had some data coming out that's not that great and yields are going up. Yields are going up for non economic reasons and that's worrisome," he said.
"We don't know what fair value should be. We never had $2.4 trillion worth of Treasurys being issued," he said. Caron noted that while there is zero net new issuance in mortgage backed securities expected this year, there will be $1.4 trillion in net issuance of Treasurys.
Brown said there are several other factors that may have been responsible for the inversion in swap spreads. One of which is the Fed's withdrawal of its mortgage purchase program, set to expire March 31.
"In anticipation of wider spreads after the end of the mortgage purchase program, some people have suggested that people have just been parking their money in swaps and waiting for the end of the programs when they have a much better opportunity to go out and sell the swap and go and buy the mortgages cheaper. it's been a kind of hiding zone," he said.
Brown also said the large amount of corporate issuance recently is another factor in the swap spreads inversion. There was another $19 billion in investment grade corporates issued this week, according to Thomson Reuters IFR.
"You marry the impact of corporate issuance and their intent to receive swaps, along with the natural reduction of players that pay in swaps...the first that come to mind are the GSEs (Fannie Mae and Freddie Mac). They are the natural payers of swaps which really puts them in an opposite position of the corporate issuers...GSEs are paying for swaps because they want to offset their mortgage portfolios," Brown said.
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