Bill Gross is a sharp guy... speaking of bond resources Briefing has a nice description of what a convexity trade is in the credit markets.
-----We have just received some confirmation that the convexity trade is definitely a factor today, as one trader indicated that he has seen a good deal of mortgage accounts selling on duration extension. So, this gives us a good opportunity to talk about exactly what is going on in this trade. When rates rise and expectations for mortgage prepayment speed fall, duration on MBS extend. That is, no one is prepaying their mortgage, so average life can extend from an average of 7-years all the way to 30-years, or stop at any point in between. What do accounts do? they sell Treasuries. These sales are of existing long positions they established in the market rally (convexity buying) or as a short sale, both of which in order to reduce portfolio duration. This is what we are seeing today, as traders cite mortgage accounts as active sellers of Treasuries.--------
MBS = Mortgage backed securities
------------Of note, some accounts look to the Agency and Swap markets when hedging for mortgage convexity (read: buying as rates fall). And, considering today's move to unwind these trades, the same story is told in both the Agency and Swap markets. That is, 10-year agencies are 3 bp wider to Treasuries and 10-year swaps are 5 bp wider to Treasuries. While we realize that convexity unwinds may not be a causal factor to the weakness in these products, it leaves plenty of room for speculation, and adds color to the Treasury market's decline today.------ |
