TALK FROM TRENCHES: TSYS GETTING TRASHED; CROSSCURRENTS HIT
By Isobel Kennedy and Robert Ramos
NEW YORK (MktNews) - U.S. Treasuries are getting trashed again today. Traders are calling today's price action "ugly", and the list of crosscurrents that are buffeting the market is growing.
For a while, players were only getting volatility from the dollar and the equity markets.
But then on Tuesday, gold took off on the upside and that put all commodities in the spotlight as inflation flags were up. Traders were freaking out as the CRB and the Journal of Commerce indices soared.
Along with soaring gold prices came the unwind of gold trades. Gold traders scrambled to cover shorts supposedly connected to the U.S. and Japanese stock markets. At one point the DJIA was off as much as 200 points on Tuesday even though it only closed down 28 points. Traders are on alert for more of these trades to materialize.
On Tuesday, players were selling U.S. Treasuries to: 1) raise money to cover gold shorts; 2) to meet margin calls on gold; 3) to offset the losses suffered on gold.
Sister market supply finally took its toll on U.S. Treasury prices on Tuesday as well. After weeks of easily absorbing a modest amount of supply, yesterday's jumbo $5.25 billion FNMA 5Y and 30y deal sent treasuries over the edge. For the first time in a while, sources said they saw accounts selling treasuries to make room for the new agency paper.
This lack of retail participation is also a thorn in the side of Treasury traders. And it is not just U.S. retail. Japanese accounts have been very good buyers of U.S. agency paper for some time. Last week there was talk that a quasi-Japan government institution bought as much as $1B of short-dated agency paper.
Normally at this time of the year, U.S. accounts will agency paper to put pure U.S. Treasuries on their books in the last quarter. Given the interest in agency paper this year, some players wonder if this will take place to any large degree as the year end nears. Dislocation is everywhere, commented one salesman.
Yesterday's weakness has spilled over into today's trade. The actual selling pressure today has not been identified, sources say. Others say players are confused and don't know what is going on.
One source said that when the uptick that many had been waiting for failed to materialize, people just started to sell.
What has all this meant for the treasury curve? Yesterday, the curve steepened to +46 from +42 bps. This morning it flattened back to +43 but it is now at +45.
Some sources report interest in putting on flattening trades ahead of today's 2Y auction. But some analysts contend that a selling concession in 2s may come via additional curve steepening, especially if domestic stocks remain unstable.
Recent trade flows reflect the lack of a consensus view on the curve, sources say. Since Monday, there have been reports of professional and customer accounts unwinding of 2Y/5Y flatteners they put on last week at pick 16 bps. Other players have been initiating new steepeners at around give 12.5 bps.
This morning there was renewed interest in putting on flatteners by selling 2s and buying 5s at pick 16 bps.
Strategists say the forces that have kept inflation in check are finally eroding. The weak dollar, oil, gold, the CRB and the JOC will continue to weigh on the back end, thus steepening the curve. Yesterday, the 2s/30s spread widened 4 bps intra-day to + 46 bps and analysts say key resistance lies at +49 bps, the 200-day moving average. A break through this level would indicate a widening to about +54 bps and then +60 bps.
Are there any pluses out there? Well tomorrow is quarter- and month-end -- and sources say that could bring the index funds in buying.
In addition, U.S. House hearings on Tsy debt buy-back is a market positive. So far details in today's Congressional testimony remain sketchy but players think the government swapping off-the-runs for new debt presumably will bolster market liquidity and efficiency.
By the way, tomorrow $29 billion in interest payments and proceeds from maturing debt will hit the market, sources say. That's a plus since retail will need to find a home for this money over quarter-end.
On the international front, tomorrow is Japan's half-year end and players wonder if the BOJ will add any extra liquidity to the market. More importantly, players are waiting for Japan's quarterly Tankan which will be released on Monday. There is speculation that if the report is strong, Japan may intervene as it did after the strong GDP was released.
Latest dose of Tokyo Tease: BOJ Hayami says there is no change in the BOJ's monetary policy while MOF Miyazawa said BOJ monetary policy will become clear in time. And by the way, an aide of Prime Minister Obuchi said the BOJ cannot be totally independent on the Japanese government.
The Hong Kong Monetary Authority last year spent about $15 billion (U.S.) buying Hong Kong stocks when that market was pressured during the global meltdown. HKMA will soon start disposing these assets through the sale of a unit trust. Oh, and by the way, the assets are now worth $26 billion, a 70%+ return in 13 months, a return any hedge fund would be proud of! So much for conventional wisdom.
NOTE: Talk From the Trenches is a daily compendium of chatter from Treasury trading rooms offered as a gauge of the mood in the financial markets. It is not hard, verified news.
ANALYSIS: RE-THINKING THE US TREASURY BUY-BACK PROGRAM
By Joseph Plocek
WASHINGTON (MktNews) - With the public comment period for the U.S. Treasury Department's proposed debt buy-back regulations ending on October 5, officials seem to be raising the public profile of the program with Assistant Secretary Lee Sach's congressional testimony Wednesday pointing out that final regulations on the buy-back program should be in place during the first quarter of next year.
Details of the program remain sketchy, especially how it will benefit the government.
The nuts and bolts had been spelled out well enough at the August refunding. The buy-backs will be a "reverse auction" conducted by the New York Federal Reserve's trading desk on behalf of the Treasury. Officials will accept competitive offers only from primary dealers in a multiple price process where successful offerers receive the price submitted with no limit as to the amounts the Treasury will purchase from an individual firm.
The Treasury would be under no obligation to deal, but would announce results in a press release. There will be one-day settlement via Fedwire. So far so good, as these are all details typical of a Federal Reserve coupon purchase in reverse.
Treasury officials have accepted so far the suggestions of the dealer-led Bond Market Association that the program would be beneficial. The August BMA report of the Treasury Borrowing Advisory Committee said, "A program of buybacks would complement a reopening policy (used to add to the dollar amount of a bond issue already outstanding) by using funds from issuance of new securities to purchase older, off-the-run securities." In other words, traders are looking for larger benchmark issues that will afford liquidity in busy markets.
But where is the kicker for the Treasury? If the market is pricing securities efficiently, there may not be a cost advantage to repurchasing securities. Government securities markets are some of the most efficient in the world with volume in the trillions of dollars and bid-offer price spreads in fractions of 1/32 that equate to about $10 per $1000, suggesting market prices are fair. If the Treasury has to pay market prices for repurchases, the present value of the saved interest costs will be incorporated into the market price.
Officials seem to recognize that bond market math may not be in their favor. "We have made no decisions as to whether we will, in fact, conduct debt buybacks," Sachs told the U.S. House Ways and Means Committee Wednesday.
There is an additional kicker in the buyback process, which is that securities purchased at more than par must have the premium charged as a budget expenditure in the year purchased under the current accounting rules. Given the inverse relationship between interest rates and bond indices, and the declining yield trend of the last decade, it would not be hard to see the Treasury racking up huge budget expenditures for buybacks. Not surprisingly, BMA has suggested changing these accounting rules to allow the buybacks.
The argument for buybacks hinges on enhancing market liquidity enough by selling "mega-issues" that reduce the government's interest costs by adding to the efficiency of trading. It summarizes as "big is better," but more study is needed to prove this assumption as fact. Just a few years ago, analysts talked about too much government borrowing crowding out private borrowers. Where's the balance?
Alternatives to the buybacks are rarely discussed. Sources note that in February, the BMA considered reinstituting call provisions in some Treasury securities. The Committee's notes show discussion of "the possibility of shifting some portion of longer term issuance into callable structures" and specifically mention a 30-year, noncall 5-year bond -- the structure sold by the Treasury in the 1980s. Why not extend that call feature to 10-years or other notes, even 5-years?
Sources say call features are common in agency and municipal paper and even possible for corporations (which now prefer floating rate debt to avoid the very problem of getting locked into unfavorable rates). The cost for a high quality credit is highly variable but is in the range of 25 to 50 basis points. Surely for the highest credit quality of the U.S. Treasury the cost of call protection will be measured in a few basis points.
The advantages of calling coupon securities are obvious: no more fuss about buybacks and no need to alter long standing budget accounting rules. |
