Jeopardy: sounds like Goodfella's for 1000 Alex....<VBG>
Bonds Get Whacked in Late Afternoon
By David A. Gaffen
Staff Reporter
As Al Pacino put it in Carlito's Way, "Here come the pain."
Until 1:30 p.m. EST, it looked like the bond market was taking the day off. But Treasury securities of all maturities tanked after the two-year note auction, and the bond, most specifically, continued to plummet after the 3 p.m. EST futures close.
And the fixed-income market looks to endure more selling even as bonds hit what some would consider their most attractive levels in a long time. The 30-year bond broached the 5.50% level for the first time since Aug. 19 of last year, and Alan Greenspan's more intense worries about the U.S. economy has the market scared. The 30-year Treasury bond lately was down 1 3/32 to trade at 96 7/32, as the yield climbed to 5.509%.
Even though yields have backed up almost 50 basis points in a month, technicals have continued to worsen, and the market is facing another round of strong economic data, beginning with Friday's Chicago purchasing managers index, through next Friday's employment report.
Most of the interest for the $15 billion two-year note auction came from the dealers, with very little from retail. The bid-to-cover ratio was 1.88 (below two is considered poor) and the auction sold with a high yield of 5.099%. In addition, the futures contract broke through several key support levels today en route to a close of 122 1/32. It passed through yesterday's low of 122 18/32, the low for the current sell-off of 122 13/32, and 122 6/32, a level first passed in 1993, then considered psychologically important.
Several investor surveys, including Stone & McCarthy and MCM Moneywatch, show that retail investors are maintaining a "long" duration. Stone & McCarthy's recent investor survey said money managers' duration, when compared to the aggregate indices, is at 104%. That means they are holding bonds with a longer maturity than the average index. Generally, longer-dated securities are considered riskier, so this is an indicator that investors are bullish. MCM's survey shows duration as 100.6% of the benchmark.
"Dealers are trying to take down all the recent supply, and institutional investors have had a long duration bias most of the year," said John Burgess, managing director at Bankers Trust Global Investment Management. "They're not buying. Most people thought 5% to 5.5% was the range. All of a sudden we're at the high end. The question is, do they blink as we start to go through it? I don't think the market is short-I think we could easily see 5 5/8% to 5 ¾%."
Most of the selling action that took place late in the day came from mortgage-backed investors. Initially they sold the 10-year note, which at one point fell 29/32 before recovering. Then they and others, including hedge funds, sold the bond, which triggered the technical action that pushed the cash bond to 5.50%.
"When we got [to 5.50%] we did see some buying, but I don't think it was fresh money-I think it was short covering," said Roseanne Briggen, market strategist at MCM Moneywatch.
Mortgage-backed investors were big buyers of Treasuries last fall because they expected a heavy level of prepayments, and holding longer-dated Treasuries were a way of hedging against having 30% to 40% of their portfolio liquidated into cash. Now that mortgage refinancings are declining, the level of prepayments is declining, and the need for that hedge has diminished. The mortgage refinancing index fell to 1324.2 for the week ended Feb. 19, its lowest level since August, while last week's figure was revised downward sharply.
A minimal bounce in the market is expected on Friday, when money managers recalibrate their portfolio's duration to match the indices, including the Lehman Brothers index. The duration is expected to increase due to the refunding earlier this month. However, there is some worry that managers will turn more bearish, and not do anything at all, thereby shortening their durations by default.
In a sense, the Treasury market is getting smacked by the get-on-the-bandwagon rally that commenced last fall. After the wave of international and liquidity problems subsided, portfolio managers retained an extreme bullish sentiment that hasn't abated despite two months of churning and a real ugly February. Part of that speaks to the inflation outlook, which remains low; the strong dollar; and the weakness in commodity prices.
But trading volume has been low, and without the leveraged action in the market to absorb the dips, retail investors, despite being bullish, aren't interested in coming in when the trend is heading in the opposite direction. They've been happy sitting on the sidelines, fattening up on corporate and agency debt while the dealers get stuck with Treasury supply.
"Volume's been thin, compared to historical standards, and there's the hangover from [the] fall debacle that's still out there," said Burgess. "The price action has been terrible and without resistance. We're not getting the big leveraged accounts and haven't had the asset allocation out of equities into bonds. That's what generally happened recently, and it was a natural self-correcting mechanism."
Not anymore.
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