Bond

The big story this morning is that Treasury yields continue their grind higher - this despite the strong 30 Year auction last week which many expected had put a bottom on bond prices at least for the short-term. As can be seen on the attached chart, the 10 Year has resumed its drift lower, with yields once again touching multi-month highs, not to mention the 10s30s continue to flatten and is about to hit 100 bps. The move prompted an early wake up call for David Ader, head of government bond strategy at CRT who sent out the following note earlier: "Just when we thought it was safe to say something nice about the market, we get a sharp move lower (alas in price, not yield) in an active overnight session. We say active as volumes were 114% of the average, but to be sure it’s harder to find a new reason for the weakness other than the price action itself. Thus we’ll caution that the weakness is in part a function of liquidity and fear." There are two schools of thought as to what is causing the gap lower: i) the realization by various bondholders that nobody is concerned about US funding levels and that the next target of the bond vigilantes will be the US itself, and ii) that courtesy of the latest round of fiscal stimulus, the economy may have bought itself a short-term bounce and it is time to fade the deflationary move in bonds which was the prevalent trade of 2010. Either way, the inflationary threat is now all too real, and with rates jumping and mortgages surging, it is difficult to envision a nascent recovery in which the prevailing price of housing just dropped yet again courtesy of higher rates. So what does this mean for stocks? Once again, courtesy of some historical perspectives by Sentiment Trader, we look at what happened in the past to stock prices when bond yields started a gap move wider.

There’s no question that the last thirty years have been very good to the bond market. In fact, the chart above may even paint the picture of what could be called the Great Bond Bull Market with price moving inverse to yield. While I have been writing for months about thinking the “bond bash” is coming to an end, I think we may have seen the true beginning of that end this week with the 10-Year Treasury yield spiking almost 40 bps higher in just three days to an intra-day high of 3.33% from 2.95%. And what might have been the impetus to bring about this potential end to the bull market in bonds? Interestingly, the most obvious possibility is also all but impossible and perhaps the reason why many seem to be surprised by the 95 bps or almost 1.0% move up in the 10-Year on an intraday basis in less than two months.

Today's CFTC data reveals some interesting inflection points. First, looking at the perishables, there seems to be a resumption in bullish sentiment, especially in coffee and corn. This is to be expected as the last week saw an inflation scare which prompted many to expect a fresh rise in commodities (despite concerns of year-end profit taking which has materialized pretty much as anticipated in the year's best performing asset class - precious metals). Where things get more interesting is looking at the various parts of the Treasury curve: after 3 weeks of rather indiscriminate selling, net spec contracts in both the 2 Year and the 10 Year have seen a modest resumption in buying, although that previously most beloved part of the curve - the 5 Year is still unable to find a base. Although the 5 Year is still the only bond that has a net positive spec balance: all others are now negative. In other words, where we go from here is pretty much a crapshoot, as this is nothing more than a coincident indicator in the latest volatile asset. Lastly, looking at currencies, we see an interesting trend - after the USD saw a substantial pick up in the past two months as Europe faced its second sovereign bankruptcy (but has for now been buried under the rug), bearish sentiment is coming back again. Yet unlike before when there was a rather obvious inverse relationship between the EUR and the USD, this time the deterioration in USD sentiment has metastasized to the Yen, and the Euro (the CHF has been rather insulated, which is as expected, as the currency continues to to be the last ditch safety currency and thus less volatile to sovereign insolvency risks).

When you are running the World's largest fiat currency system, trust is pretty much all you do have going for you - unless you plan to resort to force, of course.

The MOVE index measuring bond volatility has hit 112, a 2010 peak second only to the turbulent days following the flash crash and the first European bankruptcy. And speaking of European bankruptcy, CDS on Italy is back on the upward sliding track, last seen at over 200 bps, over 10 bps move on the day. And since there is no volatility left in a levitating market, the only market that vol hunters are now pursuing is the sovereign bond and FX markets. If and when intraday gyrations in the 10 year approach the equivalent of a stock VIX of 20+, then Bernanke will have finally achieved his goal of complete subjugation of the Banana States of America.

Yesterday's highlighted chart was the plunge in the 30 Year bond. Today, we take it one step further and demonstrate what happens to an asset class once it become clear (or unclear) that the government may not prop it in perpetuity. Presenting the average yield on Build America Bonds, which has just hit an 11 month high. If this collapse is a harbinger of what will happen once a Federal props are removed, feel free to just imagine what would happen to stocks if and when the Fed were to withdraw its support of the stock market...

Looks like the market does not like the massive flattening we discussed over the past two days. To wit, we present market commentary from a trading desk, appropriately titled "dead cat" bounce: "Another "dead cat" bounce in the Treasury complex as prices are now sitting just above session lows. Additionally, while still outperforming, 30yrs are starting to feel some of the heat. The curve remains mixed depending on what your long end maturity is. Real money remains quiet aside from some light nibbling. Fast/pro/dealer accounts continue their defensive trade and remain in control. Techs are negative but cautious due to oversold conditions."

As the 10 Year continues to plunge, the one topic nobody on CNBC is daring to discuss is the absolute slaughter for all those calling for a steeper curve, and the resultant misery that banks are again experiencing as a result. With financials supposed to be the new market leaders one can't possibly bring up the sad truth that as QE2 fails, the US financial system will take the brunt of the hit. And even as Goldman and MS get their wish for a sell off in the 10 Year, unfortunately for them this is accompanied by a less than comparable dumping of the long-end, resulting in an even greater flattening of the curve, and validating our call from last night that the bond world is about to get a whole lot more flat. Lastly, as the 30 Year Cash Pay Mortgage jumps by 20 bps W/W, the result is about a $200 billion loss in home net worth in just one week. The Uberprinter is now torn whether QE3 should be one of monetizing municipals, or, as Bill Gross has been positioning so very well for the past two months, throw it all into MBS once again.

Today's tax compromise in the US extended all expiring Bush tax cuts by two years.  The story though does not end here.  The most important thing missing from the tax extension was the expected extension of the Build America Bond program.  The Build America Bond program has been the municipal market's saviour over the past 18 months.  Since their introduction in April 2009 more than 174 Bio USD of taxable securities have been sold by municipalities backed by the program, one where the US pays 35% of the interest due on the debt.On a day when the market focussed on the Budget vote in Ireland, a country that makes up about 1.8% of Europe's GDP, we are concerned that no one is looking at the growing problems in New York, California and Illinois, three states that comprise 25% of the US GDP. The expiration of the Build America Bond program could prove to be a terrible price for the US to pay and we expect squabbles in the US Congress regarding the bailing out of States in 2011 that could easily rival that which we have witnessed from the European Union over Ireland and Greece....We continue to expect that QE3 will include the purchase of Municipal debt, a true can of worms.

Goldman, which continues its near-revolutionary overhaul of its economic and market outlook, after suddenly and very embarrassingly hiking its economic outlook ahead of today's NFP number which confirmed that all those calling for an end to the recession were merely misled by the government (as Albert Edwards once again predicted spot on), was overdue for a change in its bond targets: after all there is no way the 10 Year can remain at 2.50% (the firm's old 10 Year target) if GDP is supposed to somehow grow to 2.7%. Sure enough, FUG (Franc Garzarelli, the man behind the firm's often very disappointing "Top Trade" recommendations) has just released the firm's new bond forecasts. And unfortunately, we get merely yet another indication that instead of being ahead of the curve, Goldman is now firmly behind it, and chasing either momentum or wrong conventional wisdom: the firm now sees the 10 Year going from its current 10 Year spot to 3.75% by the end of 2011, based on an "environment of strong growth, low inflation and a bond-friendly policy set-up." In other words: everyone pile into the reflation trade. We can't wait for two things: i) Rosenberg's retort, and ii) the over/under on how long before this latest flawed recommendation by Goldman is not only revised, but once again starts calling for a few trillion in QE (which just a month ago was supposed to be an addition $4 trillion - how quickly views change after a brief "closed door" meeting).

Zero Hedge is delighted to have officially gotten on Brian Sack's nerves: after everyone's favorite Fed offer lifter bought another $6.81 billion in bonds due 2013-2014 (at a Submitted to Accepted ratio of 3.2x) the week's last POMO is now over. However, to our delight, after highlighting repeatedly that over the past two weeks the issue monetized most by the Fed was the most recently issued bond in any given bracket, today, for the second day in a row, CUSIP PU8, the November 3 year auction, was once again put on the exclusion list, making life for flipping Primary Dealers just that bit more difficult. But don't worry: with November excluded, the biggest issue monetized by far, with $4.3 billion in purchases was the 3 year issued in... October (PB0). The net result is that instead of pocketing a ~$100 million bonus this year, the RBS/JPM/DB/GS/Jef/etc bond monetization team leader, will instead collect just $99 million of taxpayer money. We will continue tracking the exclusion list and hope to have finally put an end to at least this small farce in the Fed's monetization arsenal. In the meantime: may the farce be with you Brian Sack: please be advised that unless you close the market green we will all lose faith in your market manipulative skills (granted, the Obama mandated UI extension pass at all costs may explain a slightly red close).

Jean Claude Trichet has finally learned the Bernank's lesson #1 on Central Bankering: when all else fails, buy it all. The FT reports that according to traders the ECB was on Thursday buying Portuguese and Irish bonds in €100m tranches – four times bigger than previously, which in turn sharply brought down the cost of borrowing for Lisbon and Dublin and sparked a euro rally. Just like in the US, this means that virtually no assets reflect their true value, as the ECB is now monetizing debt, without even having formally announced it is doing so, either in a sterilized or unsterilized fashion. This means that next week's update of the ECB SNP programme will demonstrate a surge in bond buying. This is especially the case when factoring in that Trichet is currently out in the market waving every Portuguese Bond in. It is a sad day that the only way the ECB, just like the Fed, can create an upward move in an asset class only by forcing a short squeeze.

The ECB voted to keep rates at 100bps today, as expected, but did little beyond that as it became clear that Frankfurt is still backtracking from its “exit strategy” rhetoric from a couple months ago, rather than transitioning from planned exit to future expansion in one fell swoop.

Hearing that as the head of the ECB continues to not answer any question, his organization is buying Portuguese and Irish bonds actively. If the vigilante attack intensifies not even the ECB will be able to withstand the onslaught.

Today the market surged after it was announced that JC Trichet has finally thrown in the towel and will launch some version of "buy the everything" program made so popular by his bald transatlantic late-afternoon genocide buddy over the last two years. Subsequently the market surged more on a rumor that America would send a mega dose of viagra to make Trichet's "bazooka" even bigger by boosting America's, er, IMF contributions to what will soon be a multi-trillion bail out. Lastly the market surged some more when that last rumor was proven to be false. Which is why tomorrow at 7:45 am Eastern (with conference to follow 45 minutes later) the hapless Pinata formerly known as Jean-Claude Trichet, whose every action is now predicated by the markets, better have something good to announce or else the market will go up so more... just as it will if there is no news. So for all those who wish to know why buying stocks is a guaranteed way to make money now that nothing at all matters, here are JP Morgan's advance thoughts previewing the ECB action, as well as Greg Fuzesi's observations on additional bond purchases.