We are keenly aware that the many of the bullish events that have been on our agenda are about to pass. These were flow stories such as the large Feb coupon payment, CMBS issuance, and impending month-end index extensions and as far as we can see are about to come to an end. We cannot ignore some weak pieces of data on the housing front (starts) along with any number of stories on the sub prime market.
We are still very attached to the negative seasonal patterns that start kicking in with month-end — and, of course, the potential for Japanese selling in fiscal-year end. We would look to the immediate bullish momentum as a selling opportunity, but are shifting the overall bearish bias a bit. Our interest in selling strength is more out the curve, sell duration and buy the shorter end.
Between some of the data (drop in CapU and IP, plus the overnight WSJ article by Fed “watcher” Ip saying Fed policy makers deem low unemployment less a factor in contributing to inflation) and the fact the Fed’s been on hold but with a tightening bias for a remarkable 7 months we are increasingly open to a full move to neutral come March. Combined with strong steepening seasonals, we look to the front end for leadership and outperformance. Technically, too, 2s/10s has held a key support at -15 bp but with momentum now pointing up. In the broader sense we mark a shift to neutral in March as the start of a long disinversion process.
From an outright perspective, we like selling strength technically, seasonally, and to get into steepening ideas (gingerly). We still like the directionality of the 5s vs the wings and consider that our number one trade idea for the bulk of this year. TY has filled and held an important gap at 10722 and momentum is bullish. We look for a move to 10802/10 as our first selling opportunity.
Highlights from the U.S. Government Bond Weekly:
The market has shown remarkable resilience over the past couple weeks — finding bullish backing despite a number of bearish events. Although we played for a modest correction/consolidation last week — even we (the perennial bulls) were biased for a bigger downtrade. The beginning of this week holds bullish potential — with the largest month-end extension since August ‘06, expected downward revisions to Q4 GDP and a decline in Durable Goods.
We are less optimistic about the latter half of the week, following the passing of the month-end demand and the beginning of the most compelling bearish part of the seasonal patterns. Although historically the 10-year sector marginally improves in February, the period between the first week of March and the May Refunding typically sees rates backup and the curve modestly steeper.
The seasonals show that between weeks 9 and 17 of the years 1990-1999, 10-year yields have increased an average of 12.7 bps. More recently, during the same weeks during years 2000-2006 (excluding 2001), 10-year yields rose 14.4 bps. The 2s/10s curve between 1990 and 1999 steepened 8 bps during that time-frame, while during 2000-2006 (excluding 2001) flattened a modest 2 bps.
We also hear from a variety of Fed speakers this week — including Bernanke — who will speak on long-term fiscal challenges and the US economy. Recent Fed rhetoric has been supportive for the Treasury market — with the official comments on developments in the subprime mortgage market and the on-hold rate stance — we see no reason to expect anything different this week.
TACTICAL BIAS: Our bias has turned to selling strength — at least in the near-term and we are impressed by the recent strength, albeit technical and a flight-to-quality in nature. We are not completely comfortable fading the strength early in the week, but expect the uptrade will grow tired as the strong month-end demand passes. Friday’s uptrade was by no means a fundamental/policy event, but it brought us back to the top of the post-Humphrey-Hawkins range — we expect this range will be challenged early this week, but are not playing for a sustained break, given the limited series of new information.
Although Asia was not completely absent from last week’s price action — the return of this customer base holds some bullish potential — especially as it corresponds with the month-end. Looking toward the end of the week — the scheduled events become more bearish. We have the Jan PCE report on Thursday — with RBSGC Economics Team calling for 0.3% MoM increase, for a 2.4% YoY rate — remaining well above the Fed’s stated comfort-zone and challenging to the market. Moreover the sharpness of the recent uptrade and the shifting seasonals (as outlined above) leave us biased for a bit of late-week softness.
OVERNIGHT EVENTS:
* Greenspan tells media US may dip into recession this year.
* German Consumer Confidence, Mar — falls to 4.4 vs. 4.8 last.
* WSJ’s IP, A1, writes that low unemployment is less a factor today in contributing to inflation for Fed policy makers.
IMPENDING EVENTS:
* No Major US data
* Corporate Deal Pricings — a few CMBS deals around, timing not clear.
* Large Month-end extension — 0.21 yrs in Tsy.
* Fed’s Bies speaks on Basel II.
NOTE: The views expressed are not of Bonds Financial but of the unaffiliated author. Bonds Financial Inc. makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.
Posted by bondsblog as Morning Call at 9:08 AM EST
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The market that once told every other market what to do, also known as U.S. government securities, is so dull these days that the world’s biggest banks are losing interest and bowing out.
Low volatility makes it very hard to generate any income, said E. Craig Coats, who was co-head of fixed-income at Salomon Brothers in the 1980s, when it was the world’s biggest bond trader.
That’s why the firms that underwrite U.S. government debt may fall to the fewest in 36 years as profits from trading Treasuries decline along with price swings in the bonds. “You have to generate your income by doing massive amounts of volume,” said Coats, who was among the elite at Salomon, a firm whose influence was caricatured in Tom Wolfe’s “Bonfire of the Vanities.”
CIBC World Markets Corp. gave up its so-called primary dealer franchise this month, reducing the number of firms that can buy and sell government securities directly with the Federal Reserve Bank of New York to 21. There haven’t been fewer since 1971. The group is down from a high of 46 in 1988.
The average daily change in yields on Treasuries has fallen to 2.5 basis points this year, from 4.9 basis points in 2001, and is the lowest since Merrill Lynch & Co. began compiling data a decade ago. A typical 10-year note trade provides about $1 in revenue for every $40 it produced in the mid-1980s, said the head trader at a primary dealer who asked not to be identified because his firm doesn’t disclose details of trading.
Merrill Lynch’s MOVE Index, which measures expectations for Treasury market volatility, fell on Feb. 5 to the lowest since the firm began tracking the data in 1988. The index, based on prices of over-the-counter options on notes and bonds, closed at 54.9 that day and finished last week at 60.7.
Decline in Revenue
Opportunities to profit from trading the $4.35 trillion of outstanding U.S. government debt are disappearing. Revenue from 10-year notes has dwindled to about $30 per $1 million trade before processing and hedging fees, which average $10 to $15, said the head trader at the primary dealer. The same trade earned about $150 in 1999 and $1,200 in the mid-1980s.
The benchmark 10-year note’s yield hasn’t moved more than 20 basis points in a week since April 2005. The yield on the 4 5/8 percent Treasury note due in February 2017, last week declined 9 basis points, or 0.09 percentage point, to 4.69 percent. From 2001 to 2006, weekly moves of at least 20 basis points occurred 31 times.
The number of primary dealers probably will fall in the next two years, said Jason Evans, head of U.S. government bond trading in New York at primary dealer Deutsche Bank AG. The decline won’t reduce the ability of investors to buy and sell large amounts of securities, he said.
`Changing Economics’
“The changing economics of the business is putting a lot of pressure, especially on the smaller or lower-tier players, to really question what is the value proposition of maintaining a dealership,” said Evans, who previously headed Treasury debt trading at primary dealer Goldman Sachs Group Inc.
Representatives at Bank of America Corp., Bear Stearns Cos., BNP Paribas, Cantor Fitzgerald LP, Credit Suisse Group, Daiwa Securities Group Inc., Deutsche Bank, Dresdner Kleinwort, Goldman, JPMorgan Chase & Co., Mizuho Securities and Morgan Stanley said they were committed to their primary dealer business. The rest either declined to comment or didn’t respond to calls.
Many firms use their primary dealership to gain more lucrative business trading and selling credit derivatives or other types of fixed income, Evans said.
Shrinking Group
U.S. government debt trading by primary dealers fell last year for the first time since at least 2001, according to data compiled by the New York Fed. Transactions averaged $525.2 billion a day, down 5 percent from a record set in 2005. The daily average rose at least 11 percent a year from 2000 through 2005.
“The primary dealer community will continue to shrink based on opportunities for profit in the marketplace,” said Patrick Haskell, former head of interest-rate sales and trading at primary dealer HSBC Bank USA. Haskell quit in December when the firm cut about 20 jobs from the group.
Twelve of 30 firms in the Bond Market Association’s 2000 directory of primary dealers have dropped out. They include ABN Amro Holding NV, which withdrew in September, and Donaldson, Lufkin & Jenrette Securities Corp., acquired by Credit Suisse Group in 2000.
The New York Fed declined to comment, spokeswoman Linda Ricci said. The market “is deep and liquid,” said Jennifer Zuccarelli, a Treasury Department spokeswoman.
Stable Growth
Price volatility has fallen as global economic growth became more stable and the Fed and other central banks made monetary policy more predictable, said Marie Schofield, a senior portfolio strategist at Columbia Management in Boston. The investment- management arm of Bank of America Corp. oversees $87 billion of bonds.
The Fed now publishes minutes of policy makers’ meetings three weeks after they occur, compared with six weeks before 2005.
“We’re seeing lower volatility in terms of economic cycles and lower volatility in terms of market cycles,” Schofield said. “Things that caused volatility in the past were excesses.”
Inflation has slowed, leading investors to accept lower and more stable yields than previously. The annual inflation rate has averaged 2.8 percent since the start of 2000, down from 3 percent in the 1990s and 5.6 percent in the 1980s. Lower inflation has enabled the Fed to keep its benchmark overnight rate lower. It has averaged 3.24 percent this decade, compared with 5.12 percent in the 1990s and 9.86 percent in the 1980s.
Economic Flexibility
The economy has also benefited from increased flexibility in the labor market as companies use temporary workers and overtime to meet production deadlines, according to a New York Fed staff report published in April 2006.
A January research report by Credit Suisse said the “persistent trade imbalances with countries that recycle a substantial portion of their surplus dollars” back into the U.S. without hedging against volatility also has contributed to lower price swings.
John Roberts, a managing director in New York at primary dealer Barclays Capital Inc. and head of the government securities division of the Securities Industry and Financial Markets Association, said the number of primary dealers is “stable to growing” in part because the business is key to winning business from central banks.
For example, Countrywide Financial Corp. became a primary dealer in 2004 and Cantor Fitzgerald joined the ranks in 2006.
Dealt Out
Almost all of the 17 firms that were primary dealers when the Fed formalized rules in 1960 have changed their names, been acquired by other securities companies or gone out of business. For example, First Boston is now part of Zurich-based Credit Suisse Group; Salomon Brothers is now owned by Citigroup Inc. in New York; and PaineWebber Inc. is owned by UBS AG, also in Zurich.
In the 1980s, as Japan increased purchases of U.S. debt, six Japanese securities firms became primary dealers: Fuji Securities Inc., Sanwa Securities Co., Daiwa, Nomura Securities International Inc., Nikko Securities Co. and Yamaichi International Inc. Only Nomura and Daiwa remain. Fuji is now part of Mizuho Financial Group Inc.
CIBC cut the jobs of all nine people involved in trading Treasuries and other securities based on U.S. interest-rates when it withdrew this month.
Chris Anderson, a spokesman for CIBC, and Patrick Phalon, a spokesman for ABN Amro, declined to comment.
Diminishing `Value’
“The value of being a primary dealer has fallen over time,” said Brad Hintz, a securities industry analyst at Sanford C. Bernstein & Co. in New York and the former treasurer of Morgan Stanley and chief financial officer of Lehman Brothers Holdings Inc., both primary dealers.
“I’m glad I was in the business when I was,” said Coats, who runs the bond division at New York-based KBW Inc., a firm that isn’t a primary dealer.
Click here to view original article published on Bloomberg.com Feb. 20, 2007
To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net
Posted by bondsblog as Trader News at 9:25 AM EST
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The market continues to hold a tight range — trading a bit soft overnight, but in the confines of the range. Our call for a corrective downtrade still stands
– at least into the 5-year auction this afternoon. A repeat performance of the strong reception to the 2-year supply will be bullish for the market, and we note that the dealer community remains the shortest it has been in the 5-year sector since Nov ‘06.
Yesterday’s new information offered a mixed bag — the higher-than-expected core-CPI print, solid reception to the 2-year supply and several deal pricings.
A less bearish spin of the inflation data can be seen on an unrounded basis, January’s print was +0.2556% vs. December’s +0.14437%, netting to a month-over-month increase on an unrounded basis of just 0.11123% vs. the 0.2% rounded gain.
The new Treasury supply met a warm reception, with very strong indirect buying, and given recent buying patterns we suspect it was largely overseas bidding. The bid-to-cover was 3.04 vs. 2.60 average of last eight 2-year auctions, and the highest since Nov ‘00. Similarly, indirects took 52.2%, the highest since July ‘04. This suggests persistent demand at these yield levels — overall supportive.
As for Fed policy, the headlines from the minutes showed little deviation from the Humphrey-Hawkins testimony, but there were some modestly supportive elements. There was a debate in late Jan over the removal of the “extend and time of any additional tightening” language, the language was retained even in light of the “confluence of better-than-expected news on economic activity and inflation”… which the Minutes suggest “… improved prospects for core inflation”, suggesting to us (at least) the March meeting will likely see the same debate.
In addition, the FOMC commented that employment “exhibited continued strength through year-end” and some significant wage pressures, but this was in the context of the Dec unemployment rate of 4.5% and has since moved higher. Lastly, while housing stabilization occurred in “most districts”, there presumably remain pockets of concern that could continue to weigh on consumption, this has yet to be seen.
TACTICAL BIAS: The market traded well given the series of data, supply and suspicious absence of any major corrective downtrade. With levels all but unchanged from yesterday — just slightly lower, we have not altered from our selling strength bias, at least through Thursday’s auction. As we stressed this morning, we will short 10s at the 4.66% intra-day low yield with a target of 4.72%. That said, we will be quick to reverse a move through 4.62% in a strong uptrade. In TY, we respect the move and are medium-term bullish, but in playing for a correction, would sell at 10726 intra-day high and 100-day moving average, but reverse and go long above 10729+ prior key resistance.
Thursday offer’s few major events — namely the 5-year supply, initial claims, and some corporate deal pricings. The Fedspeak for the week is behind us and there is no major data left — we are wary of the conventional logic of not selling of quiet market, but barring any surprises on Thursday — we continue to be biased for near-term softness.
OVERNIGHT EVENTS:
* German GDP, Q4 - final — +0.9% QoQ vs. 0.9% prior read, YoY also unrevised at 3.7% — although the breakdown was somewhat disappointing, indicating modest domestic demand (-1.3%) and the bulk of the strength from exports (+0.6%).
* The resignation of Italian Prime Minister Romano Prodi yesterday remains the topic of much discussion in Europe — but with new elections unlikely (retaining the current government), the EGB market has taken little direction from the developments.
* Strong Gilt auction — slight tail of 0.1bps and strong bid-to-cover 2.22, helped support the Gilt market this morning. UK Q4 business investment was a much stronger-than-expected 3.3% QoQ and 11.1% YoY — vs. consensus expectations of 1.3% and 8.6% respectively.
IMPENDING EVENTS:
* Initial Jobless Claim, 330k vs. 357k prior.
* Help wanted index, Jan — 33 consensus vs. 33 prior.
* 5-year Treasury note Auction
OVERNIGHT FLOWS: Overnight volumes were average — with cash trading at 83% of the 10-day moving-average, while TY came in at 115%. 10s were the most active issue with 36% marketshare, while 5s took 26% and 2s just 20%. With limited overnight developments, Treasurys traded in a tight range and during Tokyo hours we say swap selling of 10s, roll interest in the 2-year sector, and credit buying of 5s.
In London, we saw a European bank buyer of 10s, seller of old 10s, a UK real money buyer of <2s, and real money interest in 10s. Away we heard of European real money selling of 2s and 5s and Asian real money selling of off-the-run 3s.
Also Japanese real money buying of 5s and 10s, as well as hedge fund selling in the 10-year sector.
NOTE: The views expressed are not of Bonds Financial but of the unaffiliated author. Bonds Financial Inc. makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.
Posted by bondsblog as Morning Call at 9:07 AM EST
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