Prices of Treasury coupon securities posted mixed results today as benchmark securities with maturities of 5 years and less registered gains while issues with longer maturities langushed in relative ignominy. The yield on the benchmark 2 year note declined 4 basis points to 2.38 percent. The yield on the benchmark 5 year note slipped by a basis point to 3.15 percent. The outcome was less festive in the long end of the market as the yield on the 10 year note increased by 3 basis points to 3.90 percent . Likewise, the yield on the 30 year bond increased by 3 basis points to 4.64 percent. The spread differential between the 2 year note and the 10 year note widened to 152 basis points.

I have been touting this trade for about a week and originally suggested that it would grind its way into the 150s. It was a rocky road getting here and in the real world I would have been stopped out or fired after it traded as tight as 132 basis points on Friday following the labor data. Now that it is here I would unwind and be flat the spread. There might be some additional widening as the auction process unfolds tomorrow and Thursday but there is enough volatility such that it would be imprudent to fail to book profit here.

Today Fannie Mae (FNMA) and its earnings release dominated the trading landscape. FNMA reported a mega $2.2 billion loss for Q1 2008 far exceeding analysts estimates. The firm announced that it would slash its dividend and raise $6billion of new capital. Credit losses in the period totalled nearly $3.1 billion. On this news stocks hit the skids and a strong flight to quality bid developed for bonds,especially in the 2 year note.

Subsequently the bond market reversed course as OFHEO expressed confidence in FNMA and announced that once FNMA has completed raising new capital the regulator would reduce the amount of capital that it requires FNMA to hold from 20 percent to 15 percent. That news aided and abetted a stock market recovery and sparked a subsequent reversal in bond prices.

For now I would take the view that the decline in bond prices is mostly a function of supply from the Treasury later in the week. With the rebound in stock prices the 2 year note should have retreated and the curve should have flattened. That has been a recurring theme and that it did not do so suggests that the street is happy to be short the long maturities through the bidding process.

Additionally, as a part of the ongoing sterilization process the Open Market Desk offloaded $5billion of coupons in the 3 year part of the curve and that sale created nary a ripple in the market. I would suggest that the dealers used that paper to anchor sales of refunding paper.

Mortgages are tighter by 2 basis points to swaps. Investors drew solace from the reduction in capital requirements for FNMA which unshackles the firm and allows them to bulk up their footings. Other fast money mortgage buyers paid swaps and sold the refunding supply versus the mortgages. Swap Spreads widened between 1 ½ basis points and 2 ½ basis point.

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John Jansen

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