Prices of Treasury coupon securities moved dramatically higher Thursday in an exciting day of trading. The market opened with a very firm tone as the AIG confession renewed worries about credit. Some economic data fueled the fire. The weekly report on initial claims jumped sharply to 455K when forecasters had been expecting a sharp drop. There are some special factors which have influenced the data but all of the increase can not be explained away and that sends a troubling message about the labor market.

Several major retail chains reported sales for July and those sales were on the soggy side.

The ECB fanned the flames as Mr Trichet acknowledged that growth would weaken significantly in the near term. His comments sparked a rally in European bonds and helped to keep the US market well bid.

The equity market has melted today and that has sent some investors scurrying to the Treasury market for safety.

The final piece of the puzzle was the 30 year bond auction which I wrote about earlier. There was huge demand and many traders were left to scramble and cover shorts.

The subsequent fracas pushed the market to new highs.

The yield on the 2 year note has dropped 15 basis points to 2.42 percent. The yield on the 5 year note dropped 17 basis points and is closing the day at 3.15 percent. The yield on the benchmark 10 year note dropped 15 basis points to 3.91 percent and the yield on the Long Bond declined 15 basis points to4.55 percent.

The 2year/10 year spread is 149 basis points.

The 2year/5 year/30 year butterfly is 67 basis points after closing around 63 basis points yesterday.

Current coupon MBS are about 6 ticks wider to treasuries and about a tick wider to swaps. The 6 percent coupon is trading at approximately par.

Mortgages still face a host of problems. Banks are generally chunky buyers of the product but many have capital problems and can not be bulking up the balance sheet. There is fear of sales of assets buy FNMA (FNM) or Freddie Mac (FRE). Additionally, the overseas bid has dried up.

Mortgages are extremely cheap at the moment but until someone can find a way to entice the marginal buyer to partake of these cheap assets, they will stay cheap or become even cheaper.

Swap spreads are 2 basis points to 4 basis points wider as traders and portfolio managers use the swaps market to hedge MBS exposure.

The IG 10 is closing the day 134 ¼ /135 ¼. That is about 3 wider on the day.

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John Jansen

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