Thursday, January 8, 2009

A Small Conclusion on Bond So Far

This is the first week of 2009 on which many bonds are sold. Results are as follows:

4-week: sold 24b, bid/cover 3.72, discount 0.06%;
(last sale: Dec 30, 2008: sold 22b, bid/cover 3.09, discount 0.03%)

3-month: sold 26b, bid/cover 3.11, discount 0.15%;
(last sale: Dec 29, 2008: sold 26b, bid/cover 2.44, discount 0.05%)

6-month: sold 27b, bid/cover 3.26, discount 0.32%;
(last sale: Dec 29, 2008: sold 26b, bid/cover 2.51, discount 0.25%)

3-year: sold 30b, bid/cover 2,21, yield 1.2%, coupon 1.125%;
(last sale: Dec 8, 2008: sold 28b, bid/cover 2.15, yield 1.245%, coupon 1.125%)

10-year: sold 16b, bid/cover 2.59, yield 2.419%, coupon 3.75%;
(last sale: Dec 8, 2008: sold 16b, bid/cover 2.44, yield 2.670%, coupon 3.75%)

10-year TIPS: sold 8b, bid/cover 2.48, yield 2.245%, coupon 2.125%;
(last sale: Oct 8, 2008: sold 6b, bid/cover 2.22, yield 2.85%, coupon 1.375%)

There are 2 common points in the auctions:

  1. All yield rates of short-term bills increased from last auction.
  2. All bid/cover ratio increased from last auction.

Despite the drop on bond prices owing to over-bought and worries on US government deficit, the demand on the bills, notes and bonds, are all solid at the current level. After the rather rapid drop before the 2009 auctions, the new auctions signalled that investors were still looking for a comparatively risk-adversed asset as a part of their portfolio. Assume the "announcements" by China and Japan governments about the decrease of bond positions are true, then the other non-governmental investors are still long for reasonably priced US government debts. Don't forget that the primary sales on last 2-3 months are not "normal" - Treasury and FED faced severe illiquidity period and took extreme measures to inject money to the banking and finance system. The first wave has passed so far, and it is normal that the price returns to a normal range and closes its gap with FED target rate 0-0.25%.

Special attention is to be made on the 10-year note and 10-year TIPS:

  1. The trend of yield: both bonds' yields have decreased by 251pts and 605pts respectively from last sale.

  2. The difference between their yields: in this current sales the difference between Note and TIPS is 0.174% that has increased by 0.354% from -0.18%.

  3. The coupon rate of 10-year TIPS has increased from 1.375% to 2.125%.

Comparing with the last issues, this auction of the longer term bond still have their yields decreased which is a general trend. Market confidence in general is still weak and seeks for shelters should anything happens. But particularly for 10-year TIPS, despite the drop of yield rate, treasuries raised the coupon rate from 1.375% to 2.125% in order to attract bidding. It only happens when market considered that inflation is not the big concern and hence the yield of 10-year notes will be better than the 10-year TIPS, by equation that real interest rate = nominal - inflation. Thus, although in the primary market the yield rate of 10-year TIPS is still lower than that of 10-year notes, the trend may lean towards an expectation of prolonged deflation even up to 10-year. Assume this is the market expectation, then in 2009 and even 2010 USA stock market will only subject to rebound but not recovery.

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