Fixed Income Recap

Treasuries traded higher today as the two-year rallied 1/32 of a point in price while the ten-year traded higher by about a quarter of a point. The benchmark curve was mostly unchanged on the day, and stands 6 basis points steeper for the week. A basis point represents .01%.

The supply concerns that dominated Treasuries last week have abated. The payroll number we are scheduled to get tomorrow is propping up the market up for now. A big downside surprise in that number could send investors fleeing for the safety of Treasuries.

Fed MBS Purchasing
The Federal Reserve announced $22.3 billion of agency MBS purchases for the seven day period ending yesterday. A considerable jump from their average of $18 billion per week.

The Four Primary Risks of Bonds

Credit
Duration
Liquidity
Structure

Duration measures a bond’s price sensitivity to interest rate movements. The higher the bond’s duration the more volatile the price of the security will be when interest rates change. Bonds with higher durations carry more risk as a result of this volatility in price.

Duration is often confused with time to maturity. Although it is usually true that longer bonds have higher durations, duration and time to maturity are not one in the same. Only in the case of zero coupon bonds (bonds that do not generate any cash flow until maturity), is the duration and time to maturity the same number.

Another name for duration risk is interest rate risk. Thirty-year Treasury bonds are very volatile securities, even though they are risk free from a credit standpoint. The risk lies in what can happen to the general interest rate environment during the time one has their money invested. A newly issued thirty-year Treasury has a duration of about 17, meaning that a 1% change in the yield on the thirty-year Treasury will result in a 17% change in the price in the opposite direction. Remember bond prices move inversely to yields. The same 1% change in yield on the two-year Treasury results in less than a 2% change in price. The two-year experiences considerably less volatility than the thirty-year due to a much smaller duration.

Our strategy tends to lean toward the shorter end of the curve. Rarely is one rewarded for taking the extra risk of longer duration bonds. By staying on the short side we receive the principal of our investment back sooner, and therefore have the ability to reinvest where we believe the best opportunities are.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst