Fixed Income Recap

The two-year finished down 1/64, and the ten-year was lower by 1 12/32. The benchmark curve steepened by 12 basis points, and currently sits at +275 bps. A basis point represents .01%.

The recent selloff in Treasurys has pushed the yield curve to its steepest point on record, 1 basis point higher than the previous record set on October 13th 2003. Yield curve shape is based on a variety of factors, including liquidity differences between different Treasury issues and expectations for interest rates in the future. I will touch more on the reasons for the spike in longer-term rates below.

Treasurys were lower again today after $35 billion in 5-year notes came to market. The bid/cover ratio, the ratio of bids submitted to bonds sold, was 2.32, a sign of good demand compared to a 2.19 average for the last four auctions. More supply comes tomorrow when the Treasury will auction $26 billion in seven-year notes.

The increased supply is certainly making its presence felt in the market but it doesn’t deserve all the credit for the recent selloff. With all the talk of a Q3-Q4 end to the recession many are starting to wonder what will come of all the excess liquidity in the market. If the Fed is unable to pull the liquidity from the market appropriately, then inflation, simply defined as too much money chasing too few goods, will result. A larger than expected rate of inflation spells danger for investors who aim to protect the purchasing power of their savings.

Today’s auction results seem to point more towards inflation concerns rather than supply. Today’s supply was no surprise. The market has known about the record Treasury issuance that will be coming this year for some time now. The strong demand is just coming at a higher price for the US Treasury as investors look to protect against inflation. TIPS outperformed comparable nominal Treasurys by 75 basis points today, showing investor’s preference for inflation-indexed bonds compared to nominal (non-adjusted) Treasurys.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst