14:50 Floor Talk: Bond market sell-off creates afternoon volatility
Volatility has picked up this afternoon with a bond market sell-off and spike in yields dragging equities lower. Up until midday it was a very quiet session confined to a tight trading range. The most anticipated event -- the Treasury's 5-year note auction -- went well and was met with very little initial market reaction. Yield came in a bit better than expected, bid-to-cover was strong at 2.3x and participation from foreign investors was solid -- all illustrating strong demand for the sovereign debt. While bond prices began to tick lower initially, selling pressure quickly gained steam leading to a cascade lower in fixed income and spike in yields (10-year yields jumped from 3.533% to above 3.70%). This bond market selling is being attributed to large mortgage players hedging as rates moved higher against their positions and holdings. These participants need to hedge exposure that is the result of the recent spike in refinancing, and are using the longer dated bonds to do so. The thinner market conditions are only adding to the magnitude of the move and the known supply coming out of tomorrow's $26 bln 7-year auction (more supply at a relatively new maturity) is providing another reason for buyers to stay out of the way.
Equities have traded lower as a result (Dow -95, SPX -8, Nasdaq -4). The higher yields are seen as problematic as they indicate a higher borrowing costs across the board and call into question the govt's ability to keep them down, which is a key factor in the recovery effort underway. An increase in the govt's cost of capital is a concern at a time when its balance sheet is expanding. While demand held up in today's auction, which is encouraging given recent worries about the U.S. sovereign debt rating and additional upcoming supply, the unexpected bond market selloff and resultant higher yields are a concern on their own.
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