Resistance holds for now...

Despite a 243 point sell off in the Dow, the 10-year couldn't break through 4.50% decisively. Meanwhile, the 2-10 inversion got smaller and smaller all day. Now -2bps. Was -8bps yesterday, and as low as -15bps in February.

If I were a betting man, which I am, I'd bet that the 10-year backs off a bit from here. Lately its been steeper on a rally, flatter on a sell-off, so I guess we'll back away from the -2bps slope as well. Like I said before, there isn't a lot of logic to the 10-year vs. Fed Funds slope to invert much beyond 75bps. I think that is creating big resistance around 4.50%, hence why I think we'll bounce off that level tomorrow.

Too much money was sitting on flattening trades, and I think those trades are currently getting squeezed out. So I think any flattening here (i.e., increase in inversion) will be met with unwind trades. I don't think we flatten any more than -8bps or so without some very positive economic news.

Interesting note that swap spreads were basically unchanged in the 10 and 30 year area. Normally we'd see widening of swap spreads with the stock market and corporates so weak. MBS also held in OK given it was such a huge rally in rates. I think both MBS and swaps are benefiting from the steeper curve.

Also interesting was the strong performance by TIPS today. Early in the day you could blame the outperformance by TIPS on a strong day for the CRB (a widely followed commodity index). But by the end of the day, the CRB was actually down $1.83 (about 0.6%). Yet TIPS outperformed Treasuries by about 1/4 point in 10 and 30 years. I think the TIPS market is pricing in Fed cuts. Look, no matter what your inflation outlook is or your opinion about how tight monetary policy is currently, if you believe the Fed is cutting, that's bullish for inflation. If inflation is always and everywhere a monetary phenomenon, then more money = more inflation. Lower funds = more money. Ergo, ipso facto, ceteris paribus, TIPS rally.

Corps are getting hit hard. My prediction that financials would outperform industrials is looking pretty shitty right now. I clearly underestimated the impact of sub-prime on the finance sector generally. Well, check that. I underestimated the fear of contagion related to sub-prime. I had been suspicious of firms like NEW as well as sub-prime ABS for a while. Actually way too early on both, as I haven't had any exposure to that stuff for several years. But it sure feels like the market is throwing the whole finance sector out with the sub-prime bath water.

I still think finance will outperform industrials from here, I'm just not sure it will make up what its lost the last 3 weeks. Lehman's Intermediate Financials index has underperformed the Intermediate Industrial index by 46bps YTD through yesterday. I'd say financials are a buy here, but given that corporates generally are still pretty tight, it might be that everything keeps widening if the economy weakens. As a PM managing against an index, I'm going to stay long financials and am looking to add some housing sensitive bonds where I think sub-prime won't be an issue. Its going to add volatility in the short-run, but when fear is ruling the market, opportunities arise.