Thursday, July 27, 2006

Gotta keep on a-rollllllllin'!

The Treasury will be holding another 30-year auction. They do it as a re-opening, which means that rather than create a new security, they will simply add on to the old 4.5% '36 issue which was sold in February. The deal won't get as much hoopla as the February auction, which was the first since 2001, but it may none-the-less be a big deal in the corporate bond market.

That is because I'm hearing dealers want to start trading long corporate bonds off the new 30-year after the auction is complete. Up until now, long corporates were quoted off the "old bond," or the 5.375% 2/31. Currently there is about a 6bp difference between the two securities, with the old bond yielding more. Traders refer to the movement from one benchmark security to another as a "roll."

For the non-corporate bond traders reading this, here is the analogy.

Let's say you drove by the gas station and saw $3.10/gallon at one station. Then the next station says $0.80/quart. The gas is the same. You know its 4 quarts per gallon. As long as you can do elementary school level math, you know that the second station is charging $3.20/gallon.

So in the corporate bond market, you hear one dealer offer Goldman Sachs 6.125% '33 at +140/old bond. The second dealer offers the same bond at +143/new bond. You know the new bond yields 6bp less than the old bond, so the first offering is better. Simple arithmetic, right? Its an efficient market, so the second dealer should never get away with selling his bond tighter just because he changed the benchmark, right?

Well for some reason, the corporate bond market doesn't work that way. Every time they roll to a new benchmark, bonds get tighter. Just more proof the market isn't quite as efficient as it should be. Point is, if your broker calls you and says that he can now sell you long-term bonds at a better spread, ask whether he's rolling to the new bond. If he claims to not know what you're talking about, get a new broker.

1 comment:

Accrued Interest said...

If he says this he's either ignorant or lying. Either way, its no good.