For the first time in 2009 I actually purchased something to capture a changing market environment. Having stayed on the sidelines for all of the past year ( I did not sell during the crisis and did not buy during the recovery as neither one made sense to me), I decided to act. I took a long position in TBT, an ETF which gives double short exposure to the long end of the treasury curve. It is not a perfect short play on the long end of the treasury curve. TBT corresponds to twice the daily movement of the Barclays Capital 20+ Year U.S. Treasury index. However, it is an affordable way to speculate (emphasis on speculate) on rising rates on the long end of the curve. After all, I am not a man of such eminence to be able to short U.S. treasuries.
At first glance it may appear that I have changed my tune and am now predicting a blow out of long-term rates. That is not the case. I am merely predicting that long-term rates cannot stay this low forever. I would be thrilled if by this time next year the yield of the 30-year government bond is over 5.00% and the 10-year treasury note yield is over 4.00%. In fact 100 basis points may be the extent of the rise we see in the next year or two (possibly for the entire cycle).
Why do I think that the rise of long-term rates will be limited? The economy is just not that strong and economic activity, consumer activity, will not reach levels seen during the past two decades with more traditional lending standards. In fact, I think the economy will stumble somewhat during the next two quarters. What I am saying is counterintuitive I know, but markets are not behaving logically. We have gold and stocks being used as dollar hedges fueled by cheap leverage. As soon as the Fed removes its extensive stimulus and borrowing costs rise for traders, trades will begin to unwind. As short-term rates rise the U.S. dollar will strengthen as investors begin to buy on the short end of the curve at new higher rates. As the dollar strengthens, the need for dollar hedges diminishes causing a further selloff of gold, equities and junk bonds. The strengthening dollar reduces, but not eliminates the need for foreign central banks to buy long-term treasuries to manage their currencies. That is where the mild rise in long-term rates comes from.
When discussing this strategy and theory with a colleague he asked where the money that is currently invested in stocks, junk bonds and gold going to go? The answer is back to the lenders. The great rally of 2009 is mostly due to speculating with borrowed money. The Fed hopes that the economy can catch up to the equity markets and a correction will be avoided or dampened. This is the holiday season and maybe Mr. Bernanke's wish will be granted.
Monday, November 30, 2009
Wednesday, November 25, 2009
Happy Thanksgiving
This Thanksgiving we have much for which to be thankful. We live in the greatest country on earth. We have the love of our family and friends to brighten our lives and we (hopefully) have our health. There is something else for which we all should be thankful, foreign central banks. Thanks to indirect bidders (which consist primarily of foreign central banks), this week's treasury auctions (2-year, 5-year and 7-year) went very well. In fact today's 7-year auction was she strongest since last July. Not surprisingly, prices of long-dated treasuries rallied following the auction. What was surprising was the selloff of long-dated treasuries just prior to the auction. Did people really think that the auction would be a flop? For the past two months, predictions of waning interest among foreign central banks have been rampant. These predictions have been base on text book theory instead of reality.
Text books tell us that when a country lowers short-term interest rates, issues large amounts of debt relative to GDP and attempts to devalue its way out of a financial crisis, inflation and higher long-term rates are the result. The text books are correct in most circumstances, but not when it pertains to the U.S., not now. The U.S. is unique in that it is the largest market place for goods produced around the globe. This means that exporting nations need to moderate the dollar's slide by purchasing dollars (in the form of U.S. treasuries) which simultaneously results in selling their home currencies. Failure to do this results in exporters either raising prices (which could result in reduced market share) or smaller profit margins. Foreign central banks must either purchase dollars or peg their home currencies to the dollar as China has done. Pegging to the dollar has its own internal inflationary consequences so it is usually command economies, such as China, which engage in this practice as they can dictate prices and supply of goods to their consumers. At some point the U.S. may not be the dominant market place, but that day is not yet on the horizon. Look for continued strong buying of U.S. treasuries until inflation pressures resulting from growth take hold.
Growth driven inflation is not yet on the horizon because bank cannot lend the way they had in the past because they cannot securitize and sell low-quality loans to unsuspecting buyers (with the help of cooperative ratings agencies). Borrowers will have to prove their creditworthiness. Consumer borrowing will return to levels which were common before 25 years of rate declines and financial engineering by quants who have no clue why historical data was what it was, only that it was.
I had an interesting conversation with a financial adviser who was shocked that Moody's may downgrade bank preferreds, She stated that she believed that the bank troubles were past and that the stock market, oil prices and gold prices were up on string growth expectations. I explained to her that radioactive assets continue to poison the balance sheets of many banks, large and small and that commodity prices and the equity markets are rallying due to the weaker dollar. She was dumbfounded by my assessment. I am no genius. Most fixed income traders, analysts and strategists know exactly why certain assets prices are rallying. the problem is that most financial advisers are equity oriented. The U.S. treasury market is the best gauge of economic and inflation out look. It is what makes that market tick. The treasury market is telling us that economic will be unspectacular for some time. This is your father's economy. Get used to it.
Happy Thanksgiving.
Text books tell us that when a country lowers short-term interest rates, issues large amounts of debt relative to GDP and attempts to devalue its way out of a financial crisis, inflation and higher long-term rates are the result. The text books are correct in most circumstances, but not when it pertains to the U.S., not now. The U.S. is unique in that it is the largest market place for goods produced around the globe. This means that exporting nations need to moderate the dollar's slide by purchasing dollars (in the form of U.S. treasuries) which simultaneously results in selling their home currencies. Failure to do this results in exporters either raising prices (which could result in reduced market share) or smaller profit margins. Foreign central banks must either purchase dollars or peg their home currencies to the dollar as China has done. Pegging to the dollar has its own internal inflationary consequences so it is usually command economies, such as China, which engage in this practice as they can dictate prices and supply of goods to their consumers. At some point the U.S. may not be the dominant market place, but that day is not yet on the horizon. Look for continued strong buying of U.S. treasuries until inflation pressures resulting from growth take hold.
Growth driven inflation is not yet on the horizon because bank cannot lend the way they had in the past because they cannot securitize and sell low-quality loans to unsuspecting buyers (with the help of cooperative ratings agencies). Borrowers will have to prove their creditworthiness. Consumer borrowing will return to levels which were common before 25 years of rate declines and financial engineering by quants who have no clue why historical data was what it was, only that it was.
I had an interesting conversation with a financial adviser who was shocked that Moody's may downgrade bank preferreds, She stated that she believed that the bank troubles were past and that the stock market, oil prices and gold prices were up on string growth expectations. I explained to her that radioactive assets continue to poison the balance sheets of many banks, large and small and that commodity prices and the equity markets are rallying due to the weaker dollar. She was dumbfounded by my assessment. I am no genius. Most fixed income traders, analysts and strategists know exactly why certain assets prices are rallying. the problem is that most financial advisers are equity oriented. The U.S. treasury market is the best gauge of economic and inflation out look. It is what makes that market tick. The treasury market is telling us that economic will be unspectacular for some time. This is your father's economy. Get used to it.
Happy Thanksgiving.
Monday, November 16, 2009
Mae West, Dolly Parton and the Top Heavy Markets
I was discussing the markets with a very experienced an knowledgeable colleague about how "toppy" the equity market is. I told him it is "Mae West" toppy. It is "Dolly Parton" toppy. The tell-tale signs for us is the retail order flow into riskier vehicles and equity market participants positive spin on nearly economic report. Today, retail sales came in below the street consensus and the prior month's data was adjusted down. Empire Manufacturing came in well below economists expectations. Fed Chairman Ben Bernanke warns of headwinds ahead and the need for continued extraordinary monetary accommodation. In response the equity market rose 136 points.News reports indicate that many equity market experts were encouraged that retail sales turned positive. However, the fixed income market had a much different response.
Fixed income market participants took the weak economic data and Mr. Bernanke's comments for what they were and the result was a sharp rally of the prices of long-dated treasuries. Is it that the fixed income experts are smarter than the equity experts? Not really, it is just that the fixed income market participants are more honest. The equity geeks know that the economic fundamentals do not justify current equity market levels. They are hoping that they can force a self-fulfilling prophecy. That the weak dollar is helping to fuel the rally encourages the equity participants. They don't care why the market is up, only that it is up. That is until they want to take profits and then they are the first out the door.
Another sign that the equity (and fixed income credit markets) may be overdone are comments that certain phenomena "always" follows data which we are seeing now. Always is a long time and can the data can be selectively gathered by using time periods advantageous to one's argument. I say that "always" is a word that we should "never" use. Have we ever had current levels of household debt before? No. Have we ever had an economic malaise with interest rates already affective at zero? No. Have we ever had a global economy with a fierce battle for market share before? No.
What many "experts" decline to discuss is that current levels of unemployment were last seen in the early 1980s, before nearly three decades of ever-lower interest rates. The fact is that the robust growth and very low unemployment experienced since the 1980s are fundamentally unsustainable. They were fueled by ever lower interest rates and ever easier lending standards which resulted in ever higher home price which resulted in ever more home equity to be used to buy lifestyles unattainable by way of income alone. The problem is that such home price increases (and the resulting growth in home equity) is unsustainable. Now we have reverted to the mean, maybe a little below the mean, but current economic activity is much closer to fundamental levels than the credit-fueled spending binges of the 1990s and 2000. Bill Gross has it right, get conservative now.
Fixed income market participants took the weak economic data and Mr. Bernanke's comments for what they were and the result was a sharp rally of the prices of long-dated treasuries. Is it that the fixed income experts are smarter than the equity experts? Not really, it is just that the fixed income market participants are more honest. The equity geeks know that the economic fundamentals do not justify current equity market levels. They are hoping that they can force a self-fulfilling prophecy. That the weak dollar is helping to fuel the rally encourages the equity participants. They don't care why the market is up, only that it is up. That is until they want to take profits and then they are the first out the door.
Another sign that the equity (and fixed income credit markets) may be overdone are comments that certain phenomena "always" follows data which we are seeing now. Always is a long time and can the data can be selectively gathered by using time periods advantageous to one's argument. I say that "always" is a word that we should "never" use. Have we ever had current levels of household debt before? No. Have we ever had an economic malaise with interest rates already affective at zero? No. Have we ever had a global economy with a fierce battle for market share before? No.
What many "experts" decline to discuss is that current levels of unemployment were last seen in the early 1980s, before nearly three decades of ever-lower interest rates. The fact is that the robust growth and very low unemployment experienced since the 1980s are fundamentally unsustainable. They were fueled by ever lower interest rates and ever easier lending standards which resulted in ever higher home price which resulted in ever more home equity to be used to buy lifestyles unattainable by way of income alone. The problem is that such home price increases (and the resulting growth in home equity) is unsustainable. Now we have reverted to the mean, maybe a little below the mean, but current economic activity is much closer to fundamental levels than the credit-fueled spending binges of the 1990s and 2000. Bill Gross has it right, get conservative now.
Sunday, November 15, 2009
USA!
As I expected, the 10-year treasury was very well received. The bid to cover ratio was a string 2.81 versus an average of 2.61 for the last 10 auctions. The indirect bidders (which includes foreign central banks) came it at 47.3% versus a prior 47.4%. The 30-year auction was a bit softer than expected, at least on the surface. The bid to cover ration for the 30-year government bond slipped to 2.26 from 2.39 average for the last 10 auctions. Foreign central bank buying remained strong.
Last week's auctions cause prices on the long end of the curve to rally, but that did not help the U.S. dollar as investors continue to invest in foreign currencies. I think that bubbles exist in foreign currencies, equities, high yield bonds and some high grade bonds. Joining me in the camp is Bill Gross of PIMCO. Bill believes that those markets are over done and U.S. treasuries are the place to be. It is difficult for me to say this as a long-time corporate bond trader, but the credit markets are overdone here. Spreads between 10-year industrials, such as Wal-Mart are well under 100 basis points. Verizon and ATT paper are in the 100 basis point area. Only in the bank and finance arena does some value exist. That is because there could still be some bad news (but not fatal news) ahead. The more retail participation the more overvalued the asset class at this time. This goes double for floating rate notes.
I have been through the floater story before. I still have financial advisors buying floaters at tight spreads and very low yields in an effort to eliminate interest rate or, in the case of CPI floaters, inflation risk. These products do no such things. If floaters eliminated these risks for investors, they would create such risks for the issuers!!! Why is it so difficult for advisers and investors to understand this? It irks me when advisers tell me they know better and that I am wrong. Please, I don't tell financial advisers how to do estate planning, don't tell me how bonds work. Bonds have been my specialty for over 20 years.
Libor-based floaters do best when the yield curve is flat and the coupon benchmark (LIBOR) and the trading benchmarks (10-year or 30-year treasuries) are similar. This is why their prices are at discounts even though long-term rates have crept up. Fixed-rated bonds and preferreds have rallied tremendously. Most LIBOR floaters are so far below their floor coupons based on calculations that it is going to take 300 or more basis points of Fed tightening before these securities can move above their floor coupons. By that time we could be into the next part of the economic cycles heading towards lower inflation and lower long-term rates and the Fed once again easing.
CPI floaters adjust off of the year-over-year change of the rate of inflation based on the CPI Urban Consumer Index (non-seasonally adjusted). If inflation, YoY, is at 3.00% for two consecutive years, your coupon FALLS to its spread over the index. If inflation declines from 3.00% to 2.00%, your coupon drops. The coupon would be spread off of a negative calculation. Anyone buying these for inflation protection should be tested for drugs. Buying floaters is to SPECULATE that the observed benchmark will perform in a certain fashion. LIBOR floaters do best when the curve flattens and CPI floaters do bets when the RATE OF INFLATION rises. TIPs are rich as well, but at least a case can be made to have a hedge versus inflation. The best strategy for rising rates or inflation is to ladder or barbell a portfolio.
Last week's auctions cause prices on the long end of the curve to rally, but that did not help the U.S. dollar as investors continue to invest in foreign currencies. I think that bubbles exist in foreign currencies, equities, high yield bonds and some high grade bonds. Joining me in the camp is Bill Gross of PIMCO. Bill believes that those markets are over done and U.S. treasuries are the place to be. It is difficult for me to say this as a long-time corporate bond trader, but the credit markets are overdone here. Spreads between 10-year industrials, such as Wal-Mart are well under 100 basis points. Verizon and ATT paper are in the 100 basis point area. Only in the bank and finance arena does some value exist. That is because there could still be some bad news (but not fatal news) ahead. The more retail participation the more overvalued the asset class at this time. This goes double for floating rate notes.
I have been through the floater story before. I still have financial advisors buying floaters at tight spreads and very low yields in an effort to eliminate interest rate or, in the case of CPI floaters, inflation risk. These products do no such things. If floaters eliminated these risks for investors, they would create such risks for the issuers!!! Why is it so difficult for advisers and investors to understand this? It irks me when advisers tell me they know better and that I am wrong. Please, I don't tell financial advisers how to do estate planning, don't tell me how bonds work. Bonds have been my specialty for over 20 years.
Libor-based floaters do best when the yield curve is flat and the coupon benchmark (LIBOR) and the trading benchmarks (10-year or 30-year treasuries) are similar. This is why their prices are at discounts even though long-term rates have crept up. Fixed-rated bonds and preferreds have rallied tremendously. Most LIBOR floaters are so far below their floor coupons based on calculations that it is going to take 300 or more basis points of Fed tightening before these securities can move above their floor coupons. By that time we could be into the next part of the economic cycles heading towards lower inflation and lower long-term rates and the Fed once again easing.
CPI floaters adjust off of the year-over-year change of the rate of inflation based on the CPI Urban Consumer Index (non-seasonally adjusted). If inflation, YoY, is at 3.00% for two consecutive years, your coupon FALLS to its spread over the index. If inflation declines from 3.00% to 2.00%, your coupon drops. The coupon would be spread off of a negative calculation. Anyone buying these for inflation protection should be tested for drugs. Buying floaters is to SPECULATE that the observed benchmark will perform in a certain fashion. LIBOR floaters do best when the curve flattens and CPI floaters do bets when the RATE OF INFLATION rises. TIPs are rich as well, but at least a case can be made to have a hedge versus inflation. The best strategy for rising rates or inflation is to ladder or barbell a portfolio.
Monday, November 9, 2009
Rally 'Round The Dollar
The equity markets staged another rally. In keeping with recent trends commodities prices rose and the dollar fell. The relationship between the falling dollar and rising equity prices may not always exist, but it is currently a reality. Traders know full well that it is government stimulus and the printing of money and issuing of debt that is weakening the dollar and pushing asset prices higher. However, traders in different areas of the capital markets are expressing very different opinions. Most fixed income market participants acknowledge that he run-up of asset prices, including their own securities, is due to current monetary and fiscal policies.
Many equity market participants would have us believe that the resurgent asset prices are based on strengthening fundamentals. This reminds me of 2008 when oil wonks tried to convince us that rising oil prices was due to increasing demand. Anyone with half a brain knew it was a dollar hedge. When the financial crisis ensued, investors flocked to the safety of the dollar and oil prices plummeted. Some oil traders tried to explain that away by saying that oil dropped because the economic crisis was going to slow the global economy and reduce the demand for oil. This theory is blown out of the water by the current oil market. Last week, the International Energy Agency revised downward its forecast for oil consumption. However, oil prices continue to rise. Oil, gold and equity prices area all the result of a weaker dollar. Even higher high-yield bond prices are due to government stimulus. Without the government over stimulating the economy, many of these companies would not be able to refinance their debt by selling it to euphoric investors. At some point, these new bonds along with existing bonds coming due in the next five years, will have to be refinanced. This could be problematic once government stimulus is gone.
Beware of those who point to previous economic recoveries, such as 1983. I have written extensively on why the 1980s recovery is very different than today's recovery. The Wall Street Journal correctly points out the difference, not the least being that in 1983 interest rates were still very high. All the Fed had to do was to ease to reinvigorate the economy. Also, the S&P is trading at 7 times earnings rising to 10 times. When the current rally began the S&P was already at 13 time earnings and has risen to 19 times. According to the Journal the average is 16 times. The Journal also correctly points out that tax policy was becoming more business friendly in the 1980s. There is no such trend on the horizon now. All in all, this rally is only as strong as the greed which is fueling it.
Today's three-year auction was very well received by investors, especially indirect bidders which include foreign central banks. I am expecting a strong 10-year auction, in spite of more supply coming to market and fed policy which is weakening the dollar. If one is an exporter, one must do what one can to slow or stop the dollar slide to keep one's goods competitively priced. Later this week we will discuss the shape of the yield curve.
Many equity market participants would have us believe that the resurgent asset prices are based on strengthening fundamentals. This reminds me of 2008 when oil wonks tried to convince us that rising oil prices was due to increasing demand. Anyone with half a brain knew it was a dollar hedge. When the financial crisis ensued, investors flocked to the safety of the dollar and oil prices plummeted. Some oil traders tried to explain that away by saying that oil dropped because the economic crisis was going to slow the global economy and reduce the demand for oil. This theory is blown out of the water by the current oil market. Last week, the International Energy Agency revised downward its forecast for oil consumption. However, oil prices continue to rise. Oil, gold and equity prices area all the result of a weaker dollar. Even higher high-yield bond prices are due to government stimulus. Without the government over stimulating the economy, many of these companies would not be able to refinance their debt by selling it to euphoric investors. At some point, these new bonds along with existing bonds coming due in the next five years, will have to be refinanced. This could be problematic once government stimulus is gone.
Beware of those who point to previous economic recoveries, such as 1983. I have written extensively on why the 1980s recovery is very different than today's recovery. The Wall Street Journal correctly points out the difference, not the least being that in 1983 interest rates were still very high. All the Fed had to do was to ease to reinvigorate the economy. Also, the S&P is trading at 7 times earnings rising to 10 times. When the current rally began the S&P was already at 13 time earnings and has risen to 19 times. According to the Journal the average is 16 times. The Journal also correctly points out that tax policy was becoming more business friendly in the 1980s. There is no such trend on the horizon now. All in all, this rally is only as strong as the greed which is fueling it.
Today's three-year auction was very well received by investors, especially indirect bidders which include foreign central banks. I am expecting a strong 10-year auction, in spite of more supply coming to market and fed policy which is weakening the dollar. If one is an exporter, one must do what one can to slow or stop the dollar slide to keep one's goods competitively priced. Later this week we will discuss the shape of the yield curve.
Thursday, November 5, 2009
The Curve
I usually don't simply copy and paste articles from the Wall Street Journal (I leave that to those who run my desk at my real job), but Today's Wall Street Journal "Credit Market's" column speaks to my arguments about the yield curve. Besides, I have a mild concussion and have to do as little thinking as possible (maybe I should run for office?). The article notes how the Fed's decision to keep short-term rates low has hurt the prices of long-term bonds and helped the prices of TIPs. Be careful when buying TIPs because when the Fed does tighten, inflation pressures will abate, somewhat. The steepening yield curve is bad for LIBOR-based floaters. This would be a buying opportunity for such floaters as they should do better when the Fed does tighten and the curve flattens, eventually, but these preferreds are already too rich. Here is the article:
By MIN ZENG
Prices of Treasurys with longer maturities fell after the Federal Reserve reiterated its commitment to keep rates at record lows for an extended period, disappointing some investors and fanning worries that low rates may fuel inflation.
But prices of short-dated Treasurys, the most sensitive to official rate changes, gained, and traders pushed their expectations for the first rate increases into the summer of next year.
In the run-up to the Fed's statement, there had been expectations that policy makers might use a change in language to signal to markets that, with the economy on the mend, they were moving toward tightening policy. "The market got a bit ahead of itself pricing in possible changes in the Fed language," said Ian Lyngen, senior government bond strategist at CRT Capital Group.
The Fed's unchanged stance hurt longer-dated Treasurys as investors worried that the ultralow rates will fuel inflation. An additional concern for investors: record debt supply coming up next week, when Treasury sells a total of $81 billion in notes, up from the previous record of $75 billion.
The Treasury Department is scheduled to sell $40 billion in three-year notes, $25 billion in 10-year notes and $16 billion in 30-year bonds to cover its fourth-quarter funding needs.
On Wednesday, the benchmark 10-year note was down 20/32 point, or $6.25 per $1,000 face value, at 100 20/32. Its yield rose to 3.548% from 3.473% Tuesday, as yields move inversely to prices. The 30-year bond was down 1 22/32 points to yield 4.439%. The two-year Treasury gained 1/32 point to 100 6/32, lowering its yield to 0.905%.
Treasury inflation-protected securities outperformed plain-vanilla, or nominal, bonds as inflation expectations increased, measured by a widening yield spread between a 10-year TIPS and a 10-year nominal Treasury note. The spread widened to 2.12 percentage points. It suggests investors expect an average annualized inflation rate of 2.12% within a decade. That still is lower than the 2.50% expected before the collapse of Lehman Brothers.
Separately, the Fed scaled back one of its asset-purchasing programs. The Fed said it would buy $175 billion of agency debt -- issued by Fannie Mae and Freddie Mac -- less than the $200 billion the Fed had said it would buy. The Fed said the reduction reflected the limited availability of agency debt. Still, yield premiums on agencies -- as such debt is known -- widened over Treasurys by 0.03 to 0.05 percentage point in response to the Fed's announcement.
Debt Ceiling Seen Later; No More 20-Year TIPS
The Treasury pushed back the date it expects to hit the $12.1 trillion U.S. public debt ceiling to mid-to-late December, taking pressure off Congress to raise the limit. However, it noted "the government's cash flows are volatile and forecasting a precise date is difficult." Treasury Secretary Timothy Geithner has requested that Congress increase the ceiling. The U.S. public debt stood at $11.92 trillion Monday. Meanwhile, the Treasury announced plans to sell $81 billion in new securities next week to refund $38.5 billion in maturing issues and raise $42.5 billion.—Meena Thiruvengadam
Write to Min Zeng at min.zeng@dowjones.com
By MIN ZENG
Prices of Treasurys with longer maturities fell after the Federal Reserve reiterated its commitment to keep rates at record lows for an extended period, disappointing some investors and fanning worries that low rates may fuel inflation.
But prices of short-dated Treasurys, the most sensitive to official rate changes, gained, and traders pushed their expectations for the first rate increases into the summer of next year.
In the run-up to the Fed's statement, there had been expectations that policy makers might use a change in language to signal to markets that, with the economy on the mend, they were moving toward tightening policy. "The market got a bit ahead of itself pricing in possible changes in the Fed language," said Ian Lyngen, senior government bond strategist at CRT Capital Group.
The Fed's unchanged stance hurt longer-dated Treasurys as investors worried that the ultralow rates will fuel inflation. An additional concern for investors: record debt supply coming up next week, when Treasury sells a total of $81 billion in notes, up from the previous record of $75 billion.
The Treasury Department is scheduled to sell $40 billion in three-year notes, $25 billion in 10-year notes and $16 billion in 30-year bonds to cover its fourth-quarter funding needs.
On Wednesday, the benchmark 10-year note was down 20/32 point, or $6.25 per $1,000 face value, at 100 20/32. Its yield rose to 3.548% from 3.473% Tuesday, as yields move inversely to prices. The 30-year bond was down 1 22/32 points to yield 4.439%. The two-year Treasury gained 1/32 point to 100 6/32, lowering its yield to 0.905%.
Treasury inflation-protected securities outperformed plain-vanilla, or nominal, bonds as inflation expectations increased, measured by a widening yield spread between a 10-year TIPS and a 10-year nominal Treasury note. The spread widened to 2.12 percentage points. It suggests investors expect an average annualized inflation rate of 2.12% within a decade. That still is lower than the 2.50% expected before the collapse of Lehman Brothers.
Separately, the Fed scaled back one of its asset-purchasing programs. The Fed said it would buy $175 billion of agency debt -- issued by Fannie Mae and Freddie Mac -- less than the $200 billion the Fed had said it would buy. The Fed said the reduction reflected the limited availability of agency debt. Still, yield premiums on agencies -- as such debt is known -- widened over Treasurys by 0.03 to 0.05 percentage point in response to the Fed's announcement.
Debt Ceiling Seen Later; No More 20-Year TIPS
The Treasury pushed back the date it expects to hit the $12.1 trillion U.S. public debt ceiling to mid-to-late December, taking pressure off Congress to raise the limit. However, it noted "the government's cash flows are volatile and forecasting a precise date is difficult." Treasury Secretary Timothy Geithner has requested that Congress increase the ceiling. The U.S. public debt stood at $11.92 trillion Monday. Meanwhile, the Treasury announced plans to sell $81 billion in new securities next week to refund $38.5 billion in maturing issues and raise $42.5 billion.—Meena Thiruvengadam
Write to Min Zeng at min.zeng@dowjones.com
Wednesday, November 4, 2009
Carry On
The FOMC, as expected, announced that it will leave the Fed Funds rate unchanged and will keep them low for an extended period of time. The FOMC also said that although there are signs that the economy is improving there could be continued headwinds from high unemployment and constrained consumer spending due to the lack of income growth, reduced credit and lower housing wealth the Fed will continue to buy agency debt and MBS in an effort to keep mortgage rates low. The markets are concerned that the Fed is keeping rates too low for too long. This caused the yields of long-dated treasuries to rise. The equity prices gave up much of their earlier gains on the news.
The carry trade is becoming more lucrative for banks. They can borrow from mother (the Fed) and lend to father (the treasury) and make about 3.25% in the process. The Fed is concerned that the carry trade is helping to drive profits and the recovery in the financial sector and does not want to remove the punch bowl prematurely. A steep yield curve is bad news for libor-based preferreds and bonds as the disconnect between coupons and trading yields widens.
Here is the full FOMC statement:
Release Date: November 4, 2009
For immediate release
Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period. Activity in the housing sector has increased over recent months. Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.
In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
The carry trade is becoming more lucrative for banks. They can borrow from mother (the Fed) and lend to father (the treasury) and make about 3.25% in the process. The Fed is concerned that the carry trade is helping to drive profits and the recovery in the financial sector and does not want to remove the punch bowl prematurely. A steep yield curve is bad news for libor-based preferreds and bonds as the disconnect between coupons and trading yields widens.
Here is the full FOMC statement:
Release Date: November 4, 2009
For immediate release
Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period. Activity in the housing sector has increased over recent months. Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.
In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Tuesday, November 3, 2009
No Surprises
CIT filed for a pre-packaged Chapter 11 bankruptcy protection. This was not unexpected. It appears as though senior bond holders will get 70 cents on the dollar in new second lien secured notes (second claim on specific assets, probably receivables) and 30 cents in equity. Subordinate debt, preferred and equity holders are wiped out. This does not solve CIT's broken business model, but it may give them the breathing room to do so. The question is: What kind of revenues can CIT generate by focusing more on lending to higher-quality businesses and less to lower-quality businesses. Other firms are already courting CIT's better clients. Some have defected.
Don't feel too bad for institutional bondholders. Many will get par. How is that you say? Many bought credit default swap protection. As with the GM bankruptcy, bondholders buy default protection agree to compensation via a bankruptcy, deliver their bonds to whomever sold them protection, receive 100 cents on the dollar and leave the CDS seller to receive bankruptcy recovery. This is why bondholders would not agree to the bond exchange prior to bankruptcy. They needed a bankruptcy to receive par.
As part of its restructuring plan with the Her Majesty's Treasury, Royal Bank of Scotland agreed to suspend all dividend and coupon payments on its hybrid and preferred securities. It also agreed not to call any issues in. The time frame is two years. There are more details which can be found on HM Treasury's website, but the key here is that RBS and the British Government heeded the European Commissions wishes and suspended dividends. ING and ABN could take similar action. Their preferreds are not suitable for investors needing income.
One surprise came from the auto sector as GM and Ford unexpectedly reported profits. Now the annualized sales rate is over 10mm units nationwide. Unfortunately the Detroit makes need about a 16mm units sales U.S. sales pace to break into the black. Baby steps, I guess.
Don't feel too bad for institutional bondholders. Many will get par. How is that you say? Many bought credit default swap protection. As with the GM bankruptcy, bondholders buy default protection agree to compensation via a bankruptcy, deliver their bonds to whomever sold them protection, receive 100 cents on the dollar and leave the CDS seller to receive bankruptcy recovery. This is why bondholders would not agree to the bond exchange prior to bankruptcy. They needed a bankruptcy to receive par.
As part of its restructuring plan with the Her Majesty's Treasury, Royal Bank of Scotland agreed to suspend all dividend and coupon payments on its hybrid and preferred securities. It also agreed not to call any issues in. The time frame is two years. There are more details which can be found on HM Treasury's website, but the key here is that RBS and the British Government heeded the European Commissions wishes and suspended dividends. ING and ABN could take similar action. Their preferreds are not suitable for investors needing income.
One surprise came from the auto sector as GM and Ford unexpectedly reported profits. Now the annualized sales rate is over 10mm units nationwide. Unfortunately the Detroit makes need about a 16mm units sales U.S. sales pace to break into the black. Baby steps, I guess.
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