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.