Fixed Income Recap

Treasuries continued their selloff today, especially in the longer end, as the curve steepened 10 basis points to +186. U.S. Treasury Secretary-nominee Timothy Geithner announced that the Obama administration believes China is manipulating its currency, and as a result could decrease their demand for U.S. Treasuries in the future. This along with supply concerns drove longer-dated Treasuries slower.

The New York Fed announced $19 billion in MBS purchases for the seven day period ending yesterday. Continuing to stick to 30-year product but making a slight adjustment toward Fannie Mae issued securities. The Fed’s previous buying had leaned more toward Freddie Mac. I’m not sure they truly have a preference. After taking over control of both agencies they act more like one entity than before, and since they are so early into the program, the Fed is more than likely just mopping up whatever they can find at this point.

What is spread?
Spread is the measure of yield differences between two securities. It is usually quoted in basis points, or one-hundredth of one percent, and is used in order to quantify relative risk and return.

Let’s use a simple example. Today you can purchase a 2-year Bank of America corporate bond around a 5.5% yield. Without knowing anything about the current rate environment there is no way of knowing what kind of deal you are getting here. It’s important to consider the return you are getting relative to the market.

We often use Treasuries in calculations of spread because they are the highest quality in terms of credit and liquidity. The goal of any benchmark is to eliminate as many variables as possible, and in bonds nothing is more “Plain Jane” than Treasuries.

A 2 year Treasury bond is currently yielding .72%. So if you were to purchase the BAC bond I mentioned earlier at 5.5% you would be earning 4.78% more than if you bought the Treasury. Therefore, you could say 2 year BAC debt is trading 478 basis points wide of comparable Treasuries (in bond talk). In other words 478 basis points is the “credit spread”.

Since the bonds mentioned here are both 2-year bonds credit worthiness of the issuers is the only major differentiator. According to the market Bank of America is more likely to default on their debt than the U.S. Government. The larger spread over Treasuries, or the higher relative yield, is how an investor is compensated for the added risk.


Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst