Fixed Income Recap

Treasuries were up in early trading but faltered on some better than expected economic data that brought stocks higher. The selloff worsened after a poor five-year Treasury auction brought yields even higher. The two-year finished down 2/32, and the ten-year was lower by 53/64. The benchmark curve was steeper by 3.5 basis points on the day, and currently sits at +206 basis points. A basis point represents .01%.

Bids on $35 billion in 5-year Treasuries were plentiful but the rate still came in at 1.94%, higher than what was expected. The bid/cover ratio, a measure of demand for bond at auction, was 2.22, higher than the 4-auction average of 2.11.

Attention now turns to the Fed, who releases the comments from today’s FOMC meeting tomorrow at 1:15. They are expected to stand pat on Fed Funds (currently a range of 0-.25%), but the comments accompanying the decision will be closely watched. It has been six weeks now since the Fed announced its plan to buy $300 billion in US Treasuries to lower rates, but rates have returned to where they were before the Fed’s announcement. I would not be surprised if the Fed announces an increase in their Treasury purchases.

A Peek at Stress Test Results
Results of the stress tests were initially scheduled to be released on Monday, May 4th, but complete reports will probably be released sometime later that week. In the meantime, The Wall Street Journal reported this morning that regulators have told Citi and Bank of America that they may need to raise additional capital based on early results of the stress test that still haven’t been made public. Stress tests being performed by private analyst attempting to foreshadow capital needs as a result of the government’s program say BAC will need anywhere from $20-$70 billion in fresh equity. The $70 billion number comes from a stress test using an adverse situation with 12% unemployment, higher than the governments disclosed forecast of 10.3%.

The pros and cons of this program are being debated all over the street, but most agree that without transparency the tests themselves won’t get the job done. Even representatives at the banks who are working with regulators are having a hard time getting a handle on what the Fed is really searching for. Convoluted questions will lead to useless results in a “garbage in – garbage out” process such as this.

To make matters worse the government is nixing any chance of a private capital raise for a bank deemed in need of some by the stress tests. The Fed can continue to say that a negative result should not be perceived as a scarlet letter but the market has made up its mind in this regard. Raising capital in this environment would be highly difficult regardless of government involvement, but the fear of what comes with a government stake (pay restrictions, lending guidelines, board appointments, etc.) just makes it harder.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst