Fixed Income Recap

The two-year finished down 3/64, and the ten-year was lower by 45/64. The benchmark curve steepened by 6 basis points, and currently sits at +256 bps. A basis point represents .01%.

With no economic data and a shortened trading session in bond land, the market turned its focus to next week’s supply. The Treasury will issue $100 billion in 2’s, 5’s and 7’s next week, and if the market told us anything the past two days, demand for government paper is not nearly what it was a few months ago.

The media has really beaten the “US Treasury to lose its AAA credit rating” story to death. Standard and Poor’s got the ball rolling yesterday when they put the UK’s AAA credit rating on negative watch. Meaning they are still AAA but the credit agency is just revisiting the analysis.

There’s no doubt that this administration is spending borrowed funds at a frightening pace, and unless the Fed ups its participation through additional quantitative easing we will definitely see higher rates on Treasury borrowing for the rest of the year. But to say that investors should begin to worry about the credit of the US Treasury is a little much.

A lot of global money flooded into Treasuries during the collapse of the credit markets driving yields to record lows and the dollar to multi-year highs. That trend is reversing now more because of an increase in inflation expectations than a broad based currency meltdown, sorry CNBC. When economic activity picks up, inflation will begin to show itself, but even higher than average inflation from these price levels is far from destabilizing. The exposure this is getting in the media is just way too much.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

The two-year finished down 3/64, and the ten-year was lower by 1 & 33/64. The benchmark curve steepened by 15 basis points, and currently sits at +250 bps. A basis point represents .01%.

The Fed has purchased $123 billion in longer dated Treasuries since it began its current quantitative easing campaign on March 25. The target amount currently stands at $300 billion, but according to the minutes from the April FOMC meeting, some Fed officials are open to increasing that amount.

Primary dealers took those comments into consideration today when they submitted $45.7 billion in Treasuries to be purchased by the Fed, roughly 50% more than the average. Only $7.4 billion on the $45.7 billion were accepted by the Fed. The Ten-year sold off more than a point immediately after the results were announced.

Investors fearing rising rates are eager to dispose of Treasuries in favor of investments that will fare better in an inflationary environment. Dealers called the Fed’s bluff and today’s price action shows how that can backfire.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

The two-year finished up 3/64, and the ten-year was lower by 7/64. The benchmark curve steepened by 4 basis points, and currently sits at +235.5 bps. A basis point represents .01%.

There were no Fed purchases or Treasury auctions today. The Fed will buy Treasury notes tomorrow and Thursday.

TALF
The $1 trillion Term Asset-Backed Securities Loan Facility was created by the Fed to aid the flow of credit to consumers by providing liquidity for securities backed by loans for credit cards, equipment dealer floor plans and small businesses. It was expanded May 1st to include newly issued Commercial Mortgage Backed Securities (CMBS) and previously eligible TALF loans maturing in 5 years, (the previous limit was 3).

The program was expanded again today to include already issued AAA rated CMBS to spur more participation in the program. The first TALF auction on May 2nd took in $10.5 billion in securities and the auction scheduled for June 2nd doesn’t look like it will be much bigger.

Today’s announcement greatly expands the universe for TALF eligible securities. According to Bloomberg, only $35 billion in TALF bonds have been created this year. In comparison, $12.2 billion in CMBS were created last year, down from the record $237 billion sold in 2007, and although many of them aren’t rated AAA, this gives many more opportunities for firms to participate. Whether it makes sense for the Fed to take all this extra risk onto their balance sheet is another story.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

Investors fled the safety trade today as stocks rallied hard. The two-year finished down 7/64, and the ten-year was lower by 53/64. The benchmark curve steepened by 4 basis points, and currently sits at +232 bps. A basis point represents .01%.

The Fed purchased $3.18 billion in longer dated Treasuries with maturities from 8/15/19 to 2/15/26. Cumulative Fed purchases stand at $107.89 billion, still a ways from their target of $300 billion that is scheduled to finish in September.

TED Spread Continues to Fall

The spread between 3-month T-bills and 3-month Libor, dubbed the TED Spread, is widely used to measure credit market functionality. 3M Libor is the rate used by banks to lend each other money for a three month period, so unlike Treasuries, Libor lenders are exposed to default risk. When credit tightens and banks become less willing to take the risk involved in lending to each other, they move to T-bills to avoid the default risk and still maintain liquidity. As a result Libor rises and the yield on T-bills falls, widening the TED Spread. This is what happened in September and October of last year.

Three Month Libor has fallen every session since March 27th, including a 4.1 basis point decline today, bringing the TED Spread to its lowest level since August 2007.

However, on a relative basis, one would thing TED has a ways to go. For example, on August 8th 2007, the last time the TED Spread was this low, 3-month T-bills were at 4.95%. This indicates that although the TED Spread has come in from the extremely wide levels of last fall, it remains high on a relative basis. The current relative spread, which compares the nominal spread to the current rate environment, is still elevated at 389.2%, compared to just 8.7% in 2007.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst