Equity markets finished the fourth quarter strong, as market participants celebrated the Federal Reserve’s commitment to keeping exceptionally low rates in place for “an extended period.”
Economic data was mixed throughout March. Investors were excited early in the month by February’s labor report, which showed payrolls dropped less-than-expected. The strength of the labor market is widely considered the key factor determining the pace of household spending. The jobs situation is lagging previous recoveries, though, and may be weighing on consumers, which was evident with the preliminary consumer sentiment index contracting.
Weak housing starts and softening home price indicators dampened sentiment a bit, but also provided additional reasons for the Fed to keep interest rates at emergency levels. Low inflationary indicators also supported accommodative policy, with consumer prices remaining flat month-over-month and capacity utilization well below its long-term average.
Inflation remains a concern in the future and the Fed is walking a tightrope with its exit plan, but equity markets appear content with the Fed’s direction for now.
All equity asset classes moved higher in March, led by domestic REITs. REITs continue to benefit from merger and acquisition activity, headlined by the bidding for General Growth Properties, which filed for the biggest real-estate bankruptcy in U.S. history.
Small cap stocks outperformed their larger counterparts. This is somewhat surprising given the fact that credit is still relatively tight for small caps. Smaller businesses are also more likely to be affected by the healthcare legislation passed by Congress in March.
Speaking of healthcare legislation, hospitals and drugmakers appear to be the biggest winners as they pick up a glut of new paying customers. Meanwhile the insurance industry is coming out of all this relatively unscathed. In the end, the most controversial proposals – a government-run insurance option and direct government negotiation on drug prices for Medicare – were eliminated from the bill.
In overseas markets, concerns about Greece eased as the bailout of the debt-ridden country gained clarity. Despite nice gains in March, international markets have underperformed the S&P 500 in 2010, with performance for U.S. investors in many developed markets hurt by the relative strength of the U.S. dollar.
Treasury yields rose to their highest levels since late last year as investor’s appetite for risk improved following last month’s volatility in the credit markets. After a bout of flattening at the beginning of the month, the curve steepened back up to finish where it started at 280 basis points spread between the 2-year and the 10-year, just 11 basis points shy of its all time high of 291 set on February 22. The Barclays Aggregate Bond Index was down 0.12 percent for the month, with corporate debt being the best performing sector in the index.
A lot was written this past month on the end of the “Greatest Bull Market in Bonds Ever,” with many analysts calling March 2010 the beginning of the next rate cycle. A rising rate environment will hurt longer-term bonds significantly more than shorter-term bonds; given our bias toward the shorter-end of the curve, we consider our portfolios well positioned to weather such an environment. The majority of bonds we hold will allow us to reinvest more quickly than if we were to buy longer-term debt and take advantage of higher yields.
Peter Lazaroff, Investment Analyst
Cliff Reynolds, Investment Anlayst
Showing posts with label Bonds. Show all posts
Showing posts with label Bonds. Show all posts
Thursday, April 1, 2010
Friday, March 26, 2010
Fixed Income Weekly
Rates rose significantly in a week dominated by poor Treasury auctions and public statements by Ben Bernanke and other Fed officials. The yield on the two-year finished the week 6 basis points higher at 1.05%, while the yield on the ten-year rose 16 basis points to yield 3.85%. The broad bond market was down .51% for the week. US credit followed stocks higher while MBS held steady ahead of next week’s end to the Fed’s mortgage purchases.
I have spoken a lot about yields being stuck in a range for the past 15 months or so, and much of the same is likely to persist until the market senses that the Fed is closer to the removal of emergency levels of liquidity. The graphs below show the current range for the 2-year and the 10-year.
The 2-year and 10-year are in two different places within their ranges. The ten-year sits at the top of its range while the 2-year is more in the middle. As a result we now have record levels of steepness and liquidity is still being heavily favored in the market as investors continue to guard against rising rates. Despite differing greatly now, 2 and 10 year yields are set to converge as the Fed begins to reverse monetary policy. This isn’t a revolutionary view. Short term rates stand to move higher when the Fed tightens, and long term rates may actually come down depending on how the market views the Fed’s stance on inflation. Right now, the Fed isn’t even considering inflation as an issue, which could prove troublesome if they aren’t able to recognize the effects of their policy soon enough. Inflation expectations according to breakeven yields on 10-year TIPS are holding steady at around 2.25%, essentially unchanged since the beginning of this year.
I’m not saying the current position of rates is unjustified. In my opinion it makes sense for rates to be where they are. Bernanke commented briefly this week on the meaning of the “extended period” language, stating that there is no set period of time to be assigned to those words. I didn’t expect to hear him say “extended period means 6 months”, but questions from house members forced him to talk more about the subject than he felt comfortable with I think.
Below is the excerpt from his prepared remarks detailing asset sales.
If necessary, as a means of applying monetary restraint, the Federal Reserve also has the option of redeeming or selling securities. The redemption or sale of securities would have the effect of reducing the size of the Federal Reserve's balance sheet as well as further reducing the quantity of reserves in the banking system. Restoring the size and composition of the balance sheet to a more normal configuration is a longer-term objective of our policies. In any case, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments and on our best judgments about how to meet the Federal Reserve's dual mandate of maximum employment and price stability.
In my mind his remarks telegraphed a removal of at least some of the longer-term securities on the Fed’s balance sheet (i.e. MBS, Treasuries and Agency debt), before an actual rate hike. He still maintained that reverse repurchase agreements, where the Fed would essentially lend out their securities for a predetermined amount of time, are still an option but talked more about actual sales more than he has ever before. In my eyes the MBS purchases were even more “emergency” than bringing the funds rate at zero, making it the logical choice to remove first. With that being said, there is no way to really know until they decide to move. Until then I will speculate.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
I have spoken a lot about yields being stuck in a range for the past 15 months or so, and much of the same is likely to persist until the market senses that the Fed is closer to the removal of emergency levels of liquidity. The graphs below show the current range for the 2-year and the 10-year.
The 2-year and 10-year are in two different places within their ranges. The ten-year sits at the top of its range while the 2-year is more in the middle. As a result we now have record levels of steepness and liquidity is still being heavily favored in the market as investors continue to guard against rising rates. Despite differing greatly now, 2 and 10 year yields are set to converge as the Fed begins to reverse monetary policy. This isn’t a revolutionary view. Short term rates stand to move higher when the Fed tightens, and long term rates may actually come down depending on how the market views the Fed’s stance on inflation. Right now, the Fed isn’t even considering inflation as an issue, which could prove troublesome if they aren’t able to recognize the effects of their policy soon enough. Inflation expectations according to breakeven yields on 10-year TIPS are holding steady at around 2.25%, essentially unchanged since the beginning of this year.
I’m not saying the current position of rates is unjustified. In my opinion it makes sense for rates to be where they are. Bernanke commented briefly this week on the meaning of the “extended period” language, stating that there is no set period of time to be assigned to those words. I didn’t expect to hear him say “extended period means 6 months”, but questions from house members forced him to talk more about the subject than he felt comfortable with I think.
Below is the excerpt from his prepared remarks detailing asset sales.
If necessary, as a means of applying monetary restraint, the Federal Reserve also has the option of redeeming or selling securities. The redemption or sale of securities would have the effect of reducing the size of the Federal Reserve's balance sheet as well as further reducing the quantity of reserves in the banking system. Restoring the size and composition of the balance sheet to a more normal configuration is a longer-term objective of our policies. In any case, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments and on our best judgments about how to meet the Federal Reserve's dual mandate of maximum employment and price stability.
In my mind his remarks telegraphed a removal of at least some of the longer-term securities on the Fed’s balance sheet (i.e. MBS, Treasuries and Agency debt), before an actual rate hike. He still maintained that reverse repurchase agreements, where the Fed would essentially lend out their securities for a predetermined amount of time, are still an option but talked more about actual sales more than he has ever before. In my eyes the MBS purchases were even more “emergency” than bringing the funds rate at zero, making it the logical choice to remove first. With that being said, there is no way to really know until they decide to move. Until then I will speculate.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Friday, March 19, 2010
Fixed Income Weekly
A fairly slow week was highlighted by comments from the FOMC and February’s CPI reading that flattened the curve as short-term yields and long-term yields moved inversely to each other. The two-year Treasury yield rose 4 bps to .99% while the ten-year fell 2 bps to 3.68%.
Consumer prices were unchanged in February from the previous month, versus an expected .1% rise, the first time the index didn’t print a positive change since last March when prices fell -.1%. The actual reading missing expectations by .1% isn’t huge news, but a larger trend of decreasing inflation expectations made its presence felt in the marketplace this week. Breakeven yield’s, which measure the spread between yields on TIPS and nominal Treasurys, fell steadily throughout the week. Ten-year breakevens fell 7 basis points to 220 as investors demanded higher real yields while nominal yields fell. Some of the movement on the long end of the curve is due to some positioning before next week’s $118 billion in Treasury issuance but words from the Fed this week also had an impact.
The “extended period” language was left unaltered, which indicates that the Fed intends to keep rates where they are for at least the next 4-6 months. A fed hike in early 2010 was a popular thought last fall, but any chance of that has been put off until the summer at the soonest. Implied probabilities point to a 28% chance of a hike to .5% by the August meeting, lower than the 50% chance the market was assigning to that at the beginning of the year. Regardless, removal of the “extended period” language will have to come first. If you follow the 4-6 month buffer between the removal of the language and the actual hike, the language will have to be dropped after the next meeting if we are to get a hike in the summer.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Consumer prices were unchanged in February from the previous month, versus an expected .1% rise, the first time the index didn’t print a positive change since last March when prices fell -.1%. The actual reading missing expectations by .1% isn’t huge news, but a larger trend of decreasing inflation expectations made its presence felt in the marketplace this week. Breakeven yield’s, which measure the spread between yields on TIPS and nominal Treasurys, fell steadily throughout the week. Ten-year breakevens fell 7 basis points to 220 as investors demanded higher real yields while nominal yields fell. Some of the movement on the long end of the curve is due to some positioning before next week’s $118 billion in Treasury issuance but words from the Fed this week also had an impact.
The “extended period” language was left unaltered, which indicates that the Fed intends to keep rates where they are for at least the next 4-6 months. A fed hike in early 2010 was a popular thought last fall, but any chance of that has been put off until the summer at the soonest. Implied probabilities point to a 28% chance of a hike to .5% by the August meeting, lower than the 50% chance the market was assigning to that at the beginning of the year. Regardless, removal of the “extended period” language will have to come first. If you follow the 4-6 month buffer between the removal of the language and the actual hike, the language will have to be dropped after the next meeting if we are to get a hike in the summer.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Friday, March 12, 2010
Fixed Income Weekly
Treasurys were slightly lower across the curve after a quiet week of trading. The curve was 4 basis points flatter at end the week at +275 bps, 17 bps under the all time record set on Feb 22.
A strong credit market last week was followed up by heavy issuance of corporate debt this week. According to Bloomberg, some $30 billion in corporate bonds were issued by close of business Thursday, bringing the year to date total to just shy of $200 billion. Credit spreads have been steadily moving lower while Treasurys have remained in a tight range. CFOs are definitely aware of this and are taking advantage of the environment to raise cheap capital. And thanks to today’s news that Obama plans to nominate San Francisco Fed President Janet Yellen to Vice Chairman of the Federal Reserve, one of the most dovish of the 12 Fed Presidents, companies will likely see better chances still to borrow cheaply. The term “dovish” is used to describe those who favor easy monetary policy, as opposed to “hawkish” policy makers, who traditionally lean toward tighter monetary policy. The effect of ZIRP on the cost of debt is two-fold. Rates are low, and as investors stretch out to grab more yield in the face of measly low-risk returns, spreads will continue to tighten as long as rates stay here.
The FOMC meets next week and is expected to stand pat on rates, but all eyes will be reading the comments that accompany the rate decision. Namely, “the exceptionally low/extended period” section. Not much is being said one way or another on that, but I expect to hear more speculation early next week. I don’t think the committee is ready to remove them yet, but we are certainly closer than we were in January.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
A strong credit market last week was followed up by heavy issuance of corporate debt this week. According to Bloomberg, some $30 billion in corporate bonds were issued by close of business Thursday, bringing the year to date total to just shy of $200 billion. Credit spreads have been steadily moving lower while Treasurys have remained in a tight range. CFOs are definitely aware of this and are taking advantage of the environment to raise cheap capital. And thanks to today’s news that Obama plans to nominate San Francisco Fed President Janet Yellen to Vice Chairman of the Federal Reserve, one of the most dovish of the 12 Fed Presidents, companies will likely see better chances still to borrow cheaply. The term “dovish” is used to describe those who favor easy monetary policy, as opposed to “hawkish” policy makers, who traditionally lean toward tighter monetary policy. The effect of ZIRP on the cost of debt is two-fold. Rates are low, and as investors stretch out to grab more yield in the face of measly low-risk returns, spreads will continue to tighten as long as rates stay here.
The FOMC meets next week and is expected to stand pat on rates, but all eyes will be reading the comments that accompany the rate decision. Namely, “the exceptionally low/extended period” section. Not much is being said one way or another on that, but I expect to hear more speculation early next week. I don’t think the committee is ready to remove them yet, but we are certainly closer than we were in January.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Friday, March 5, 2010
Fixed Income Weekly
Bond traders sat on their hands for most of the week, waiting for two big news releases, the prepayment speeds for Freddie MBS last night, and the jobs report this morning. For the week the curve was slightly flatter, falling 1 bp to 279 basis points 2s to 10s. Credit tightened after being flat last week, mostly on today’s positive news. Markit’s current CDS index stands at 85.6, 9 points higher than the multi-year lows set in January. CDS is quoted as the cost of default insurance, so the lower the better.
The curve actually sat much flatter before the heavy selling on the long end after this morning’s jobs report, which showed business cut 36,000 payroll positions, better than the 68,000 expected. The labor participation rate ticked up slightly from 64.7% to 64.8% and the unemployment rate held steady at 9.687%. The big story leading up to the release was that severe weather was going to put the hurt on the data. The effect of things like this is impossible to accurately measure, but the market was ready to see a terrible number, and ignore it, but instead we saw a better than expected number, and stocks rallied like a Subaru.
Prepayment speeds are usually a non-event, but Freddie Mac purchased every loan that was at least 120 days delinquent from their mortgage pools in February, so March FHLMC speeds were expected to skyrocket. Freddie MBS underperformed Treasurys in early trading, but buyers stepped in to prove the selloff was a little unjustified considering overall speeds may actually slow down going forward due to the cleanup. Fannie Mae is expected to follow Freddie’s lead in the next few months, but will buy only “a substantial portion” of their 120+ delinquent loans. Fannie Mae is considered to have more problems compared to Freddie, but although Thursday’s release gives some insight into what will come, it by no means answers the market’s questions on what is to come with FNMA.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
The curve actually sat much flatter before the heavy selling on the long end after this morning’s jobs report, which showed business cut 36,000 payroll positions, better than the 68,000 expected. The labor participation rate ticked up slightly from 64.7% to 64.8% and the unemployment rate held steady at 9.687%. The big story leading up to the release was that severe weather was going to put the hurt on the data. The effect of things like this is impossible to accurately measure, but the market was ready to see a terrible number, and ignore it, but instead we saw a better than expected number, and stocks rallied like a Subaru.
Prepayment speeds are usually a non-event, but Freddie Mac purchased every loan that was at least 120 days delinquent from their mortgage pools in February, so March FHLMC speeds were expected to skyrocket. Freddie MBS underperformed Treasurys in early trading, but buyers stepped in to prove the selloff was a little unjustified considering overall speeds may actually slow down going forward due to the cleanup. Fannie Mae is expected to follow Freddie’s lead in the next few months, but will buy only “a substantial portion” of their 120+ delinquent loans. Fannie Mae is considered to have more problems compared to Freddie, but although Thursday’s release gives some insight into what will come, it by no means answers the market’s questions on what is to come with FNMA.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Monday, March 1, 2010
February 2010 Recap
After enduring an 8.03% drop from Jan. 19 to Feb. 8, the S&P 500 posted a solid monthly gain despite concerns about sovereign debt and lackluster economic data.
January retail sales data showed that U.S. consumers are starting to pull more of their weight, but a surprising increase in initial jobless claims and disappointing durable goods report near the end of the month kept investors expectations for the economy tempered. Housing data didn’t help either, with sales of previously owned U.S. homes falling 7.2% in January to a seven month low.
More important to the markets was the Federal Reserve raising the interest rate it charges banks for emergency loans and reaffirming that broad tightening of credit was not imminent. In addition, core consumer prices fell for the first time since 1982, leaving room for the Fed to keep rates relatively low if necessary.
The MSCI EAFE index posted a small loss of 0.65% on weaker-than-expected European Union GDP data and concerns surrounding Greece’s debt problem. The MSCI Emerging Markets Index squeaked out a 0.34% gain in the face of China removing economic stimulus. The bright spot among international areas was the MSCI Pacific Ex-Japan Index, which posted a 3.12% gain on strength in Australia.
Domestic REITs outperformed all other asset classes amid merger and acquisition activity. Multiple bids were made public for General Growth Properties, which filed for the biggest real-estate bankruptcy in U.S. history after amassing $27 billion in debt during an acquisition spree. Simon Property Group offered $10 billion and Brookfield Asset Management, which owns roughly $1 billion in General Growth debt, offered $2.63 billion for a 30% stake. General Growth is holding out for a higher bid, which led REITs to advance further.
Rates were barely lower for the month, falling just a few basis points across the curve, while news in bond land was dominated by sovereign credit issues overseas. Corporate spreads domestically were tighter by a few beeps compared to the end of January, despite widening out mid-month to levels not seen since November.
January retail sales data showed that U.S. consumers are starting to pull more of their weight, but a surprising increase in initial jobless claims and disappointing durable goods report near the end of the month kept investors expectations for the economy tempered. Housing data didn’t help either, with sales of previously owned U.S. homes falling 7.2% in January to a seven month low.
More important to the markets was the Federal Reserve raising the interest rate it charges banks for emergency loans and reaffirming that broad tightening of credit was not imminent. In addition, core consumer prices fell for the first time since 1982, leaving room for the Fed to keep rates relatively low if necessary.
The MSCI EAFE index posted a small loss of 0.65% on weaker-than-expected European Union GDP data and concerns surrounding Greece’s debt problem. The MSCI Emerging Markets Index squeaked out a 0.34% gain in the face of China removing economic stimulus. The bright spot among international areas was the MSCI Pacific Ex-Japan Index, which posted a 3.12% gain on strength in Australia.
Domestic REITs outperformed all other asset classes amid merger and acquisition activity. Multiple bids were made public for General Growth Properties, which filed for the biggest real-estate bankruptcy in U.S. history after amassing $27 billion in debt during an acquisition spree. Simon Property Group offered $10 billion and Brookfield Asset Management, which owns roughly $1 billion in General Growth debt, offered $2.63 billion for a 30% stake. General Growth is holding out for a higher bid, which led REITs to advance further.
Rates were barely lower for the month, falling just a few basis points across the curve, while news in bond land was dominated by sovereign credit issues overseas. Corporate spreads domestically were tighter by a few beeps compared to the end of January, despite widening out mid-month to levels not seen since November.
Friday, February 26, 2010
Fixed Income Weekly
The bond world has been a busy one lately. The situation in Greece has been very volatile, which is understandable considering the conflicting opinions in the market and the “contagion” type effect a Greek default could have within the Eurozone and beyond. Chairman Bernanke’s testimony was as expected, but still meaningful as Big Ben confirmed the need for exceptionally low interest rates for a considerable amount of time, in addition to the importance of the Fed’s role as the primary regulator of the banking system.
Treasuries have been fighting two separate battles. One is Fed policy. The short end has been bouncing around within a tight .7%-1.1% range for 6 months now. The hike in the discount rate last week brought about a kneejerk move higher in short-term yields, but after much nay saying by policy makers they have settled down to just about where they were before the Fed made the change. The Fed remains very unconcerned with current levels of inflation, Q4 PCE was 1.6% annualized versus 1.4% in Q3, but longer term effects of current policy have the market demanding much higher yields on the long-end, which explains the record high spread between 2s and 10s of 291 basis points on Monday.
Secondly, the budget/credit/currency issues in Europe are pushing money into dollars, and in turn Treasurys. It’s the typical safety trade really. It sure helped with the $126 billion the Treasury had to sell this week, which all traded through the “when issued” yield, a sign of better than expected demand.
Next week is full of more Fed speak, which should get the market jumpstarted after closing on a very quiet note (relatively) this week.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Treasuries have been fighting two separate battles. One is Fed policy. The short end has been bouncing around within a tight .7%-1.1% range for 6 months now. The hike in the discount rate last week brought about a kneejerk move higher in short-term yields, but after much nay saying by policy makers they have settled down to just about where they were before the Fed made the change. The Fed remains very unconcerned with current levels of inflation, Q4 PCE was 1.6% annualized versus 1.4% in Q3, but longer term effects of current policy have the market demanding much higher yields on the long-end, which explains the record high spread between 2s and 10s of 291 basis points on Monday.
Secondly, the budget/credit/currency issues in Europe are pushing money into dollars, and in turn Treasurys. It’s the typical safety trade really. It sure helped with the $126 billion the Treasury had to sell this week, which all traded through the “when issued” yield, a sign of better than expected demand.
Next week is full of more Fed speak, which should get the market jumpstarted after closing on a very quiet note (relatively) this week.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Friday, February 19, 2010
Fixed Income Weekly
The Fed took the market by a bit of a surprise after Thursday’s close when they moved the discount rate higher by 25 basis points to .75%, in addition to lowering the maximum term from 28 days to overnight. Before the crisis the spread between fed-funds and the discount rate stood at 1%, Thursday’s move brings the spread to about .65% if you use the current market fed-funds rate of 14 basis points. The reason for the 100 basis point spread during normal times is to penalize banks for going to the Federal Reserve for funding and encourage banks to get funding from other institutions through the fed-funds market. The spread was lowered in March of 2008 to lessen the strain on banks and provide a cheap source of liquidity for banks unable to obtain funding through fed-funds.
The short end sold off hard immediately after the release, gaining about 10 basis points in yield in the few hours following the announcement, but eased off the lows a bit in Friday’s trading. I don’t think that this move was meaningless, but it’s pretty close. The jump in rates was from the low end of the .8% to 1.1% range on the 2-year that we’ve been in for a while, and should expect to be in for at least the first half of 2010. As far as this move telegraphing an adjustment to the fed-funds rate goes, we still haven’t seen anything substantial from the Fed. Sure, Thomas Hoenig became the first dissenting vote last meeting when he urged to committee to remove the “extended period” language from the statement, but Thursday’s test will be followed by many more before a real move is made.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
The short end sold off hard immediately after the release, gaining about 10 basis points in yield in the few hours following the announcement, but eased off the lows a bit in Friday’s trading. I don’t think that this move was meaningless, but it’s pretty close. The jump in rates was from the low end of the .8% to 1.1% range on the 2-year that we’ve been in for a while, and should expect to be in for at least the first half of 2010. As far as this move telegraphing an adjustment to the fed-funds rate goes, we still haven’t seen anything substantial from the Fed. Sure, Thomas Hoenig became the first dissenting vote last meeting when he urged to committee to remove the “extended period” language from the statement, but Thursday’s test will be followed by many more before a real move is made.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Friday, February 5, 2010
Fixed Income Weekly
Sovereign Debt
Concerns over government debt levels are building across the globe, and the effects have been felt beyond the sovereign debt universe. Stocks, commodities and foreign currencies all suffered in the back half of the week, as risky assets were shed in favor of US Treasury and Agency bonds. It was nice to see Dollar hold up in the face of all this, considering the budget and debt issues we face domestically. The dollar index rose 1.68% during the last 3 days of the week, and gold fell 4.62% over the same period.
Several dealers sighted heavy buying on the longer end, an obvious safety trade, while yields on bills were actually higher for the week, as investors sought duration to gain from the rally in bonds.
To try and put the sovereign credit issues into perspective I built this table comparing CDS of some major countries with some more familiar US companies. There are some large discrepancies between credit ratings and CDS cost (BB- Venezuela at 1,055 basis points vs. BB- Turkey at 214 bps.). This should explain pretty clearly how little credit ratings are worth these days.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Concerns over government debt levels are building across the globe, and the effects have been felt beyond the sovereign debt universe. Stocks, commodities and foreign currencies all suffered in the back half of the week, as risky assets were shed in favor of US Treasury and Agency bonds. It was nice to see Dollar hold up in the face of all this, considering the budget and debt issues we face domestically. The dollar index rose 1.68% during the last 3 days of the week, and gold fell 4.62% over the same period.
Several dealers sighted heavy buying on the longer end, an obvious safety trade, while yields on bills were actually higher for the week, as investors sought duration to gain from the rally in bonds.
To try and put the sovereign credit issues into perspective I built this table comparing CDS of some major countries with some more familiar US companies. There are some large discrepancies between credit ratings and CDS cost (BB- Venezuela at 1,055 basis points vs. BB- Turkey at 214 bps.). This should explain pretty clearly how little credit ratings are worth these days.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Thursday, January 28, 2010
Fixed Income Weekly
Greece
With a budget deficit of 13% of GDP and a rapidly maturing debt load, Greece is in a little bit of a pinch. I think I mentioned this briefly last week but sovereign debt is becoming more of a global problem, and all eyes are have been on Greece the last few weeks to gauge how other countries will deal with the issue.
Much was made last week when Greece announced they would price €8 billion in 5-year debt in their first bond sale since mid December, but the market initially priced in the concerns accurately when the bonds came to market on Tuesday in a relatively clean auction. But news since then has sent yields on Greek debt higher, including the bond sold in Tuesday at a 99.34 price. That same bond closed at 96.34 today, and it doesn’t even settle for the first time until Feb 2. OUCH!! I heard CDS on 5-year Euro denominated Greek debt quoted at 420 basis points as of this afternoon, up from 324 basis points two days ago when the 5-year priced.
The skittish market comes after comments from Greek Finance Minister George Papaconstantinou, (his close friends call him “Papa”), denying that there is any bailout assistance coming from the ECB or IMF. He also denied any talks with China over a deal to sell a special debt issue to them, which wouldn’t be a bailout per say, but not exactly something a healthy Greece would necessarily have to do.
The near future looks rough for Greece, as half of the bond issuance for 2010 is slated for Q2 to refinance maturing debt. Officials seem confident that fiscal reform will be the answer, but days like today lead me to believe that the market does not share their confidence.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
With a budget deficit of 13% of GDP and a rapidly maturing debt load, Greece is in a little bit of a pinch. I think I mentioned this briefly last week but sovereign debt is becoming more of a global problem, and all eyes are have been on Greece the last few weeks to gauge how other countries will deal with the issue.
Much was made last week when Greece announced they would price €8 billion in 5-year debt in their first bond sale since mid December, but the market initially priced in the concerns accurately when the bonds came to market on Tuesday in a relatively clean auction. But news since then has sent yields on Greek debt higher, including the bond sold in Tuesday at a 99.34 price. That same bond closed at 96.34 today, and it doesn’t even settle for the first time until Feb 2. OUCH!! I heard CDS on 5-year Euro denominated Greek debt quoted at 420 basis points as of this afternoon, up from 324 basis points two days ago when the 5-year priced.
The skittish market comes after comments from Greek Finance Minister George Papaconstantinou, (his close friends call him “Papa”), denying that there is any bailout assistance coming from the ECB or IMF. He also denied any talks with China over a deal to sell a special debt issue to them, which wouldn’t be a bailout per say, but not exactly something a healthy Greece would necessarily have to do.
The near future looks rough for Greece, as half of the bond issuance for 2010 is slated for Q2 to refinance maturing debt. Officials seem confident that fiscal reform will be the answer, but days like today lead me to believe that the market does not share their confidence.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Friday, January 22, 2010
Fixed Income Weekly
Treasury yields were lower again this week as flight to quality trade began to emerge, helping bonds repair the damage done in December. A short lived spike in rates appeared on Friday as the Treasury announced it will sell $118 billion in 3-, 5- and 7-year notes next week, but rates fell back to finish the week about 7 basis points lower across the curve.
A few negative developments in the credit space hurt spreads for the first time since last November when the problems with debt laden Dubai World were first made public. Cost of default insurance on a broad index of corporate debt rose 14% this week to a one-month high.
A few negative developments in the credit space hurt spreads for the first time since last November when the problems with debt laden Dubai World were first made public. Cost of default insurance on a broad index of corporate debt rose 14% this week to a one-month high.
Greece announced plans to issue 3-5 billion Euros of five-year debt next week. Greece hasn’t issued any debt in the open market since spreads widened recently as investors grew weary about Greece’s heavy deficits. Ten-year Greek bonds currently trade about 320 basis points over German Bunds. US Treasury supply announcements move markets plenty, but the credit markets will be watching the results of this auction closely as sovereign debt problems become an even greater concern.
Banks have had a tough week, thanks to a proposal from President Obama aimed at limiting the risk of “to big to fail” financial institutions. Financials, by far the largest industry sector in the corporate bond market, will naturally feel the brunt of the damage if anything resembling what the President is proposing is enacted. The proposal focuses heavily on proprietary trading by FDIC insured institutions. Banks with large “prop trading” operations, (Goldman Sachs, Morgan Stanley, and other large banks), are leading the move downward.
Fannie and Freddie
We haven’t heard much on this front since the limit on aid that the Treasury could give the agencies was secretly raised from $300 billion dollars to infinity billion dollars on Christmas Eve. A recommendation was announced today by Barney Frank to “abolish” both of the agencies and replace them with something new. No comments were made detailing the reform, but as we have said a lot, the system is quickly moving toward being entirely FHA. This will likely turn out to be just another step in the same direction.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Friday, January 8, 2010
Fixed Income Weekly
This week the market’s attention was focused primarily on comments from various Fed officials and the minutes from December’s FOMC meeting.
The Fed minutes were pretty uneventful. Some voting members are content with winding down the Fed’s purchasing program on schedule (March) while others are pushing a possible expansion of the program in order to protect the still fragile housing market from the exit of the mortgage market’s biggest investor.
So far the Fed’s exit strategy has been limited to emergency lending programs that have been slowly unwinding due to decreased demand, but if the March does end up being the final month of MBS purchases it will be the first active step by the Fed to begin tightening. It’s not surprising to see some disagreement within the FOMC.
Bernanke
Several Fed officials spoke this week, but Bernanke’s speech on Sunday at the Annual Meeting of the American Economic Association in Atlanta caught my eye. The argument he presented was based on his belief that a lack of regulation, not unnecessarily low interest rates, led to the housing bubble.
From Big Ben’s speech…
The most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards… The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter.
This argument isn’t anything new from the Fed. The street is used to investors like Bill Gross talking up their positions on CNBC, and that’s all the Chairman is doing here. We are entering the second year of a 0-.25% target for Fed Funds and there are still 3-months to go until the Fed is finished buying MBS, so unless he wants the bond vigilantes to run his current monetary policy out of town he better keep up this sort of talk.
Exotic mortgage products did help bring monthly payments down, which in turn brought a much stronger bid to the property market. But Option Arms and the like came about only because there was enough demand from investors (Banks, Hedge Funds, Pensions, etc.) for those products. Extremely low interest rates, if left too low for too long, incentivizes investors to ignore risk in their search for additional yield which leads to more bubbles and more instability in the future. Talk up your position if you want Chairman Bernanke, but relying heavily on regulation instead of worrying about the effect monetary policy can have on asset prices is foolish and irresponsible.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
The Fed minutes were pretty uneventful. Some voting members are content with winding down the Fed’s purchasing program on schedule (March) while others are pushing a possible expansion of the program in order to protect the still fragile housing market from the exit of the mortgage market’s biggest investor.
So far the Fed’s exit strategy has been limited to emergency lending programs that have been slowly unwinding due to decreased demand, but if the March does end up being the final month of MBS purchases it will be the first active step by the Fed to begin tightening. It’s not surprising to see some disagreement within the FOMC.
Bernanke
Several Fed officials spoke this week, but Bernanke’s speech on Sunday at the Annual Meeting of the American Economic Association in Atlanta caught my eye. The argument he presented was based on his belief that a lack of regulation, not unnecessarily low interest rates, led to the housing bubble.
From Big Ben’s speech…
The most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards… The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter.
This argument isn’t anything new from the Fed. The street is used to investors like Bill Gross talking up their positions on CNBC, and that’s all the Chairman is doing here. We are entering the second year of a 0-.25% target for Fed Funds and there are still 3-months to go until the Fed is finished buying MBS, so unless he wants the bond vigilantes to run his current monetary policy out of town he better keep up this sort of talk.
Exotic mortgage products did help bring monthly payments down, which in turn brought a much stronger bid to the property market. But Option Arms and the like came about only because there was enough demand from investors (Banks, Hedge Funds, Pensions, etc.) for those products. Extremely low interest rates, if left too low for too long, incentivizes investors to ignore risk in their search for additional yield which leads to more bubbles and more instability in the future. Talk up your position if you want Chairman Bernanke, but relying heavily on regulation instead of worrying about the effect monetary policy can have on asset prices is foolish and irresponsible.
Have a good weekend.
Cliff J. Reynolds Jr., Investment Analyst
Monday, January 4, 2010
December 2009 Recap
The Santa Claus Rally helped equity markets advance in December as did better-than-expected economic data and news that major recipients of TARP (Bank of America, Citigroup, Wells Fargo) will be able to repay the government.
The U.S. dollar made a drastic reversal early in the month on signs of improving economic data, most notably an encouraging November nonfarm payrolls report, which gave credence to the idea that the Fed will raise interest rates sooner than the market expects. The stronger dollar sent commodities, especially gold, lower. Meanwhile, the tight negative correlation between stocks and the dollar over the past several months seemingly weakened.
Riskier, or more volatile, asset classes made the biggest gains during the month. Both mid caps (represented by the S&P 400) and small caps (represented by the Russell 2000) outperformed of large caps (represented by the S&P 500) in December and all of 2009. After dominating all other asset classes in 2009, emerging markets continued to outpace large cap stocks in both domestic and foreign developed countries.
It should be little surprise that Information Technology and Consumer Discretionary were among the top performing sectors in December. The other top performing were Utilities and Telecommunication, which both benefited from investors seeking dividends amid low (virtually zero) yields on money-market funds and CDs.
The worst performing sector was Financials. Mega-banks repaying TARP funds is a reason for optimism indeed. But banks pressured prices by flooding the markets with new equity issuances to replace TARP capital. Also weighing on financials was the prospect of the Fed raising interest rates. Financials have greatly benefited from easy profits made by borrowing virtually interest-free capital and buying Treasurys to earn a risk-free rate.
Bonds finished the year with their worst month since October of 2008. The Barclays Aggregate Bond Index declined 1.88 percent in December. Treasurys took the brunt of the damage as heavy supply overwhelmed short-staffed trading desks that struggled to take bonds down. IEF was down 4.39 percent in December and 6.60 percent for the year. Credit and MBS outperformed Treasurys for the month, as did TIPS, which returned -2.09 percent.
--Peter J. Lazaroff, Investment Analyst
Cliff J. Reynolds Jr., Investment Analyst
Fixed Income Weekly
Risky assets, including stocks and corporate bonds, experienced a substantial recovery in 2009. The same investors who flocked to Treasurys at the height of the credit crisis in 2008, shunned them for riskier investments as the panic subsided. The Fed kept policy ultra-loose throughout the year and kept rates very low, buying $1.086 trillion in Agency MBS and $300 billion in Treasurys through their quantitative easing programs.
A graph of where we stand rate wise. (intraday 12/31/09)
2010?
So what’s in store for bonds in the New Year? The Fed still has about $200 billion in MBS to purchase, which should be completed by March. Expectations for Treasury issuance in 2010 vary from “as much as humanly possible” to “even more than that”, and rates are likely to edge higher throughout the year as the fed begins to signal a policy reversal in the second half of 2009. Fannie and Freddie are all but entirely owned and run by the Government, so subsidies to homeowners will likely continue even after the tax credit expires at the end of April and the credit quality of their bonds will likely continue to move closer to that of Ginnie Mae. And based on Bernanke’s demeanor and the Fed’s recent language my expectation is for them to move more than 25 basis points on the Fed Funds Target rate (to .75% maybe?) by Q3 2009 (at their September 21st meeting maybe?) after removing the remainder of their emergency liquidity and repo programs by the summer.
Happy New Year Everybody!!
Cliff J. Reynolds Jr., Investment Analyst
A graph of where we stand rate wise. (intraday 12/31/09)
Treasury Issuance
Heavy supply concerns dominated much of my commentary during 2009, but supply actually had very little effect on the rate environment. The Treasury auctioned just under $2.2 trillion in coupon Treasurys in 2009 ($2,195,836,163,400 to be exact). That was a 113% increase from the year before and growth is showing no sign of stopping in 2010. Claims that the US will soon be replaced as the world’s reserve currency were also prominent this past year, causing many to think that the abundance of foreign buyers of US debt will soon be a thing of the past. But the US relies on foreign buyers of debt no more than those same countries rely on the strength of the Dollar to support their export dominated economies. So don’t expect radical changes to the landscape any time soon.
Credit
Investment grade credit was outdone only by non-investment grade credit in 2009. CSJ (1-3 year credit) outperformed LQD (12 year credit) on a price only basis due to rates moving higher, but LQD barely beat out CSJ when you factor in interest income. For 2009 CSJ was up 3.09% price only and 7.08% total, while LQD was up 2.46% and 8.46% respectively. They both massively underperformed HYG (High Yield Corporate Bond) which returned 28.5% in 2009.
This year’s strong rally in credit was still only a partial reversal of damage done in 2008. By most measures credit spreads are sill wider than they were before the crisis began, but absolute yields are still lower, which is very accommodative to corporations looking to borrow.
Credit Default Swaps, which are used as insurance against a default, followed the rally in corporate bonds in 2009. According to Markit the cost of default protection on a broad basket of corporate debt fell 63% in 2009 to 85 basis points. The cost is quoted as an annual payment based on a percentage of the the notional amount insured.
2010?
So what’s in store for bonds in the New Year? The Fed still has about $200 billion in MBS to purchase, which should be completed by March. Expectations for Treasury issuance in 2010 vary from “as much as humanly possible” to “even more than that”, and rates are likely to edge higher throughout the year as the fed begins to signal a policy reversal in the second half of 2009. Fannie and Freddie are all but entirely owned and run by the Government, so subsidies to homeowners will likely continue even after the tax credit expires at the end of April and the credit quality of their bonds will likely continue to move closer to that of Ginnie Mae. And based on Bernanke’s demeanor and the Fed’s recent language my expectation is for them to move more than 25 basis points on the Fed Funds Target rate (to .75% maybe?) by Q3 2009 (at their September 21st meeting maybe?) after removing the remainder of their emergency liquidity and repo programs by the summer.
Happy New Year Everybody!!
Cliff J. Reynolds Jr., Investment Analyst
Friday, November 20, 2009
Fixed Income Weekly
Short-term yields continued their march downward this week mostly driven by comments from St. Louis Fed President James Bullard. Headlines read “Fed will not increase rates until early 2012”, but were pretty misleading if read without the rest of the speech.
Below is a graph of the current on-the-run 2-year since it was issued late last month. Yesterday the 2-year tested the all time lows of .649% set in late 2008.
The majority of the Fed President’s speech focused on monetary policy going forward, namely the status of quantitative easing and near zero fed funds. Bullard prefaced the quote that ran across the newswires by sighting that the Fed has waited 2.5-3 years from the end of the past two recessions to begin raising interest rates, which would give us an early 2012 initial interest rate hike if the Fed decided to follow similar protocol. Problem is, this is no normal recession and the Fed has chosen to fight the deflationary threat to the economy in non-traditional ways (i.e. QE).
Instead of waiting for an initial hike from current levels 2.5 years from now, a scenario where the Fed moves to more of an accommodative policy within a year while beginning to test the securities market with reverse repos to unwind the QE is more likely.
Early year-end profit taking may have been another factor pushing the short end lower this week. According to Bloomberg, 3-month bills traded as low as .005% on Thursday and stayed that low all day Friday, likely due to managers moving to the sidelines through the holiday season and year end. Stocks are down a little for the week so this seems like a logical thought at least.
The last time bills yielded below .05% was in the aftermath of the Lehman Brothers bankruptcy which forced The Reserve Fund (a major money market fund who held a concentrated position in commercial paper issued by Lehman) to break the buck. This forced an exodus of cash from mmkt funds into bills, sometimes accepting negative yields in order to do so. We are in same place now for a different reason. Now more than ever, the Fed’s liquidity is urging investors to love risk again by punishing them for hoarding cash.
Cliff J. Reynolds Jr., Investment Analyst
Below is a graph of the current on-the-run 2-year since it was issued late last month. Yesterday the 2-year tested the all time lows of .649% set in late 2008.
The majority of the Fed President’s speech focused on monetary policy going forward, namely the status of quantitative easing and near zero fed funds. Bullard prefaced the quote that ran across the newswires by sighting that the Fed has waited 2.5-3 years from the end of the past two recessions to begin raising interest rates, which would give us an early 2012 initial interest rate hike if the Fed decided to follow similar protocol. Problem is, this is no normal recession and the Fed has chosen to fight the deflationary threat to the economy in non-traditional ways (i.e. QE).
Instead of waiting for an initial hike from current levels 2.5 years from now, a scenario where the Fed moves to more of an accommodative policy within a year while beginning to test the securities market with reverse repos to unwind the QE is more likely.
Early year-end profit taking may have been another factor pushing the short end lower this week. According to Bloomberg, 3-month bills traded as low as .005% on Thursday and stayed that low all day Friday, likely due to managers moving to the sidelines through the holiday season and year end. Stocks are down a little for the week so this seems like a logical thought at least.
The last time bills yielded below .05% was in the aftermath of the Lehman Brothers bankruptcy which forced The Reserve Fund (a major money market fund who held a concentrated position in commercial paper issued by Lehman) to break the buck. This forced an exodus of cash from mmkt funds into bills, sometimes accepting negative yields in order to do so. We are in same place now for a different reason. Now more than ever, the Fed’s liquidity is urging investors to love risk again by punishing them for hoarding cash.Cliff J. Reynolds Jr., Investment Analyst
Monday, November 16, 2009
Fixed Income Weekly
The process of money creation is complex. Flooding the market with cash to keep Fed Funds low is a very traditional way to stimulate an economy, and the Fed is all in on that front with Fed Funds at zero. They took it a step further this year and moved into longer assets to bring down longer term interest rates on things like mortgages. All of this buying has left banks flush with cash and rates low, hoping to spur lending and economic growth. Fed funds has been at 0-.25% for 11 months, they have purchased $300 billion in Treasuries notes, over $1 trillion in Agency MBS and over $100 billion in Agency debt in addition to $43 billion in TALF and billions more in other confusingly named programs. So why isn’t there any real growth?
The graphs below show the decline in credit since late 2008. The first graph shows Commercial Loans, the second shows Consumer Loans.
Banks are required to hold a certain amount of cash at the Fed, called required reserves. Excess reserves, cash that banks chooses to hold at the Fed in excess of the required amount, have grown since the Fed began pumping the system with cash. The reason for this is lack of demand for funds by both households and businesses – basically banks have nothing to do with all the liquidity. The graph below shows the level of reserves, both required and excess, that banks currently hold at the Fed.
True money creation is more than just Fed induced liquidity. Money creation will only happen if there is adequate demand for money, and right now there isn’t. Excess liquidity has a track record of producing high levels of inflation, but the lack of demand for loans is keeping inflation in check right now.
The public can ridicule banks all they want for not lending, but that is not the problem. Businesses are not expanding and households are still trying to repair the damage done to their home values and/or from their lost income. Stimulus, whether it is monetary or fiscal, still relies on true demand to foster a recovery, and risky asset rally that has been labeled an “economic recovery” has some difficult times ahead unless we get some.
Cliff J. Reynolds Jr., Investment Analyst
The graphs below show the decline in credit since late 2008. The first graph shows Commercial Loans, the second shows Consumer Loans.
Banks are required to hold a certain amount of cash at the Fed, called required reserves. Excess reserves, cash that banks chooses to hold at the Fed in excess of the required amount, have grown since the Fed began pumping the system with cash. The reason for this is lack of demand for funds by both households and businesses – basically banks have nothing to do with all the liquidity. The graph below shows the level of reserves, both required and excess, that banks currently hold at the Fed.True money creation is more than just Fed induced liquidity. Money creation will only happen if there is adequate demand for money, and right now there isn’t. Excess liquidity has a track record of producing high levels of inflation, but the lack of demand for loans is keeping inflation in check right now.The public can ridicule banks all they want for not lending, but that is not the problem. Businesses are not expanding and households are still trying to repair the damage done to their home values and/or from their lost income. Stimulus, whether it is monetary or fiscal, still relies on true demand to foster a recovery, and risky asset rally that has been labeled an “economic recovery” has some difficult times ahead unless we get some.
Cliff J. Reynolds Jr., Investment Analyst
Friday, November 6, 2009
Fixed Income Weekly
FOMC – Baby Steps
This week’s decision by the Federal Open Market Committee (the committee that determines the Fed’s monetary policy) did some decent market moving this week despite only being one of many baby steps to come.
So what changed from last release? Not much. The committee sees household spending expanding, compared to only stabilizing in September. The previously scheduled $200 billion in agency debt purchases will now be reduced to “about $175 billion”, due mostly to the lack of paper available. Other than that, it was a carbon copy of the statement from the September 23 release. A Barron’s article from a couple weeks ago speculated that some Fed officials were considering removing all or part of the “exceptionally low levels of the federal funds rate for an extended period” phrase from the comments. We didn’t get that much of a switch from last meeting but we are definitely a little closer now.
Fannie Mae – The Landlord
Announced yesterday, Fannie Mae will begin renting homes back to troubled homeowners who prove they cannot afford to pay their mortgage. The new “Deed for Lease” program will offer an alternative to eviction to homeowners who have their mortgage either owned or guaranteed by Fannie Mae. In order to qualify homeowners must be between 1 and 11 months late on their mortgage and cannot qualify for a loan modification. Yes. There are homeowners who are more than 11 months late on their mortgage but still living in their home. Could that be masking some problems from the housing data the market has been juiced about lately? Just a thought…
The leases will be for 12 months, after which they will try to sell the home at a higher price than they could right now. Fannie claims that it is unlikely that homeowners will be able to buy their home back after the lease expires, sighting that the home will only be offered to qualified homebuyers. In reality, the term “qualified” has held several different meanings within the credit universe during the last few years, so who’s to say that someone with a major blemish on their credit history in the last year and no down payment won’t again be considered qualified. It’s a loose term at best. My expectation is for this program to crash and burn just like the mortgage modification program.
Cliff J. Reynolds Jr., Investment Analyst
This week’s decision by the Federal Open Market Committee (the committee that determines the Fed’s monetary policy) did some decent market moving this week despite only being one of many baby steps to come.
So what changed from last release? Not much. The committee sees household spending expanding, compared to only stabilizing in September. The previously scheduled $200 billion in agency debt purchases will now be reduced to “about $175 billion”, due mostly to the lack of paper available. Other than that, it was a carbon copy of the statement from the September 23 release. A Barron’s article from a couple weeks ago speculated that some Fed officials were considering removing all or part of the “exceptionally low levels of the federal funds rate for an extended period” phrase from the comments. We didn’t get that much of a switch from last meeting but we are definitely a little closer now.
Fannie Mae – The Landlord
Announced yesterday, Fannie Mae will begin renting homes back to troubled homeowners who prove they cannot afford to pay their mortgage. The new “Deed for Lease” program will offer an alternative to eviction to homeowners who have their mortgage either owned or guaranteed by Fannie Mae. In order to qualify homeowners must be between 1 and 11 months late on their mortgage and cannot qualify for a loan modification. Yes. There are homeowners who are more than 11 months late on their mortgage but still living in their home. Could that be masking some problems from the housing data the market has been juiced about lately? Just a thought…
The leases will be for 12 months, after which they will try to sell the home at a higher price than they could right now. Fannie claims that it is unlikely that homeowners will be able to buy their home back after the lease expires, sighting that the home will only be offered to qualified homebuyers. In reality, the term “qualified” has held several different meanings within the credit universe during the last few years, so who’s to say that someone with a major blemish on their credit history in the last year and no down payment won’t again be considered qualified. It’s a loose term at best. My expectation is for this program to crash and burn just like the mortgage modification program.
Cliff J. Reynolds Jr., Investment Analyst
Friday, October 30, 2009
Fixed Income Weekly
Treasury Market Happenings
This past week was a memorable one for the Treasury market that saw yet another record amount of paper coming to the street in addition to the long awaited end of the Fed’s $300 billion Treasury purchases program.
The supply started on Monday with a $7 billion reopening of the current 5 year TIPS benchmark, that was pretty uneventful. Despite a slew of deflationary factors in the market, inflation protection is in pretty serious demand. The bid/cover ratio was over 3 for the first time since the first 5-year TIPS auction in 1997.
Demand for new paper this week peaked on Tuesday as a record $44 billion in new two-year notes were auctioned with a bid/cover of 3.63 versus a 6 month average of 3.07. This is unbelievable to me. In one day the U.S. Treasury sold debt equal to the size of the GDP of The Dominican Republic, and there was still a line of unfilled buyers out the door. A shift in the source of demand really stood out as domestic investors dominated the auction for the short duration bonds. U.S direct buyers took 26.1% of the auction versus an average of 5.7%. Indirect bidding (or foreign demand) typically takes the largest slice of short term auctions, given the bias foreign central banks have toward the shorter end.
The $41 billion 5-year auction on Wednesday saw demand come back down to more normal levels, and although demand continued to wane on Thursday with the $31 billion seven-year auction, the week was an overall win for the Treasury considering the $123 billion total weekly supply.
The Treasury securities portion of the Fed’s QE also ended on Thursday. As you all are well aware of short term rates are extremely low, and Tuesday’s especially strong two-year auction is good evidence of how far we are from a significant shift in policy that will eventually move the short end, but as we lose a major buyer of intermediate term bonds the longer portion of the curve remains a concern for the market. The housing market is depending heavily on low intermediate term rates, and as the homebuyer credit is slowly phased out, which seems to be likely, low mortgage rates will be the only crutch for credit demand to stand on. The big question now is, “Was the Fed that crutch?”
Housing Market
This past week was a memorable one for the Treasury market that saw yet another record amount of paper coming to the street in addition to the long awaited end of the Fed’s $300 billion Treasury purchases program.
The supply started on Monday with a $7 billion reopening of the current 5 year TIPS benchmark, that was pretty uneventful. Despite a slew of deflationary factors in the market, inflation protection is in pretty serious demand. The bid/cover ratio was over 3 for the first time since the first 5-year TIPS auction in 1997.
Demand for new paper this week peaked on Tuesday as a record $44 billion in new two-year notes were auctioned with a bid/cover of 3.63 versus a 6 month average of 3.07. This is unbelievable to me. In one day the U.S. Treasury sold debt equal to the size of the GDP of The Dominican Republic, and there was still a line of unfilled buyers out the door. A shift in the source of demand really stood out as domestic investors dominated the auction for the short duration bonds. U.S direct buyers took 26.1% of the auction versus an average of 5.7%. Indirect bidding (or foreign demand) typically takes the largest slice of short term auctions, given the bias foreign central banks have toward the shorter end.
The $41 billion 5-year auction on Wednesday saw demand come back down to more normal levels, and although demand continued to wane on Thursday with the $31 billion seven-year auction, the week was an overall win for the Treasury considering the $123 billion total weekly supply.
The Treasury securities portion of the Fed’s QE also ended on Thursday. As you all are well aware of short term rates are extremely low, and Tuesday’s especially strong two-year auction is good evidence of how far we are from a significant shift in policy that will eventually move the short end, but as we lose a major buyer of intermediate term bonds the longer portion of the curve remains a concern for the market. The housing market is depending heavily on low intermediate term rates, and as the homebuyer credit is slowly phased out, which seems to be likely, low mortgage rates will be the only crutch for credit demand to stand on. The big question now is, “Was the Fed that crutch?”
Housing Market
This week I stumbled upon the graph below from the San Francisco Fed showing the rise and fall of non-agency mortgage backed securitization over the past decade. The graph below shows the distribution of market share of new mortgage origination since 2000.
Source: San Francisco Fed
http://www.frbsf.org/publications/economics/letter/2009/el2009-33.html
Some excerpts from the report:
· According to Federal Reserve flow of funds data, the banking institution share of total mortgage assets declined from a peak of about 75% in the mid-1970s to about 35% in 2008. Much of the decline in banking institution housing portfolios over this period was related to the expansion of the government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac, and Ginnie Mae.
· At its peak in late 2007, non-agency securitizations accounted for nearly 20% of outstanding mortgage credit.
· Non-agency securitizations were much more likely to involve adjustable-rate mortgages, including option ARMs, to be rated as subprime, and to have less-than-full documentation of borrower income and assets.
· In the fourth quarter of 2006, approximately 10% of originations in our sample were labeled by originators as "subprime." For the entire universe of mortgages, subprime loans are estimated to have made up about 20% of originations in 2006. By the first quarter of 2008, the subprime share was effectively zero. Since then, increased FHA lending—identified here by Ginnie Mae's share—has revived this segment of the market.
The graph is pretty incredible. The rapid growth and even more rapid contraction of the non-agency sector are directly correlated to the rise and fall of real estate prices. The ease with which non-prime borrowers could secure non-traditional forms of financing, proved to be beneficial to all parties involved… as long as property values continued to appreciate. When that segment fell apart during the initial stages of the credit crisis massive amounts deleveraging ensued, affecting more than just housing.
Even though non-agency securitization is still a non-player in mortgage lending, the government has stepped in to pick up the slack. As evidenced by the huge surge in GNMA market share since mid 2007. It tough to be bullish on the prospects for housing outside of the government tax credit programs and government subsidized lending. The sustainability of a recovery in the housing market is dependent on sources of demand that are also sustainable. Reinflating prices, or simply putting a quick floor under prices, provides little to be positive about further out.
Cliff J. Reynolds Jr., Investment Analyst
Monday, October 26, 2009
Bond Market Weekly
This week was a big one for Fedspeak and speculation on the timing of the turnaround in monetary policy. A move to just an accommodative level of interest rates from the current environment where 0% interest rates has been and continues to be the breathing machine keeping the economy barely alive, will be a significant movement. And even though more people seem to be jumping into the “sooner rather than later” boat, a real turnaround in rates doesn’t appear to be much of a near term reality.
Fedspeak
San Francisco Fed President Janet Yellen used her appearance on Tuesday as an opportunity to comment on news of the Fed testing reverse repos with firms other than primary dealers. Reverse repos are used by the Fed to tighten money policy. Bernanke & Co. have spent most of 2009 buying everything in sight and leaving the market flush with cash and entering into reverse repos would lend out those same securities in exchange for cash. It’s not much different than just selling the securities for cash, but repos can be done on terms as short as overnight.
First of all, the fact that the Fed is looking beyond the 18 firms it is already set up to trade with is somewhat notable. The Fed wants the program to stay as liquid as possible, and expanding the number of firms the Fed trades with definitely achieves that goal, but the market may have started to get ahead of itself. The short end of the curve didn’t really react to the release, thanks to Janet Yellen’s speech, but street chatter was heavy as the market continues to gain more insight into how the Fed will unwind its balance sheet.
Excerpt from Yellen’s comments Tuesday:
“We don’t want anyone to question the bank’s ability and willingness to tighten monetary conditions when the time comes… Not now… We want to be absolutely certain that this is something we can do.”
Yellen is a voting member and her comments coincide with most of the voting membership of the FOMC, but views from outside the voting membership differ considerably.
Philadelphia Fed President Charles Plosser, who won’t get a FOMC vote until 2011, spoke on the same day as Yellen, but expressed a different stance. Plosser’s comments focused on the large lean toward riskier assets on the Fed’s balance sheet, including TALF and even the $1.25 trillion in agency MBS that the Fed will finish purchasing net week.
Excerpt from Plosser’s comments:
“My fear is that we are going to do things during the transition that never allow us to get out to a successful point at the end of the day… It’s more difficult this time because of the composition of our balance sheet.”
This begins to make me wonder. What kind of impact is the composition of the voting membership having on its policy? Do they have some information that non-voting members don’t have, or is Plosser just making outrageous comments from outside? Such a fragmented committee adds to the complexity of the Fed’s policy turnaround, whenever the decision is made.
Differing Views
A new perspective surfaced this morning in a Financial Times article saying that some FOMC members are considering removing the “extended period of time” wording that we have all gotten so used to seeing since March. This contradicts Fed comments from earlier this week. Gauging by what the market did this morning after the FT article surfaced, more credence is being given to speculation on what the Fed might do the language of the meeting statements than actual comments from voting members of the committee. The 2-year moved above 1% for the first time since September and closed there for the first time since August 28.
In my view this is the just the Fed testing the waters a little bit. The Fed Funds Target Rate is still being defined by a range (0-.25%) so the rate as it trades right now, (.12%) could still double and remain within the target range. So if you factor in the time it will take the Fed to end the buying programs, which is next week for Treasuries and most likely Q1 2010 for MBS, the gradual movement of statement language toward that of a Fed looking to begin tightening monetary policy and the need for at least a partial move in the market rate for Fed Funds, we are looking at a late 2010 rate hike at the earliest.
Cliff J. Reynolds Jr., Investment Analyst
Fedspeak
San Francisco Fed President Janet Yellen used her appearance on Tuesday as an opportunity to comment on news of the Fed testing reverse repos with firms other than primary dealers. Reverse repos are used by the Fed to tighten money policy. Bernanke & Co. have spent most of 2009 buying everything in sight and leaving the market flush with cash and entering into reverse repos would lend out those same securities in exchange for cash. It’s not much different than just selling the securities for cash, but repos can be done on terms as short as overnight.
First of all, the fact that the Fed is looking beyond the 18 firms it is already set up to trade with is somewhat notable. The Fed wants the program to stay as liquid as possible, and expanding the number of firms the Fed trades with definitely achieves that goal, but the market may have started to get ahead of itself. The short end of the curve didn’t really react to the release, thanks to Janet Yellen’s speech, but street chatter was heavy as the market continues to gain more insight into how the Fed will unwind its balance sheet.
Excerpt from Yellen’s comments Tuesday:
“We don’t want anyone to question the bank’s ability and willingness to tighten monetary conditions when the time comes… Not now… We want to be absolutely certain that this is something we can do.”
Yellen is a voting member and her comments coincide with most of the voting membership of the FOMC, but views from outside the voting membership differ considerably.
Philadelphia Fed President Charles Plosser, who won’t get a FOMC vote until 2011, spoke on the same day as Yellen, but expressed a different stance. Plosser’s comments focused on the large lean toward riskier assets on the Fed’s balance sheet, including TALF and even the $1.25 trillion in agency MBS that the Fed will finish purchasing net week.
Excerpt from Plosser’s comments:
“My fear is that we are going to do things during the transition that never allow us to get out to a successful point at the end of the day… It’s more difficult this time because of the composition of our balance sheet.”
This begins to make me wonder. What kind of impact is the composition of the voting membership having on its policy? Do they have some information that non-voting members don’t have, or is Plosser just making outrageous comments from outside? Such a fragmented committee adds to the complexity of the Fed’s policy turnaround, whenever the decision is made.
Differing Views
A new perspective surfaced this morning in a Financial Times article saying that some FOMC members are considering removing the “extended period of time” wording that we have all gotten so used to seeing since March. This contradicts Fed comments from earlier this week. Gauging by what the market did this morning after the FT article surfaced, more credence is being given to speculation on what the Fed might do the language of the meeting statements than actual comments from voting members of the committee. The 2-year moved above 1% for the first time since September and closed there for the first time since August 28.
In my view this is the just the Fed testing the waters a little bit. The Fed Funds Target Rate is still being defined by a range (0-.25%) so the rate as it trades right now, (.12%) could still double and remain within the target range. So if you factor in the time it will take the Fed to end the buying programs, which is next week for Treasuries and most likely Q1 2010 for MBS, the gradual movement of statement language toward that of a Fed looking to begin tightening monetary policy and the need for at least a partial move in the market rate for Fed Funds, we are looking at a late 2010 rate hike at the earliest.
Cliff J. Reynolds Jr., Investment Analyst
Monday, October 12, 2009
Treasury Inflation Protected Securities
Real Yield – measured by subtracting inflation from nominal yield – is an extremely important factor in fixed income investing. High inflation not only destroys purchasing power but is also greatly influences investor behavior. Traditionally investors will demand higher rates of interest as inflation creeps higher in order to preserve their purchasing power. However, as the graph below shows, negative real interest rates are not impossible.
click to enlarge
While year-on-year inflation, as measured by the Consumer Price Index, was 12.3% in December of 1974, the prevailing yield on the ten-year Treasury was at 7.4%, a real yield of -4.9%. A similar situation happened again just a few years later. By the mid-80’s inflation had calmed down, but Treasury yields remained elevated. Real yield on the Ten-year Treasury reached a record 9.5% as investors sought revenge for the past decade of poor inflation adjusted returns. This all happened without the presence of TIPS.
When they were introduced in 1997 Treasury Inflation Protected Securities changed the landscape of investing. While still maintaining the full faith and credit of The US Government, investors are now given the option of accepting a lower coupon in exchange for future adjustments to principal based on CPI. TIPS trade on a yield basis, just like any other bond, but if you assume CPI accurately measures inflation, the quoted TIPS yield is a real yield. If you don’t, please take a number… the Bureau of Labor Statistics will be with you shortly.
click to enlarge
Some argue that TIPS won’t provide the inflation protection they advertise when the Fed moves to nip inflation in the bud, saying that when inflation begins to go away, the absolute return of TIPS (real yield + inflation) will be diminished. But is that important? If you buy TIPS, do you necessarily want runaway inflation? If you are looking to spend the dollars you are investing on real goods at some point in the future, the inflation portion of your return will be offset by the run up in prices of real goods. Leaving you with an effective hedge against what would otherwise hurt your return.
Secondly, a certain author of a certain Wall Street Journal article argues that a shift toward tight money from the Fed will move so many investors out of TIPS, driving prices for the securities down, that any benefit will be negated. The graph above shows the movement in TIPS yield that happened as a result of the world moving from $150 per barrel oil in the summer of 2008 to the largest deflationary scare in the Post WW2 era. (A pretty serious adjustment) This movement from 1.5 to 3% in TIPS translates into a 14% decline in the price of the 10-year TIP, while the nominal 10-year was up about 16% over the same period. So that means we should all load up on ten year Treasurys at 3.30% right?
Diversification is key to any sound investment strategy and the correlation of TIPS with other asset classes is attractive to investors. It is the unique characteristics of TIPS compared to other asset classes that provide this benefit, along with unique risks.
Cliff J. Reynolds Jr., Investment Analyst
Subscribe to:
Posts (Atom)