Comments on: Closing Comments October 27 2008 http://acrossthecurve.com/?p=1974 A daily bond market chronicle Wed, 08 Sep 2010 04:43:57 +0000 http://wordpress.org/?v=2.9.1 hourly 1 By: PrefBlog » Blog Archive » October 27, 2008 http://acrossthecurve.com/?p=1974&cpage=1#comment-3400 PrefBlog » Blog Archive » October 27, 2008 Tue, 28 Oct 2008 03:11:04 +0000 http://acrossthecurve.com/?p=1974#comment-3400 [...] reported in early September that the five-year TIPS note was in danger … any more auctions like today’s will eliminate the uncertainty! The average yield was 3.27 percent which means that the new bond yields more than the nominal 5 [...] [...] reported in early September that the five-year TIPS note was in danger … any more auctions like today’s will eliminate the uncertainty! The average yield was 3.27 percent which means that the new bond yields more than the nominal 5 [...]

]]> By: ndk http://acrossthecurve.com/?p=1974&cpage=1#comment-3399 ndk Tue, 28 Oct 2008 01:21:07 +0000 http://acrossthecurve.com/?p=1974#comment-3399 Not only that, but during the heady last days of the commodity bubble (March 10th), the 5 year real yield dropped as low as 0.01%. We fail at counter-cyclical monetary policy. Not only that, but during the heady last days of the commodity bubble (March 10th), the 5 year real yield dropped as low as 0.01%. We fail at counter-cyclical monetary policy.

]]> By: ndk http://acrossthecurve.com/?p=1974&cpage=1#comment-3398 ndk Tue, 28 Oct 2008 00:31:17 +0000 http://acrossthecurve.com/?p=1974#comment-3398 sasso, that'd be a hypothetical if this were happening in isolation. It's across the curve, though (sorry). Check these real yields on 5's: http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/real_yield.shtml 1.70% on 6/10/08, and 3.74% today. Not only is that 115 bps over nominal; it's a major fork in the neck of the economy and every asset class out there. This butchers DCF calcs. I've been trying to think through what the "equilibrium" real interest rate is and how it would be changing now. It's been between 1% and 5% in U.S. history, according to most estimates. Not that equilibrium is a relevant word these days... sasso, that’d be a hypothetical if this were happening in isolation. It’s across the curve, though (sorry). Check these real yields on 5’s:

http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/real_yield.shtml

1.70% on 6/10/08, and 3.74% today. Not only is that 115 bps over nominal; it’s a major fork in the neck of the economy and every asset class out there. This butchers DCF calcs.

I’ve been trying to think through what the “equilibrium” real interest rate is and how it would be changing now. It’s been between 1% and 5% in U.S. history, according to most estimates. Not that equilibrium is a relevant word these days…

]]> By: Oren http://acrossthecurve.com/?p=1974&cpage=1#comment-3397 Oren Tue, 28 Oct 2008 00:04:04 +0000 http://acrossthecurve.com/?p=1974#comment-3397 Good point... There's the 70 bp/year, plus a little bit. If the deflation expectation is enough to drive the factor to 1, the nominal yield goes down by 3.66/4.5 = 81 bp/year. Good point… There’s the 70 bp/year, plus a little bit. If the deflation expectation is enough to drive the factor to 1, the nominal yield goes down by 3.66/4.5 = 81 bp/year.

]]> By: sasso http://acrossthecurve.com/?p=1974&cpage=1#comment-3396 sasso Mon, 27 Oct 2008 23:33:51 +0000 http://acrossthecurve.com/?p=1974#comment-3396 agree that the pricing is interesting but as far as being paid the greater of original principal or adjusted there is some risk since it's a reopening and you're paying an index ratio of 1.03666 which could potentially be marked back to 1.00 if deflation were to persist no? agree that the pricing is interesting but as far as being paid the greater of original principal or adjusted there is some risk since it’s a reopening and you’re paying an index ratio of 1.03666 which could potentially be marked back to 1.00 if deflation were to persist no?

]]> By: Oren http://acrossthecurve.com/?p=1974&cpage=1#comment-3395 Oren Mon, 27 Oct 2008 23:29:28 +0000 http://acrossthecurve.com/?p=1974#comment-3395 The deflation expectation calculation for the TIPs is off. Deflation, unless it's huge, has a very small impact on the nominal return from TIPs, because they have optionality in the redemption value: the maturity value is the larger of the original face and the adjusted (in this case deflated) face. If there is cumulative deflation over the life of the bond, it affects only the coupons. Let's say there's 1%/yr deflation expectation on a 3% coupon bond. After 5 years, the nominal coupon will be down by roughly 15bp on the original face. Over the life of the bond, the average reduction in the coupon is roughly half of this - say 7 bp. So to get 5 year TIPs trading 70 bp wide of nominal bonds, you'd need to assume something like 10%/yr deflation expectation. As y81 says, this has to be due to something other than deflation expectations. The deflation expectation calculation for the TIPs is off. Deflation, unless it’s huge, has a very small impact on the nominal return from TIPs, because they have optionality in the redemption value: the maturity value is the larger of the original face and the adjusted (in this case deflated) face. If there is cumulative deflation over the life of the bond, it affects only the coupons. Let’s say there’s 1%/yr deflation expectation on a 3% coupon bond. After 5 years, the nominal coupon will be down by roughly 15bp on the original face. Over the life of the bond, the average reduction in the coupon is roughly half of this – say 7 bp. So to get 5 year TIPs trading 70 bp wide of nominal bonds, you’d need to assume something like 10%/yr deflation expectation.

As y81 says, this has to be due to something other than deflation expectations.

]]> By: Dave http://acrossthecurve.com/?p=1974&cpage=1#comment-3394 Dave Mon, 27 Oct 2008 22:36:29 +0000 http://acrossthecurve.com/?p=1974#comment-3394 John, thanks for including some definitions in your closing comments (like explaining "tail"). Greatly appreciated. Dave John, thanks for including some definitions in your closing comments (like explaining “tail”). Greatly appreciated.
Dave

]]> By: Wordout - TIPS - For Today http://acrossthecurve.com/?p=1974&cpage=1#comment-3393 Wordout - TIPS - For Today Mon, 27 Oct 2008 21:59:30 +0000 http://acrossthecurve.com/?p=1974#comment-3393 [...] where I found the latest addition to my reading schedule, a guy named John Jansen who publishes Across The Curve. Here is part of what he had to say about today’s bond markets(emphasis [...] [...] where I found the latest addition to my reading schedule, a guy named John Jansen who publishes Across The Curve. Here is part of what he had to say about today’s bond markets(emphasis [...]

]]> By: y81 http://acrossthecurve.com/?p=1974&cpage=1#comment-3391 y81 Mon, 27 Oct 2008 21:27:29 +0000 http://acrossthecurve.com/?p=1974#comment-3391 I agree, ndk, that is stupid pricing. It must be due to other factors driving up the price of the nominal note? (I believe, when we don't know what those other factors are, we refer to "technical" factors.) I agree, ndk, that is stupid pricing. It must be due to other factors driving up the price of the nominal note? (I believe, when we don’t know what those other factors are, we refer to “technical” factors.)

]]> By: ndk http://acrossthecurve.com/?p=1974&cpage=1#comment-3390 ndk Mon, 27 Oct 2008 20:59:46 +0000 http://acrossthecurve.com/?p=1974#comment-3390 "When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater." That's what makes this pricing remarkably stupid. http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm “When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.” That’s what makes this pricing remarkably stupid.

http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

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