Across the Curve

Curve Flattens

 There is a rather substantial unwind of curve steepening trades taking place today.It is happening in the Treasury market as well as in the swap market. This trade is very well owned and if holders of the position decide to simultaneously head for the exits ,life could become rather painful .

There are several reasons for these trades to be unwound or reduced in size. The statement which flowed from the FOMC at the conclusion of its meeting yesterday would be a prime motivator for reducing steepening exposure. First of all the statement itself exposes fissures on the Committee and indicates that there is a coterie of members still concerned about the impact of policy on inflation and inflationary expectations. Additionally,with the funds rate at 2.25 percent and the real rate at zero when measured against the FOMC’s favored metric,core PCE, it is safe to believe that we have seen the last large move from the Fed and subsequent moves will be measured. And as I noted in my opening comments post this morning the Fed risks draining the reserveoir of good will which they have accumulated over the last 30 years and turning themselves back into some G William Miller caricature if they allow inflation to rekindle on their watch.

Other factors motivate the unwind of steepeners. Morgan Stanley reported better than expected earnings this morning and that report assembles a triumvirate of investment banks( along with Lehman and Goldman yesterday) which marched through a very difficult financial quarter and did not stumble noticeably. For now it looks as though the end of the world will be delayed or if it arrives speedily it will end with a whimper rather than a bang.

The news that OFHEO has relaxed stringent capital requirements for FNMA and Freddie Mac has the animal spirits racing in that market. They will be able to buy securities which are clogging the dealer pipeline and that will provide the market with some breathing room to function properly and effectively.

The last piece of the puzzle was a Wall Street Journal back pages story that the administration would be willing to hold talks with Congressional Democrats about a coordinated Federal response to the crisis. The translation is that they will soon spend taxpayer money to fix the mess.

The move in the Treasury curve is huge. The 2year note is about unchanged and the 10 year note is up 23/32 . The move is even more pronounced against theLong bond which is up nearly 1 24/32 . The 2 year 10 year spread is now inside of 180 basis points and rests currently at 178 basis points.