Some Closing Commentary

October 6th, 2008 4:43 pm | by John Jansen |

Prices of Treasury coupon securities rocketed today as fear gripped every corner of the world today. Money markets are frozen, stocks have returned to levels last seen in the glory days of the 1990s, corporate finance mechanisms are locked, commodities are skidding to new lows and risk in any form is shunned as if it were some hideous disease. From this venue I converse with traders and portfolio managers throughout the day. I have been in the market for three decades and the people with whom I speak are mostly veterans. I have never heard people as fearful and concerned as they are presently. Participants are trying to discern a solution and they do not see one on the horizon.The yield on the benchmark 2 year note has plunged 20 basis points to 1.38 percent. The yield on the benchmark 5 year note has tumbled 25 basis points to 2.39 percent. The yield on the benchmark 10 year note has dropped 18 basis points to 3.42 percent. The yield on the 30 year bond has slid 15 basis points to 3.94 percent. (Subsequent to the Lehman bankruptcy filing when money funds broke the buck, the bond traded at modern low yield of 3.90 percent intraday. I do not believe, and please correct me if I am wrong, that we closed at a yield below 4.00 percent. So this would be a rather historic happenstance.)

The 2year/10 year spread is 3 basis points wider at 204 basis points.

The 2year/5year/30 year spread has exploded in favor of the 5 year note. That spread is 55 basis points after closing at 44 basis points Friday.

The Treasury market remains a bastion of illiquidity. A long bond trader with whom I regularly speak lamented the woes of the 2021 through 2023 sector. In a steepening environment that sector has underperformed 2024 and 2025 paper by about 10 basis points over the last several weeks. As an example, the August 2023 issue is 7 basis points cheap to November 2024 bonds. It should trade a little expensive to that piece of paper.

Separately, I would also offer the opinion that the Treasury market has underperformed given the sturm and drang which permeates the market. (In the interest of full disclosure I am long the 10 year note.) So in September when the bond traded to that 3.90 yield I spoke of earlier, the 10 year Treasury traded as low as 3.25 percent. That fractured the previous low in this grand cycle of 3.30 percent which was attained in March when Bear Stearns was folding its tent.The all time low for the 10 year note was around 3.10 percent in June 2003.

So, as an owner of the security I am a little disappointed that we were unable to pierce the 3.40 percent level.

I think there are several reasons for this turn of events. In the first instance the Treasury will soon begin to fund the purchases of $700 billion of securities. There will be more paper to bid on so that weighs on sentiment. Additionally, participants want and crave liquidity and they feel that they have a better chance to escape unscathed in a bill than in some coupon in the belly of the curve.

The morass in the money markets has set pundits pontificating and prognosticating on steps the Federal Reserve might adopt to stem the tide. One suggestion I heard in several places (three actually) was that if the situation did not rectify itself shortly, it would compel the Fed to guarantee all libor deposits and all commercial paper. I am not sure how that would work. I am hoping that they will write me a check, too, though.

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  1. 2 Responses to “Some Closing Commentary”

  2. By Adam on Oct 6, 2008 | Reply

    Great info you give everyday, thanks for all the hard work.

    “..Fed to guarantee all commercial paper” WOW

    Could you comment on the CDS trading that went on today for Fannie…
    recovering 99.9 percent on the senior debt,Fannie Mae’s senior swaps recovering 91.51 percent the sum insured.

    leads me to think, we might have tiptoed away from the brink.

  3. By matt on Oct 6, 2008 | Reply

    Calculated Risk has a post about a possible Fed program to outright purchase commercial paper or to create a SPV to do it. Also, I read somewhere that the Fed is ruminating over the possibility of an unsecured lending program (let’s hope it’s not a non-recourse unsecured–I wouldn’t put it past them as a way to recapitalize the banks with all of the shenanigans of late).

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