Closing Comments November 25 2008

November 25th, 2008 5:29 pm | by John Jansen |

Prices of Treasury coupon securities surged today in response to actions of the Federal Reserve System to alleviate some of the credit pressures associated with the credit crisis. As I discussed in an earlier posting the Central Bank announced that it would begin buying GSE debt as well as MBS guaranteed by the GSEs. The Federal Reserve System will acquire $500 billion plain vanilla MBS and $100 billion of GSE direct issues.The news sparked waves of buying especially in MBS. The buying in agencies and mortgages led to buying of other assets as a hedge for sales of MBS and agencies.

The yield on the 2 year note dropped 13 basis points to 1.15 percent. The yield on the 3 year note dropped 12 basis points to 1.38 percent. The belly of the curve was the superstar of the day, The yield on the 5 year note tumbled 21 basis points to 1.99 percent and the yield on the 10 year note passed through a mini interest rate cycle as its yield plummeted 25 basis points to 3.07 percent. The yield on the Long Bond fell 16 basis points to 3.62 percent.

The 2year/10 year spread collapsed to 192 basis points from 204 basis points.

The 2year/5year/30 year butterfly improved 17 basis points to 79 basis points as the belly outperformed the wings.

The Treasury auctioned sold $26 billion five year notes today and it was one of those Dutch auctions which redounded to the benefit of the taxpayers. The auction average was 2.11 percent and that was fully 4 basis points better than where the issued was being exchanged in the marketplace prior to the auction. Foreigners demonstrated that they have not lost their appetite for US bonds as they took down 37 percent of the auction.

Some market participants with whom I speak view today’s action by the Federal Reserve as quantitative ease and the passing (for now) of the funds rate as a barometer of monetary policy. One investor mentioned that the funds rate has been well below the target rate for most of this month anyway and had already lost its place in the Fed’s firmament.

Central bankers have often spoken of what they could do in a crisis such as the current one. Chairman Bernanke made himself famous before he was Chairman when he noted in a speech that the Federal Reserve would always cling to the right to drop money into the system from helicopters. Some would argue that today’s action constitutes a measure of that medicine.

The Federal Reserve and academics have said that the Federal Reserve could fight a credit crunch by buying large blocks of long risky assets. Today’s action falls in that category.

They have stated that they could blow up there balance sheet and they have done that with a vengeance.

They can also attempt to jawbone rates lower and I think they have engaged in forms of that.

The only policy prescription of which they have not availed themselves is to announce that the funds rate will remain low for the foreseeable future. I would not be surprised to see them do that at the December meeting.

This is somewhat off topic but I guess its fits under the general rubric of monetary policy. The dollar has begun to soften versus the Euro and versus the pound. One trader with I speak regularly suggested that the UK and the European community would not countenance any significant appreciation of their currencies and he expected that those countries would be forced into easing policies to keep the dollar from giving too much ground.

Mortgages are finishing the day 2 ticks weaker to swaps. Negative convexity raised its ugly head at prices well above par brought sellers to the fray.

Two year swap spreads are tighter by 8 ¾ basis points at 97 ¾. Five year spreads are tighter by 12 ¼ basis points and are 87 ¼. Ten year spreads are narrower by 8 ½ basis points at 14 ½ and 30 year spreads are better by 9 ½ basis points and are NEGATIVE 43 ½.

Two year and three year agencies are about 15 basis points tighter and 5 year and 10 year paper is about 35 basis points tighter.

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  1. 6 Responses to “Closing Comments November 25 2008”

  2. By Kevin Mackey on Nov 25, 2008 | Reply

    Any insight on the enormous move in the 10 year?

  3. By John Jansen on Nov 25, 2008 | Reply

    i think that guys who got lifted out of spread product probably bought it as a hedge. Cover your risk first and then unwind whatever whacky basis trade you backed into.

  4. By S on Nov 25, 2008 | Reply

    Any thoughts on when this ruinbber bands snaps. Seems like we have a binary outocme now: hyperdeflation or hyperinflation (to be follwed by hyperdeflation)

  5. By ndk on Nov 25, 2008 | Reply

    S, the Fed has seriously reduced its ability to respond to any increase in inflation. Normally, we curb inflation by selling off a lot of treasury bonds on the Fed’s books. We don’t have any treasury bonds left to sell.

    We do have some new ways we can take cash out of the system now, but more importantly, a surge in inflation right now would be a cannonball through the Fed’s already tattered balance sheet. At some point, this will matter. A lot of it is repos, but we can’t throw bad assets back onto our banks’ balance sheets at this point.

    On the other hand, all this government intervention is seriously deflationary, because it raises real interest rates as they borrow to fund their programs.

    I think your binary outcome is reasonable, but I have a fairly likely single outcome regardless of what happens: a loss of trust in our dollars.

  6. By Headlinecharts on Nov 25, 2008 | Reply

    Hi, would you mind explaining this a bit more to those of us still learning.

    “The buying in agencies and mortgages led to buying of other assets as a hedge for sales of MBS and agencies.”

  7. By John Jansen on Nov 26, 2008 | Reply


    Suppose a trader sells $100 million mortgages to a client. Let us assume he had no position before the trade and that his book was totally flat before the transaction. That transaction makes him short the market. Suppose mortgages begin to trade higher in the moments after this transaction and he cannot replace the bonds which he just sold at a level which he deems appropriate.

    Suppose the Treasury market has not moved and priced there are at the same level they were atwhen the mortgages traded. In that instance the trader might choose to buy a Treasury to replace the MBS. In so doing he has replaced his market risk (his short position) with a new trade (basis risk) which represents the relative of the value between the MBS and the Treasury.

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