Closing Comments June 25 2008

June 25th, 2008 4:37 pm | by John Jansen |

Prices of Treasury coupon securities are registering mixed results as participants react to the FOMC statement. In the immediate aftermath of the release of the FOMC statement yields jumped higher. The 2year note yielded 2.94 percent and the 5 year note traded as cheap as 3.63 percent. Yields across the curve are closing significantly lower and the curve is steeper.The benchmark 2 year note is lower in yield by 5 basis points and rests at 2.82 percent. The yield on the 5 year note is unchanged for the day at 3.53 percent. The yield on the 10 year note is higher by 3 basis points at 4.11 percent and the yield on the Long bond is higher by 2 basis points at 4.65 percent.

The 2year/10 ear spread has steepened by a whopping 8 basis points and sits at 129 basis points.

The 2year/5year/30 year butterfly is 42 basis points.

The main event of the day was the release of the FOMC statement at 215PM New York time. (I am a very provincial New Yorker. All time is New York time) I would begin with the back end of the statement and suggest that the Federal Reserve has a bias to tighten. They note that “the downside risks to growth have diminished” and “the upside risks to inflation expectations have increased”. I would classify that as a bias to tighten.

However, that bias to tighten is swamped and overwhelmed by the economic speed bumps which they take cognizance of in the opening paragraph. I think the proper way to read the opening statement is to note that the economic strength which they discern springs from the rebate checks which have supported consumer spending.

They cite a host of circumstances which will preclude them from raising rates anytime soon. They note that labor markets have softened. They recognize that financial markets remain under considerable stress. Credit conditions are tight. They note the ongoing contraction in housing. I think it is interesting that they use the word contraction. That is a much stronger usage than slowdown.

They also note that energy prices will weigh in growth and significantly say that it will weigh on growth for a FEW quarters.
Against that background and that litany of detail of the factors which weigh on economic activity, it is inconceivable to me that the Fed will hike rates anytime soon. The funds rate will be at the present level for a very long time.

I will offer one caveat to that view. It is a global market now and if the ECB raises rates the Fed might find it necessary to respond with a fine tuned and calibrated move of its own to protect the currency.

Salespeople with whom I spoke reported waves of buying by an eclectic group of end users. The preponderance of the buying was inside of 5 years.

The prospect of a Fed on hold enticed buyers and there was some rather chunk buying of mortgages by end user clients.

Swap spreads were about a basis point tighter in the 5 year and 10 year sector.

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