Friday, May 29, 2009

BOND, CORPORATE & TREASURY BOND.

shaken, not stirred and by special request, this section will attempt to capture movements in yields and timely commentary and events affecting bonds (both corporate and treasury). These topics can reflect inflation concerns as well as if credit markets are flowing commercially (which was the big concern 5 or 6 months ago).

June 8 -- Some things to know...

(1) Typically the spread between the 10 year bond rate and a bank home mortgage is 160 basis points (or 1.6%), although I recognize that these are not normal times. Now days, the spread may well be greater. Right now, the 10 year bond rate is about 3.8% and home mortgages in my neighborhood are at 5.6%. As an fyi, the 10 year rate is expected to reach a minimum of 4% in the next few months due to greater risk appetite for stocks as investors flee treasuries and also due to expected fed rate raises.

(2) If you are curious to see whether the Fed may raise its rates, and thus treasuries will raise accordingly. Consider the 2 year treasury yield. This is the yield most sensitive to the Federal Reserve's benchmark interest rate. As a point of interest, this rate moved up to 1.33% as of now (its highest since November 2008).




More May 28 -- So the 7 year note auction wasn't particularly impactful on the rates but here are a couple of things to consider as a basic thought process when thinking through the treasury yields/rates.

(1) Is the slope of the yield curve (ie. plotting out the rate of the 3 mth, 2yr, 7 yr, 10 yr, etc with the rate on the y axis and the treasury durations on the x axis) upwarding sloping or inverted. If its upward sloping, that means that you have to pay people more money to hold your money longer into the future and less for just 3 mths. Whats that mean? well, that is how a normal society should be. Risk is greater in the future/long-term bc of unknowns. An inverted yield curve means that you have to pay people a high rate (or lots of money) to hold treasuries (ie. US dollars) in the short term. This could indicate that people dont have much faith in the currency in the short term.

(2) What are the rates specifically for the different treasuries? Right now longer term treasuries are getting higher rates, especially compared to the low rates for short term treasuries. This could mean a couple of things: (i) people want to be compensated for holding US dollars longer bc they believe that there are long term risks to the currency ... losing its AAA rating or inflation; (ii) high rates are necessary to attract buyers if the market is going to promise a person a higher return with not much more risk over the same period of time.

(3) Even though banks set their 30 yr mortgage rates and not the government (altho it can influence it by purchasing mortgage backed securities to affect supply/demand), think about it this way ... if the government has to promise people high rates 30 years out bc people don't trust the value of the US $ 30 yrs from now to be just as solid or because people are expecting inflation in future years and want interest rates that will ofset the inflation (and thus lost purchasing power), then of course banks are going to have the similar concerns and are going to want their loans to have higher returns to compensate for the less valuable dollar and/or inflation. Thus, as you watch longer term treasuries rise, keep an eye on those 30 yr mortgages, which we at TSM know will only serve to hamper home buying, which we at TSM know plays a crucial role in laying the foundation for this economic recovery.

This may have been the type of thoughts/commentary that the reader who requested this section was initially thinking/wanting to see, so hopefully this is helpful. But as with all section on the blog, they're being fleshed out and taking shape as I post.

May 28 -- An important treasury/inflation/bond data point to checkup on is the 10 year treasury/2 year treasury spread (the difference between the 2 rates). As of the end of May 27th, the spread between the notes was 275 basis points (or 2.75%). That is the "steepest" yield curve/spread recorded. High treasury rates mean a couple of things... it means that its more expensive for the government to raise the debt (and so if its more expensive for the government, then its more expensive for us the taxpayers...moreover, expensive debt can = instability and this encourages peoples comments that the US could follow the UK and have its AAA debt rating called into question. That would be detrimental to the dollar value - which is the worlds reserve currency - it could give an excuse to consider other reserve currencies and continues to make commodities/oil/etc more expensive to the US.

What's a way to get treasury rates back down? If the Fed buys the treasuries then it effective supresses supply and so rates go down. But the Fed can't buy all the treasuries - that would just make it even more expensive in the long run to pay back or force the government to print money (inflationary!). So in the end, high rates may likely be inevitable. The question is, when and how much will it kill economic recovery?

PS, $26 billion in 7 yr notes are being auctioned off tomorrow (28th). It'll be interesting to see how much the Fed buys of this and what impact there may be on rates.

May 22 -- Another note regarding treasuries... earlier this week the Federal Reserve had issued a statement (albeit one sentence in its 'minutes' from meetings weeks earlier) that it would begin buying treasuries. What's that mean? A couple of things, if the Fed is buying, then supply is less for everyone else which means that the value should go up. Also, it could be interpreted to mean that the currency is more stable and ensures value since the federal government is buying it and supporting it. This would increase value as well. What happened yesterday? The Fed bought only approx 7 billion out of 45 billion dollars worth of treasuries issued. This is less than expected. So what effect does that have? The opposite. To much supply to the public and less conviction in the stability of the currency causes treasuries to lose value.

Here's a good question: why should we care about treasuries?? Because it today's world of chaos and risk aversion, treasuries are the "safe haven." So if the rates and yields vary, so does your return. That hits your pocket book and that's what makes it relevant.

May 21 -- The big news today is that the UK may lose its AAA rating. Now this isn't really suprising or news. But it's hitting markets and getting a reaction for the simple fact that a credit agency has come out and said what everyone was thinking and already knew. It's the shock power that a credit agency would actually say that the UK (an established developed economic country) may not be as creditworthy and reliable as everyone thought. The idea of such a stalwort not being reliable is somewhat parallel or similar to the idea of the banking system potentially not being able to pay everyone their money back - its the idea that the most established countries/countries/people are not actually reliable possibly. Take away a foundation and people freak.

The other aspect of this is that America is up ther with the UK - established, AAA rating currently, but will have a GDP-to-debt ratio of possibly 50% or 100% in the next years as a result of the "save the day" bailout and funding measures by the government. Well, the idea that the US of A might not have a AAA rating some day is a dose of reality that usually isn't seen as a real possibility. Too many politics involved. We have bigger guns. We're the US of A. Even if we don't deserve a AAA rating, we'd still get it. Well when your debt is that big it can't be ignored. And when you have a saving-based nation like China who is poised to become the economic powerhouse for the next phase of world dominance, and considering they are taking measures (albeit small, but still active measures) to turn their currency into more of a regional currency with thoughts of its possibly being the world's reserve currency some day rather than the dollar --- mix all of that together, and its very possible that in 5 years the world won't need a AAA rated USA. Ok, they will need the USA but the notion that we might be called out for the debt-laden nature we are wouldn't be so far fetched.

So how does this tie into treasuries? I'm only partly sure - I'm still trying to fully understand and get familiar with this area of the market. But basically, you dont want treasuries. If demand for treasuries is going to go down and you have an endless endless supply of t-notes/bills/bonds being issued to fund the "save the day" deal... then you don't wanna be in that arena. Simple - over-supply plus low or even unstable demand = declining value.

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