Bond Expert: Wednesday Wrap

Prices of Treasury coupon securities raced higher and the yield curve inched towards perpendicularity as weak economic numbers overwhelmed the day of stability offered by the Treasury rescue package. The yield on the 2 year note tumbled 24 basis points to 1.57 percent. The yield on the 5 year note dropped 17 basis points to 2.85 percent. The yield on the benchmark 10 year note fell 10 basis points as it once again slipped below 4.00 percent and is now 3.98 percent. The yield on the 30 year bond dropped 5 basis points to 4.23 percent.The 2 year/10 year spread widened 14 basis points to 240 basis points. As a point of reference the last time that the spread reached these levels was in 2004. The record wide occurred in 2003 at 273 basis points.

The 2 year/5 year/30 year spread closed at 10 basis points which means the 5 year outperformed the wings by 3 basis points today.

Economic data released today highlight the parlous state of the US economy. In a note to clients a JPMorgan economist makes several points which manifest how dire the situation is and the extent of the retrenchment by consumers. He notes that ex auto retail sales have contracted at an annualized rate of 5.4 percent in the last three months. That is the steepest decline for any three month period since the inception of this series in 1967. (I was listening to Barry Maguire croon “The Eve of Destruction”.) Additionally, JPMorgan estimates that real consumer spending will have declined at a 3.2 percent rate in Q3. If that comes to pass, it will be the worst reading for that category since Jimmy Carter imposed credit controls in the spring of 1980.

The Empire Survey of Manufacturing plunged to -24.6 from -7.4. Prognosticators had forecast -10.0. New orders fell in line with the headline number but other components were not quite as negative.

With the steep declines in the equity index today I decided to visit the history books. I do not have Bloomberg so actually a friend did the legwork. The long bull market in stocks began in 1974 with the S&P Index at 62. The highest recorded level in human history was in October 2007 at 1576. For the Fibonacci aficionados among us a 61.8 percent retracement would place the index at 640. A 50 percent retracement would bring the index to 819. My friend said that the market tried several times to penetrate that level in 2002/2003 but failed each time.

The corporate bond market remains gridlocked with very little trading. Liquidity is impaired and bonds trade by appointment. One salesman seeking a glimmer of optimism noted that it is better than last week. Last week participants were waiting for the bankruptcy of a large financial firm whereas today the market has what my former colleague described as a “recession feel”. I am not sure that is better but he thought so.The IG 11 is 188 ½ 189 ½ which is about 12 wider on the day.

The IBM 10 year which priced last week at T+ 3 7/8 percent over the 10 year note is making its holders happy as it is 360/355.

Not so the American Express 5 year bond which I have grown to admire. It is now 750/700. It was issued at a spread of 4 3/8 percent over the 5 year Treasury. When the spread reaches the level at which it doubles the initial offering spread (+ 8 ¾ percent) I will stop writing about it!!

There was actually a small new issue today from utility Ohio Edison. It was a 30 year deal which was marketed on a yield rather than a spread basis .The issue launched at 8 ½ percent which equates to a 425 basis point spread to the Long Bond. One salesman thought at that level the new bond is between 50 basis points and 100 basis points cheap to comparable paper.

Comments

[whidbey:]

But no one knows how to price these bonds when the capacity for earnings in the issuer is unknown and unknowable. Bonds are for now OUT of the portfolio unless it is just a tradition and not an earnings exercise.

2008 Oct 16 10:30 AM

[proseadvocate:]

When is the Treasury going to guarantee the insured Munis so that market will turn around? Especially since those bonds are probably safter than Treasuries...

2008 Oct 16 02:42 PM