Bond Expert: Tuesday Outlook

Prices of Treasury coupon securities are taking a sharp tumble as the first trading day of Q2 2008 begins. The yield on the benchmark 2 year Treasury is higher by 6 basis points to 1.65 percent. The yield on the benchmark 5 year note has jumped by 8 basis points and opens the New York trading session at 2.52 percent. The yield on the 10 year note has climbed 6 basis points to 3.47 percent and the yield on the 30 year bond is 5 basis points higher at 4.34 percent.The yield differential between the 2 year note and the 10 year note is 182 basis points.

Equity markets around the globe have rallied to begin the new quarter as traders in those markets cheer the tabla rasa made possible by the flipping of a calendar page. In Asia the Hang Seng and the Nikkei were each up a little more than 1 percent. European markets are all posting solid gains and if I eyeball the Bloomberg listing of the major European exchanges the average gain is around 1.25 percent.Futures markets are predicting a robust opening stateside as the ephemeral hope of a better day sparks jubilation and euphoria for the ever optimistic equity crowd.

If I sound somewhat bitter or perhaps flummoxed it is because I am amazed at the price action in light of some of the financial news released overnight. UBS has announced a Brobdingnagian type loss of $12 billion following a write down of more than $19 billion . The firm will rattle the tin cup via a rights offering in which it seeks to raise $15billion. The current Chairman was last seen floating over Zurich in a golden parachute searching for a job as a gnome. The Financial Times story on this reads as if it were some sort of satirical piece as it notes that the Chairman designate is famous in Switerland for his role in the collapse of Swissair. I do not know anything about that but presiding over a debacle would seem to be a perfect credential for his new role here.

The carnage does not end with UBS. Deutsche Bank is taking writedowns in the neighborhood of $3.4 billion. These losses relate to the firm’s leverage loan book and commercial loan portfolio. And in a statement which accompanied the news the bank’s CEO noted that “conditions have become significantly more challenging during the last several weeks”.

Separately, Lehman announced after the close of trading yesterday that it would replenish its coffers by raising $3billion in new capital as it seeks to stifle speculation that it will follow Bear Stearns as the next high profile victim of the credit crunch.

The Tankan survey of Japanese manufacturers fell to 11 from 19 and stands at its lowest level in 4 years.

Equity markets have rallied on this cascading flow of ugly news as the eternal optimists in that market view the disclosures as confessional in nature. The mindset is similar to those seeking help for various addictions who need to hit rock bottom before they can turn their lives around. That approach has been shown to be effective for many people and places them on the road to recovery from their personal demons.

But the analogy limps in that the damage from alcoholism and other addictive substances wreaks havoc on far more individuals than the addicted party. There is often time long lasting and deep damage to spouses ,children and friends. It is rarely confined to the one individual.

Such is the case here as firms come clean. The damage has spread through the system and can hardly be undone with a vociferous public mea culpa.

The economy is probably in recession and the ravages of that recession have barely percolated through the general economy. We are just entering the stage of weakness in which the loss of jobs accelerates and spending drops off sharply. The unemployment rate( while somewhat contrived as the low rate is an algebraic result of discouraged workers reducing the denominator of the fraction) is only 4.8 percent. Recessions are made of sterner stuff and more pain that that.

To pronounce that the end nigh is a delusionary act. This episode of financial weakness is unique and at every turn since it began in earnest last August has surprised observers with its virulence and ability to arrive at the most pessimistic outcome.

In my opinion the fat lady has not yet sung and the optimism of the equity crowd is misplaced.