Thursday's Bond Outlook: Expecting a Respite From Recent Volatility

Libor: There is still tension in the money market as the key three month Libor rate climbed 6 basis points to 4.21 percent. The overnight rate fell to 2.68 percent from 3.79 percent the previous day.

Prices of Treasury coupon securities have, on balance, posted modest gains in overnight trading. The yield curve continues to steepen and the 2 year /10 year spread has reached a local high water mark at 195 basis points. The yield on the 2 year note has declined 4 basis points to 1.78 percent. The yield on the 5 year notes also dropped 4 basis points to 2.82 percent. The yield on the 10 year note is unchanged at 3.73 percent and the yield on the Long Bond has edged lower by a basis point to 4.20.

The Senate passed the bailout legislation last night and markets await action by the House of Representatives. Press reports tend to suggest that the bill will pass the House on its second attempt but given the shocking and unexpected defeat of the bill the first time, it is difficult to hold that position with any confidence.

European policymakers are discussing methods to soothe their markets, too. France has proposed a bailout fund while policymakers in Germany have rejected that idea.

In the meantime, most economic data shows a pretty dramatic weakening of the global economy.

I want to revisit the monthly car sales data for the US which was released yesterday. Car sales in September were at an annualized pace of 12.5 million units in September. To place that number in some perspective sales in August were at a 13.7 million pace. When compared to recent quarterly averages the fall off in purchases is rather stark. In Q2 2008 sales averaged 14.1 million, in Q1 2008 15.2 million and in Q4 2007 16.0 million.

In the UK home prices declined again, falling 1.7 percent from the prior month. Year over year home prices have dropped 12.4 percent.

Eurozone PPI dropped 0.5 percent in August as cheaper energy reduced costs. On a year over year basis the index is still up a chunky 8.5 percent, though that is down from 9.2 percent in July.

In the UK a survey by the Bank of England demonstrated that banks intend to continue tightening credit. Mortgage lending declined more than expected and banks expect defaults to rise.

In Spain the jobless rate hit an 11 year high and unemployment stands at 11.3 percent.

European stocks are mostly higher on the good feeling generated by the US Senate action on the bailout. Japanese stocks declined in reaction to the weakness in US auto sales and trading in futures markets indicates that US stocks will open with modest declines.

In the US markets, I expect a respite from the volatile trading of recent days. Participants should busy themselves squaring positions and reducing risk in advance of the monthly labor data tomorrow.

Comments

[JasonC:]

Sick ward - National City, some notes at triple digits.

Morgan Stanley, some notes at 30% and many at 20% despite their $9 billion capital infusion from Japan.

Joining them today, Sallie Mae, with some notes now selling at 50 cents on the dollar with yields into the 50s.

Ambac is also in the sick ward with its debts yielding 20%. Some AIG paper and even Wachovia paper remains offered at outsized yields, the last even though Citi has agreed to assume their debts.

The pressure on GE was minor in comparison, yields hit 7.5% before the Buffett announcement and capital raise, then 6.5% on that news. They have since split the difference and now sit at 7%. That is still huge for a AAA credit that just raised an extra $17 billion in capital. Some sources mentioning Grant's IRO article on GE as one cause for the concern. Personally I think it is stock screen thinking and tangible book value, with people ignoring its earning power.

Goldman Sachs bonds can be bought to yield 10.5%. Even high quality finance related paper remains extremely distressed. The libor rates are the tip of an iceberg, the real deteriorating is down in the secondary bond market. I suspect the shorts have a new playground, there and in the CDS markets.

But National City needs a serious workout, it can't sustain rates like that in the secondary market.

2008 Oct 02 11:34 AM