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Aly Iman
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Aly Iman is the Chief Strategist at risConometrics Inc, a boutique forecasting, economic consulting and risk advisory firm in New York City. Aly is member of the adjunct faculty at the City University of New York where he teaches course in economics and finance on a part-time basis. Aly combines... More
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risConometrics
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risConometrics Webblog
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  • Let's Discuss Live ( LDL )
    I recall the time when working on the trading floor, I would send email approvals to traders or raise concerns on certain trades and I would instead a call back from the traders. They would request reconsideration or seek extension on an approval or a lower haircut on a specifically hairy trade and they would make the request on the phone. And they would argue their case. And at times quite well - well enough to certainly deserve a consideration and, sometimes, an actual approval.

    However, the smarter ones would actually walk up to me and ask in person what they were requesting.

    Reminded me of the 'LDL' term - recently brought out in GS emails.

    There is nothing like an in-person conversation. Its good for team work, its good for relationship building and, sometimes, it can lead to avoiding potentially inappropriate siutations.


     





    Disclosure: None
    Apr 27 12:55 PM | Link | Comment!
  • Pray Negative Swap Spreads / Inversion in Swap Spreads is Not the Double Whammy In The Making!
    Yesterday March 23, I released a note to clients and posted it here on Seeking Alpha and on titled: "Inversion in USD and Sterling Swap Spreads - Negative Swap Spread - and The Alarm It May be Raising".

    A copy of the client note forwarded to risConometrics’ clients is here.

    In the note, I mentioned the inversion in the swap rates and what I hope it is not implying. Specifically, the red flags raised in the note were:
    • Is the swap spread turning negative on entirely technical factors (such as hedging induced by negative gamma exposures) or is it harbinger of a more fundamental change in risk perceptions – namely the increase in betas of sovereigns as risk entities relative to corporates?
       
    • How much of the inversion is on account of increase in govy yields per se? If govies blow out, mortgage rates will inevitably follow. Double whammy for deficits and housing?
    Today (March 26) Tom Lauricella at WSJ ran the following story, "Unease at Deficit Hurts Demand for Treasurys; Mortgage Costs on the Rise". Excerpts from Lauricella's story ran as follows:


    "A sudden drop-off in investor demand for U.S. Treasury notes is raising questions about whether interest rates will finally begin a march higher—a climb that would jack up the government's borrowing costs and spell trouble for the fragile housing market.....

    This week, some investors turned up their noses at three big U.S. Treasury offerings.....The poor demand, especially from foreign investors, sent the bonds' prices sharply lower and yields higher. It lifted the yield on the 10-year note to 3.9%—its highest since last June, and approaching the psychologically important 4% mark. That mark has been pierced only briefly since the financial crisis in 2008.

    Investors' response marked a big shift from auctions in recent months in which major foreign buyers, such as central banks, had snapped up Treasurys. It could spell trouble for the U.S. housing market; the rates on many mortgages are linked to the yield on the 10-year note.

    The move up in its yield coincides with the impending end of the Federal Reserve's program to support the mortgage market. The Fed has bought $1.25 trillion of mortgage-backed securities, bolstering their prices and thus holding down their yields.

    In the past two days, mortgage rates have also ticked up. The average 30-year mortgage rate rose to 5.13% on Thursday from 5.06% on Monday, according to HSH Associates in Pompton Plains, New Jersey............There are some temporary factors behind the lackluster demand for this week's Treasury offerings, such as a reluctance by Japanese investors to make new investments ahead of their fiscal year-end March 31........Adding to the focus on the Treasury market's woes this week has been an unusual development in an important, but usually ignored, market: interest-rate swaps. These common derivatives entail contracts that typically involve trading one stream of interest income for another. And in the past week, investors are being paid more to own U.S. Treasurys than U.S. corporate bonds.

    This week, some investors turned up their noses at three big U.S. Treasury offerings, a big shift from auctions in recent months in which major foreign buyers, such as central banks, had snapped up Treasurys. It could spell trouble for the U.S. housing market; the rates on many mortgages are linked to the yield on the 10-year note.....

    Let us hope these signs are a minor blip and not the double whammy in the making!

    Disclosure: None
    Mar 25 11:20 PM | Link | Comment!
  • Inversion in USD and Sterling Swap Spreads - Negative Swap Spread - and The Alarm It May Be Raising!
    What has happened?
    It has happened in both the Sterling and the US Dollar bond markets. The 10s USD swap rate is now trading below the 10s USD govy rate for the first time as of yesterday. Such inversion was already in place in the 30s swap/Treasury end of the USD curve and now it has been extended to the middle section of the USD swap/Treasury term structure.
     
    Why has it happened?
    The inversion is being driven by a host of factors including hedging activity from broker dealers. High government bond supply is driving the govy yields upwards. Another factor helping cause the inversion is the increased demand by investors using swaps for meeting longer term liabilities rather than committing capital to buy longer maturity bonds. At present, there is a tangible attractiveness in using swaps as opposed to bonds as a means of financing. This is not too different to repo financing / wholesale funding type transactions being conducted through swaps. Large issuance of corporate debt which is swapped from fixed coupons to floating rates has also increased the likelihood of the inversion. Furthermore, the inversion in yields is likely being accentuated by technical factors - notably a number of structured derivative trades betting on the shape of the govy and swap curves cease paying a coupon when swaps trade below govies. Thus the unexpected inversion is leading to a surge in demand for hedging (so called negative gamma trap) that, in turn, has magnified the inversion.

    In the Sterling markets, the 10s swap is already below 10s Gilts at 3.80 and 3.91 percentage points respectively. Similar to the US case, in the UK, pension fund demand has pushed swaps into negative spread territory as rather than commit cash to buying longer term bonds, funds have chosen swaps to lock in long term fixed rates. This is not surprising given the steep yield curves provide incentives to rollover short maturity funding to longer periods and the general paucity of long term funding sources given the uncertainty on the economic climate. 

    The inversion in the USD swap rates also reflects a lack of capital amongst market participants since an inversion in swap/govy spreads should, in theory, be arbitraged away. However, executing such an arbitrage trade depends on committing capital for an extended period. This has not been easy. 30s inversion shows the difficulty of financing long term balance sheet trades given the uncertainty ahead. 10s inversion is now showing similar difficulty in financing at the 10 year maturity horizons.
     
    Risks Ahead?
    The inversion is rare but not something that has not happened in the past. In normal markets, yields on govies trade at a discount to swaps as govies reflect AAA risk and swaps reflect counterparty lending risk. However, read in the context of blowing budget deficits, let us hope that the inversion is not spelling out more ominous signs such as an impending surge in govy yields that will increase funding costs of the Government and inevitably also lead to a rise in mortgage rates. That would be a double blow to deficits and housing that we could all do without.
     
    Interestingly, the inversion in swaps ties in with the notion that sound US corporates like Berkshire are issuing debt at yields lower than that of debt issued by the US Treasury.
     
    Aly Iman
    Chief Strategist & Partner
    risConometrics Inc.

    Note:
    PDF of this comment was forwarded to risConometrics' clients and is availalbe for download at
    http://www.risconometrics.com/risConometrics_comment_032410.pdf

    Blog: www.risConometrics.com/webblog/

    Disclosure: None
    Mar 23 10:24 PM | Link | Comment!
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