Vikram Saxena

Yields Soar as Mortgage Bond Holders Start to Sell

I was betting that TBT will go down. However to keep my risk limited I used options, since it limits my max loss. I used a put spread to reduce the theta (time decay) while capturing most of the delta (price based movement). Regarding strikes, I opened the long leg, at or near the money, and the short leg at or near my downside price target.


On May 28 12:08 PM RiskReturnOptimizer wrote:

> Please elaborate your Long TBT Bearish Put Spread position.
>
> This one is very interesting to me, since TBT is already double inverse
> price of 20 year treasury.
>
> Put spread is buying one put and selling another put.
>
> What strike prices are you using?
>
> What exactly is the derivative trade (e.g., put spread on a double
> inverse index) ....... is there is simpler bet on direction of treasury
> yield?

Long Term Treasury Yields Likely to Rise, Pressuring Dollar Lower

All the green shoots being sighted are unlikely to grow into trees, if the longer term interest rates continue their upward march. Unless Ben does a Greenspan, and encourages people to use ARMs, the Fed efforts to re-capitalize US consumers via cheaper rates on fixed rate mortgages will be in serious jeopardy if this spurt continues. Long bond yields tend to move in big spurts and the current spurt has taken the yield on the 10 year up by more than 70 bp since the low reached after the Fed's quantitative easing announcement in March. This trend will "Round-Up" the green shoots if not arrested.

Friday Outlook: Watching Paint Dry

I think instead of window dressing, we are seeing window breaking (as termed by Art Cashin on CNBC). Hedge funds are massively short the market and want their shorts to go back further before the quarter end. The rumors about LEH/ML seem to strengthen the thesis, that there are some significant money trying to get the some high profile under performing stocks to go down further.

So the securities under pressure in the second half of this week might see more pressure on Monday and then rally into the rest of the week as the hedgies rush to reduce their short exposure.

After the big up day earlier this week, the market listlessly drifted down with very little conviction in any direction. This is really an odd behavior and suggests that the traditional window-dressing is being supplemented by sometime more, and newer.

5 Reasons the Fed's Credit Bailout Will Likely Disappoint

Matt:

Have you looked at where the ABX AAA indices are trading? The market is already pricing the risk; AAA bonds dont trade with a 50 handle. And with Mark to Market rules the banks have to take the write-downs as they occur.
www.markit.com/informa...
Index Series Version Coupon RED ID Price High Low

ABX-HE-AAA 06-1 6 1 18 0A08AHAA1 86.19 100.38 84.17
ABX-HE-AAA 06-2 6 2 11 0A08AHAB8 70.06 100.12 66.1
ABX-HE-AAA 07-1 7 1 9 0A08AHAC6 55.94 100.09 53.46
ABX-HE-AAA 07-2 7 2 76 0A08AHAD4 52.92 99.33 52.47

www.markit.com/informa...
The TABX index tracking the BBB sub-prime mezannine debt converted into CDOs is treating them as pretty much worthless even the 40-100 tranche.


Another thing to keep in mind: The salvage value for loans on homes in foreclosure varies between 50-80% of the home's market value depending on the size of the loan and the market condition. Assuming an average recovery of 66%, the number of loans defaulting has to be 3 times the credit support before the bond take real losses. And not all these loans were no-down payment loans; in many cases they homeowners had some kind of equity in the deal (downpayment).

Homes have a tangible value and use; in nominal dollar terms there are unlikely to fall significantly below the replacement costs. Of course their real values has collapsed with the collapse of the USD.

Rate Cuts and Inflation: Linkage Overblown?

That should read:
However just because commodity prices translate to inflation to a lower degree does not mean that they are *NOT* the prime cause of inflation right now.

Rate Cuts and Inflation: Linkage Overblown?

robbyt:

There is nothing contradictory about what I have written.

In emerging markets the cost of the raw material is a major component of the production cost since labor is cheap and marketing is a much smaller component. In the US, it is the cost of labor and marketing which dominates the cost of raw materials when you consider the cost structure.

To get a perspective, the price of most commodities has gone up multiple times but inflation in the US still in the low single digits. That highlights the impact which commodity price increase has in the US; visible but not in the same order of magnitude.

However just because commodity prices translate to inflation to a lower degree does not mean that they are the prime cause of inflation right now. And higher Fed Funds Rate will not have any direct impact on the price of commodities (except for their effect on the exchange rate).

Rate Cuts and Inflation: Linkage Overblown?

SIMPLE d:

It is again a US centric view. What we got to realize that the US and US consumption is no longer the prime driver when it comes to the demand for commodities. That is a fundamental shift from the past.

It is easy to blame excess money supply for inflation. However, in the US economic structure most of the costs are in distribution and marketing; not in production. The raw material cost is a very small percentage (except for energy which is a tax across all elements).

I agree that the US Dollar is a major factor. However, there are other factors in play apart from interest rates when it comes to the dollar. Look at the interest rates in the Greenspan and the value of the dollar to get an alternative perspective.

Rate Cuts and Inflation: Linkage Overblown?

robbyt:

The issue is not whether inflation is good or bad. There is no doubt about that.

The issue of debate is the degree of control which the Fed has in reducing inflation in the current environment. Since the inflation is not being driven by US consumption, the senstivity of inflation to the Fed funds rate is much lower than it used to be in the Volcker era.

On the other hand, what is quite certain is that lower rates will provide support to the US economy. Once the credit markets and the housing markets stabilize, the Fed can attack inflation at will.

Even in Volcker's time, what got us out of the inflationary spiral was increasing effeciency and greater energy supply. His rate increases helped limit US growth till the energy demand/supply situation became balanced again. However right now, any rate increases in the US will not significantly affect the demand in the emerging economies. They might strengthen the dollar but there are many other factors at play when it comes to the dollar. Remember that the Fed Funds Rate were much lower and the Dollar much higher in the Greenspan era.

Rate Cuts and Inflation: Linkage Overblown?

nitroae23:

A lot of people in the West confuse the correlation between the markets and the economies of the developing economies. The markets, especially the equity markets, will continue to be strongly correlated. However, the underlying economies are not.

Growth in China and India is not only been driven by the West but also their internal growth. These economies were long shackled by artificial constraints, which are gradually withering away and they are going to play catch-up with the rest of the world.

To learn more, watch the interview on CNBC with Mohammed El-Erian (PIMCO/Harvard) one of the most respected investors on Wall Street. El-Erian understand emerging markets better than most.

www.cnbc.com/id/158402...#

Around 4:00 Minutes is where the discussion about emerging markets start.

Rate Cuts and Inflation: Linkage Overblown?

nitroae23:

We live in a different world than which Volcker lived in. The USA no longer is the largest driver of raw-material consumption that it was two decades ago. The growth in demand is coming from countries whose economies can grow significantly organically, with out much help from growth in the developed world.

Increasing interest rates in the USA will not have a significant effect on the consumption of raw-materials in the emerging markets. Hence interest rates are not the right tool when it comes to commodity driven inflation in the USA.

Incidentally, what fixed the energy driven inflation during Volcker's time was the increasing energy effeciency and greater oil supply coming on line. We need to focus our interest on that; not on the false hope that decreasing growth in the West will sufficiently decrease demand in the emerging markets.

en.wikipedia.org/wiki/...