Bond Expert: Monday Outlook

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Includes: FMCC, FNMA
by: John Jansen

Prices of Treasury coupon securities are modestly higher in overseas trading, partially reversing some of the losses suffered on Friday. Credit fears still dominate, and they dominate in the press and were ever present at the deliberations at Jackson Hole over the weekend. Bloomberg carried a story about the strains in the money markets and how some money market credit spreads will probably widen into year end.

A small bank failed in Kansas this weekend and that only draws attention to the general plight of the industry and conjures up concerns regarding the state of the regional banks and some of the larger major institutions.

Speaking to the BBC from Jackson Hole, bank of England Deputy Governor Bean expressed his strong view that the crunch would persist for a considerable time.

Danish Consumer confidence slipped to -12.2 in August from -9.7 in July. It was the weakest reading in 18 years. The sharp drop in oil failed to buoy confidence of consumers and that bit of quirky behavior flummoxed economists who had expected that lower prices would cheer the masses.

Asian stock moved sharply higher as the drop in oil prices bolstered sentiment.

European shares are modestly lower. (London appears to be closed.)

Futures markets are indicating that share prices will open lower when trading begins in a little more than 2 hours.

The US market confronts the Existing Home Sale report today. Prognosticators are forecasting a slightly higher result than the previous month as lower prices should help clear the market.

I think that the trading backdrop this week will be dominated by the tension between heavy issuance from the Treasury and credit fears which will swirl about FNMA and Freddie Mac. It is hard to say which will win as it is hard to know what sort of rumors will fly regarding the GSEs.

I would counsel taking a shot on a short the curve position and expect that supply and the month end technicals will successfully take me out of the trade. I would trade with very short stop and would exit quickly of the position runs against me.

I rambled and never gave yield levels.

The yield on the 2 year note has declined 3 basis points to 2.37 percent. The yield on the 5 year note has declined 3 basis points also to 3.11 percent. The yield on the benchmark 10 year note is lower by 4 basis points and it rests at 3.83 percent. The yield on the Long Bond dropped 2 basis points to 4.45 percent.

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The markets seem to be on an inexorable mission to push FNMA and Freddie Mac to the brink and to test the mettle of the Treasury and Hank Paulson. The markets will be very thin this week as many participants will be off until after the Labor Day holiday and will not return to the bond market wars until the first trading day of September, on Tuesday September 2.

Against that background I think that it will become increasingly easy to muscle FNMA and Freddie Mac. The stock will continue to approach zero and bond spreads and various credit derivative indicators should continue to widen ,exacerbating the financial stress of these troubled firm.

The exigencies of circumstances will force Mr Paulson to act. The holiday weekend will be an ideal cover for him to exercise his power and recapitalize FNMA and Freddie Mac. If he chose to act at this time next weekend (Sunday evening at about 1000PM New York time) it would allow foreign markets a chance to trade on the information and it would allow the potentates and grand poohbahs of the Fed and the Treasury to spend the Labor Day holiday bending the ears of senior managers at the large banks and hedge funds and money managers.

That would allow for some discussion of whatever the Treasury has proposed and hopefully would allow something of a graceful opening of trading when the markets begin trading after the long holiday weekend.

What do you think?