Monday, August 21, 2006

Forecast review...

Since I started this blog in early July, I've made many brash predictions. Unlike other forecasters, I'm willing to go ahead and review what went well and what didn't.

1) I called for the 10-year rate to rise on 7/5, and stuck with that prediction until 8/14. In that time, the 10-year yield fell 22bps. I thought the Fed would hike to 5.50% and then hang there for several months. The Fed actually stopped at 5.25%, and now the market is pricing in cuts by mid-2007. The 10-year may make a technical reversal, but it will be minor. I don't see a lot of upside, though, so I think its worth being neutral on rates generally.

2) On 7/6, I said I favored A-rated corporates over BBB-rated issues, on the theory that credit conditions are too easy. Since then, the Merrill Lynch A-rated index has tightened by 1bps (using OAS) while the BBB-rated index has widened by 1bps. Its moving in the right direction, but this is more of a 6-12 month trade so we'll have to check back.

3) On 7/7, I predicted corporate spreads would tighten, because too many PM's were short corporates in their portfolios. I believed that eventually, they'd be forced to come into the market, causing spreads to tighten. The Merrill Lynch Corporate Master index OAS is flat since then, but again, I'd view this as at least a 6-month trade, so we'll see. Incidentally, I think that if A-rated issues outperform BBB-rated, its evidence of just this sort of movement by managers. If you don't like corporates, but feel compelled to put cash to work, you're going to buy higher-rated stuff first.

4) Also on 7/7, I said I thought MBS spreads might widen on volatility fear, but that MBS would outperform on carry, so I was long MBS. Well, I was right to be long, but wrong on the reason. MBS spreads have tightened substantially since then, from +64 to +51. The Fed has been even more transparent than I thought, making it obvious when they were pausing and leaving the market with little doubt (right or wrong) about further hikes. So there likely won't be a vol scare. This is a case of better to be lucky than right.

5) On 7/14, I said I'd "sell the heck out of TIPS." Since then, the Jan 2016 TIP is up 1.86% vs. 1.76% for the Feb 2016 Treasury (price only). Not much there. 5-year issues underperformed (+0.58% for TIP vs. 1.05% for Tsy), but the inflation adjustment cuts the underperformance down to about 25bps, so not much there either. I'm narrowing this prediction down to the 2-5-year area. I think there is a much better chance of sharply lower inflation (maybe because oil prices hold steady) than sharply higher.

6) Finally, on 7/25 I said the curve would steepen. Since then, the 2-10 slope has declined from -5 to -4bps. Not much there, but the 2-30 slope has moved from +1 to +10. I still like a steepener, favoring 5-7 year issues over other parts of the curve. Hard to say how long this might take, and its possible there is deeper inversion if the Fed is looking like a cut sooner than later. Even so, I see the 30-year trailing intermediate-term issues.

Mixed bag. 1 clearly wrong, 2 kind of right but need more time to see. 2 more are neutral, and 1 was right but for the wrong reasons. I'll check back in later.