Tuesday, August 21, 2007

You do have your moments

The stock market was lower most of Monday, and yet the investment-grade credit market managed to stay mostly unchanged. Actually most names were tighter, including financials, but compared to the volatility of the last two weeks, today is downright boring. Late in the day stocks rallied and finished modestly higher, but I don't think this had a big effect on spreads.

Ben Bernanke can go ahead a crack a half-smile. While Friday's announcement about the discount rate sent the stocks and credits soaring, that was no test. I believe strongly that the Fed has little interest in propping up the stock market, or for that matter, pushing general credit spreads tighter. So to see the markets improve markedly after their announcement was no test.

It was the sense of panic that the Fed was looking to ease. It was the extrapolation of sub-prime losses to infinity that the Fed was looking to quash. So today's calm in the market has got to make the FOMC happy, if only for a day.

Some items worth noting about the market after the discount rate cut:

1) The 2-year is currently over 100bps below target Fed funds. The 5-year is about 75bps through FF. I'm feeling bearish at those levels. The market is (almost) universally thinking target rate cut in September. I agree, but how many cuts will it take for the curve to rally much from here? I say more than 100bps worth, and I don't thank that's happening. Again, I liken this to 1998. After the Fed was done cutting thrice in the fall of 1998, the entire yield curve moved substantially higher during 1999.

2) There are some massive technicals in MBS right now, even in agency stuff. Banks and dealers are tightening their repo haircuts and/or cutting credit lines. Many leveraged players (especially REITs and hedge funds) are having to sell (at whatever price) to be incompliance. If you traffic in bonds that REITs like, such as hybrid arms, the selling pressure may continue for a while.

3) I never thought I'd say this, but today's t-bill auction brought some much-needed supply to that market. Investors are moving en masse out of Prime money markets and money market alternatives and into government money markets. All that cash moving at once has the yield on 4-week bills falling below 2%. Honestly, though, I can't blame money market investors looking to get out of anything that could possibly have ABSCP. I think many investors will eventually realize they are better off in like 2-year Agencies that money markets. Or a short-term investment-grade corporate mutual fund. That will normalize the t-bill market. Dunno how long that will take.

4) Long-term tax-exempt municipal bonds rated AA/Aa or better are widely available at or above the 30-year Treasury rate. Its called a liquidity premium, but its become awful expensive.

5) Countrywide paper maturing in December 2007 could have been bought at $95, or like a 25% annualized yield, on Thursday. Before you say that's ridiculous, consider the situation. By December, either Countrywide has figured out a way to finance themselves or they haven't. If it's the former, they're probably in fine shape. If it's the later, they're bankrupt. Finance companies are more likely than any other type to be suddenly bankrupt, since they are constantly in need of cash.

6) There is a rumor this morning that Warren Buffett could buy parts of Countrywide. I believe he would at least look at them. Remember he offered to buy LTCM the morning of the Fed bail out, so the guy is comfortable with rescue attempts.

7) Bernanke, Paulson and Dodd are meeting today at 10AM. Market will be waiting for this meeting, as there is yet more rumors that the Fed cuts today. I doubt it very seriously.


Anonymous said...

Good to see you posting again.

"how many cuts will it take for the curve to rally much from here?"

I thought the Treasury Yield Curve looked good (positive slope, only flat(tish) between 6mo. and 2yr.

Obviously I'm still unclear on this whole "good"/"bad" thing. Please help.

"compared to the volatility of the last two weeks, today is downright boring"
I always like your market summaries, like this 'un. Please keep them coming.

"I think many investors will eventually realize they are better off in like ... short-term investment-grade corporate mutual fund"
I thought thats what Money Market Funds, e.g. BPRXX, were anyway.
Please tell us more.

"rumor that ... Warren Buffett could buy parts of Countrywide"
Yup. I thought he might like
a) the income stream of their Mortgage Service business

b) the chance to do jumbo mortgages at (more) lucrative yields than in the recent past.

c) the opportunity of participating in the coming real estate workout

"Remember he offered to buy LTCM the morning of the Fed bail out"
Yes but, god luv'im, his offer was too low. At least he got the satisfaction of seeing about a dozen street firms pay too much for (LTCM) assets when they were under extreme stress

Anonymous said...

Hey, great blog. A couple questions:

(1) I'm having trouble finding quotes on Agency paper -- do you know where a guy without a bloomberg terminal can find these (for free)?

(2) I know you're not an equity guy, but what kind of risk do you see for a REIT like NLY, who only buys agency paper? Their portfolio has no credit risk (unless you think Fannie, Freddie, etc. won't make good on their gurantees), but I'm guessing that NLY will still face margin calls and increased haircuts on the collateral it posts in the repo market. NLY could be a great place to be in the current credit envornoment, since they make money off the spread between short-term and long-term paper. i.e., a steepening yield curve is great for them.


Anonymous said...

Dodd is just the guy we need to really screw things up.

Accrued Interest said...


Its the inversion from FF-2 years that takes away all of the upside of a long duration position, IMO.

By short corp funds, I mean non-money markets that have, say, a 2 year average life.

Applesaucer: Do you mean specific agencies or the agency market generally? I'm going to write a whole post on NLY. Its one of the few stocks I know a lot about.

Anonymous said...

Thanks tddg, I am obliged to you.

Anonymous said...

Thanks for the reply.

What I'm talking about are the Agency Securities that NLY buys -- FHLMC, FNM and GNMA MBS -- and presumably use as collateral in the repo market.

I'm really looking forward to your NLY post. Last Summer I established a position in them at ~$12 and considered making it substantially bigger last week when they traded heavily back down into the $12s. I hesistated because of the margin call issue (and, ironically, in NLY's case, I would assume that it might hurt them that 75% of their MBS are fixed and will not be resetting to higher rates) and possible erosion of book value. But now they're back in the $15s.

IMHO, NLY would make a no-brainer equity bear market warrior, considering how the yield curve is likely to move in a bear market scenario (i.e., steepen). And it's "easier" than shorting or buying puts.

My thinking is that they don't trade back down into the $12s anytime soon unless (1) another panic sets in that specifically relates to mortgage collateral; or (2) the market shakes off this credit crunch and the yield curve begins to flatten again.

Not looking for advice, of course -- just interested in your thoughts.