Wednesday, April 30, 2008

The Fed and looking away to the future

The Treasury market has spent most of April backing away from financial disaster levels. The 2-year Treasury closed at 1.34% on 3/17, the day Bear Stearns was bailed out/purchased by J.P. Morgan. On Friday the 2-year traded as high as 2.50%. Similarly, the 5-year closed at 2.20% on 3/17, and traded as high as 3.24% on Friday.

When the 2-year traded down to the 1.30's it reflected a number of problems, including fear, illiquidity in other rates product, and the expectation that the Fed would continue aggressive rate cuts. Since then all three of these elements have backed off to some degree. But one thing that hasn't changed at all is the fact that the real economy is quite weak. It may be that the worst of bank writedowns are past us, but housing prices are showing no signs of bottoming. Yesterday, the Case-Shiller index showed home prices declined by 12.7% in 20 large metro areas over the 12 months ending in February. Inventories remain high, and there are still many delinquencies that are going to turn into foreclosures. While it does appear that we are now working through the housing problems, the fundamentals simply don't support a turnaround in the very near term.

We also know that in past recessions, unemployment tends to remain high, or even continues to rise, even after the economy starts growing again. This pattern will be present in this recession as well. Yes I know, 1Q GDP came out positive this morning, but there was a significant inventory effect. I'm going to keep calling this a recession until I'm really proved otherwise (which I doubt). Anyway, even if you presume a relatively mild recession, we're going to have elevated unemployment for a while.

So where does this leave the Fed? Today we got a 25bps cut, with the statement still sounding quite dovish. Those that are calling this statement "hawkish" are speaking relative to recent statements. Unless the Fed's favorite inflation gauges start rising, or the Fed really believes inflation expectations are rising, there will be no impetus for hikes any time in 2008.

Look back at the 2-year Treasury. The long-term spread between short-term inter-bank lending rates and Treasury rates is about 40bps. So if Fed Funds were going to remain at 2.25% for the next 2 years, fair value for the 2-year Treasury would be 1.85%. So with the 2-year actually in the 2.30% range, the market seems to be expecting Fed Funds to average something like 2.70% over the next 2-years.

Feels to me like that expectation is a bit high. If the Fed holds at 2% for 9 months, the Fed would have to hike 112bps immediately thereafter for Funds to average 2.70%. The hike would have to be more extreme if we used a discounting method rather than a straight average. Of course, there are any number of patterns that could justify current rates, but all of them would involve aggressive Fed hikes by early 2009.

And to assume the Fed starts hiking aggressively in early 2009 also assumes that housing and employment start showing some real signs of improvement by then. I'm not going to say it can't happen, but that seems like a very optimistic scenario. In other words, it seems that the odds of the recession being deeper or longer than what is priced in is relatively high, whereas a more optimistic scenario is just not very realistic.

As I said in a previous piece, inflation is the wildcard. If we see some real pass-through effects from food and energy then the Fed will have no choice but to hike rates. At that point the yield curve would flatten severely, possibly even causing the 10-30 year maturities to rally while the 2-7 year maturities sell off.

But in the short-term, it looks like the 2-5 year part of the curve is relatively cheap. If you have cash sitting around, now is probably a good entry point.

Thursday, April 24, 2008

Treasuries: This far, no further!

The Treasury market continues to struggle to find a right value given improved market liquidity but still weak economics.

Last Friday the Dow soared over 200 points. At mid-day, the Treasury market was acting the way you'd expect, the 10-year fell nearly 1 point, its yield reaching as high as 3.85%. And yet by the end of the day, with stocks still soaring, the 10-year had rallied to a small gain on the day, finishing the day at 3.71%. There was no late day economic release or spooky trading in one of the brokerages or any such thing. Buyers just came in.

Monday morning the Treasury made another run at higher rates, this time despite disappointing earnings from Bank of America and a weak open in stocks. By about 9:30, the 10-year rate had risen 6bps to 3.77%. Once again, however, the market found only buyers at those higher levels, and by the end of the day, the 10-year was unchanged at 3.71%. Once again, there was no particular news that fueled the rally. In fact, both commodities and stocks rallied modestly toward the end of Monday, both of which should be negative for bond prices.

On Thursday we finally got a selloff that held, despite a real ugly housing release. The 10-year finished at 3.83% and the 2-year at 2.38%.

So what's next? In the long term, real money investors don't tend to own a lot of Treasuries. Mutual funds are marketed on yield, and you don't generate yield by holding a bunch of government notes. Same goes with retail investors. In normal times, they tend to chase yield, which will never be in Treasuries. In time, these investors will return to their more normal buying habits, which will result in yields rising.

But in the intermediate term, it may take a little more evidence of economic improvement before Treasury rates make another substantial move higher. I think the worst of the liquidity crisis is past us, but we still have a weak economy will still be dealing with housing-related problems for a while. That will probably keep the Fed in a easy money mode for a while, which will be supportive of interest rates generally.

The thing to watch is primarily inflation data. I think bad housing data is mostly priced in (today's rally supports this thesis), and while it could turn out worse than currently expected, inflation is actually the more important element for rates. Food and energy inflation has been problematic for a while, but the leakage into core inflation measures has been mild so far. The Fed has been gambling that it could afford to cut rates to improve liquidity because weaker employment would take care of the inflation problem.

If either employment is not as weak as currently expected and/or unemployment fails to contain inflation, the Fed will make a U-turn on rates. It is widely agreed among Fed economists that recessions may come and go, but elevated inflation expectations can be difficult (and painful) to bring down. Even if it means creating a double recession (or prolonging the current recession), they will do it to avoid creating higher inflation expectations.

The way to play this is to own cash-flow producing bonds. Agency mortgage-backed bonds are a good choice, as they return principal cash flow every month. This gives one the chance to earn an attractive yield and still have the chance to reinvest principal cash flow at higher rates should inflation tick up. iShares has an exchange traded fund that follows the Lehman Fixed-Rate MBS index, its ticker is MBB.

I don't like Treasury Inflation Protected Securities (TIPS) here. The problem is that TIPS pay investors based on realized inflation, not the threat of inflation. Its very possible that the Fed gets out ahead of inflation expectations, and TIPS returns are unexciting. On the other hand, shorter duration bonds, like MBS, will tend to perform well whether rates rise because of Fed activity or inflation, which seems like a better bet.

ABX: Nothing can stop that now...

I've written recently that liquidity in the market is improving. Ultimately this will help pull us out of our current recession. Without liquidity, lending would never recover, and therefore housing would never recover. With liquidity, time will eventually bring both back to normal levels.

But lest you think I'm some dead brained bull, please understand that everything isn't OK. Look at the ABX indices, and notice how many of those prices are basically at their all-time lows. We've seen everything from credit to municipals to agency MBS show substantail improvement, but the good vibrations don't extend to home equity CDS.

That's because the improvement in other bond sectors reflects a recovery in liquidity. But liquidity isn't the problem in subprime lending. That's especially true for the A and BBB-rated portions of the ABX (which, by the way, is based on original rating). The BBB portions will pay some interest cash flow from here on out, but that's about it. Forget about principal. And that's not going to change. There will be a continued erosion of the ABX BBB prices as those lingering interest payments are made.

Wednesday, April 23, 2008

Ambac update...

S&P says the 1Q loss won't impact Ambac's rating, claiming that the loss was within their projections. It isn't on their website yet. More commentary as it becomes available.

Ambac: Wanna buy some death sticks?

You can read the actual news for yourself. Bottom line is they lost about 2 1/2 times their market value. Let that roll around in your mind for a while. CDS on Ambac's insurance sub (i.e., the AAA entity) is quoted at +750/year, up about 40bps. The parent company is 17 points up front +500bps/year, up 2 points from yesterday.

Haven't heard anything from the ratings agencies yet. As I've argued before, their AAA/Aaa rating on insured bonds is kind of academic at this point. They have $16 billion in claims paying resources, which means that they can probably pay off all insured bonds with cash to spare. Whether that merits a AAA or not is a matter of opinion. I think Ambac's stock is complete shit, but I also think shorting their insurance sub is dumb.

I'd also point out that the general market doesn't care much about Ambac's results. Dunno exactly how the stock market will open here, but the futures suggest slightly positive. Credit spreads away from monolines are opening mostly unchanged. Would there be any chance of a positive open given these results from Ambac 3 months ago?

Still no word from the ratings agencies. I'll point out that Moody's and S&P have previously argued that mark-to-market losses aren't indicitive of actual cash losses, and therefore the MTM losses Ambac is currently reporting aren't relevant. Not all of their $11/share loss was MTM, but worth considering. I still don't buy Ambac as a long-term profitable company. Maybe they can survive primarily as a reinsurer, but they'll never make it as a major muni insurer again. No way.

Tuesday, April 22, 2008

Its against my programming to call bottoms

Friday's discussion on bearish market sentiment was really great. Thanks for all who commented.

Most of the comments seemed to focus on stock prices. As a bond pro, I spend my time thinking more about yield spreads, both in credit and other sectors. As discussed many times (many, many, many times), there were two elements causing spreads to widen: poor liquidity and weaker economics.

Liquidity has improved dramatically since the Bear Stearns bailout. The feeling is totally different than in some of the other false rallies (in credit) we've experienced since September. Previously, any hiccup would cause spreads to move drastically wider. There were times when we moved a bit tighter, then some writedown would be announced, and it would all go to hell again. It isn't as though we haven't had hiccups the last couple weeks. The 200 point sell-off on GE's earnings is an example (I wrote about this here). Or Wachovia's need for more cash. Or Bank of America's weak earnings report. Now these events are taken in stride. Spreads have moved wider on certain days, but its controlled, more reasonable. Not panicky. I won't say that spreads (especially in CDS) aren't still volatile. The massive amount of shorts in CDS that have been or are being covered is seeing to that.

Plus the correlation of spreads has broken down. Now it isn't necessarily true that agency debt, MBS, and credit all move the same direction on any given day. Hell municipals had become highly correlated with credit spreads. Now it seems that these spreads are moving on their own supply and demand conditions, not on liquidity fear.

So am I calling a bottom? Well, I don't really invest that way, so if I didn't have a blog, I wouldn't really think about a "bottom" very much. I try to stick to fundamentals and spend only a little time on technicals. Liquidity is part of any fundamental analysis of a bond, so indeed it became tough to value many different bonds in recent months. And deep fundamental investors tend to be a little early, seeing the fundamentals shift and/or pricing (un)attractive before the market actually shifts.

But yeah, if you stick a gun to my head, I'd say we've seen the wides in credit spreads. Not because the economic problems are solved, but because liquidity has improved to the point that people are willing to be opportunistic. That will put a lid on how far investment-grade names will move before yield hungry investors come in. Issuers will be able to come to market with new issues, and the wheels of the credit market will continue to churn.

Friday, April 18, 2008

Ultra-Bears: I take it back!

I have a question for the bearish readers of Accrued Interest. I've corresponded with many of you and have heard many well-reasoned arguments for a bearish future. And here I'm not talking about those who think the recent stock rally has gone a bit too far and are looking for a 2% pullback. No. I'm talking about those who think that stocks will be lower over the next 2 years, or even longer.

So here is food for discussion in the comment section. If you are this kind of bear, what would convince you that you are wrong? In other words, what evidence could reasonably appear which would convince you that your bearish stance won't work out?

I ask this out of selfish motivations. The ultra-bears have been right so far. I mean, I was dismissive of some of the worst case scenarios which people presented over the last year or so. But on the other hand, I do not believe that things are so bad that we won't get through it. And I also think that the financial markets will recover faster and ahead of the economy as a whole. So remaining short, or even on the sidelines, is a dangerous game right now. And I want to hear from intelligent people who have actual money they are using to bet against the U.S. recovering.

And I want to hear what would convince you to cover your short and potentially go the other way. Because that's the true sign of a well-thought out trade. Everyone always has a reason why they make the trade, but a good trader also has an exit plan in case s/he is wrong. Let's hear it.

Rise Lord LIBOR!!

When trying to gauge the market's generalized view of counter-party risk, swap spreads are a good place to start. This is the spread between Treasury securities and the fixed leg of a plain-vanilla interest rate swap. Since there is necessarily some bank or brokerage as the counter-party of such a swap, the spread is a good indication of counter-party risk.

So it comes as little surprise that swap spreads have been elevated in recent months. 2-year swap spreads averaged 40bps during the first half of 2007, recently spiked above 100bps just before the Bear Stearns collapse. Afterwards, it declined into a more stable trading range in the low 80's.

But in the last week, spreads appear to be spiking again, having risen 13bps in the last three trading days, from 83 to 96bps on Thursday, and briefly crossing +100bps. (On the chart, Libor is in orange and 2-year swaps in white).

Is it a return of the liquidity crunch? Its a bit of a conundrum, because most other indicators have been pointing the other way. The VIX has declined over 3 points in the this week. The CDX indices are significantly tighter: investment grade -19bps this week and high yield -56bps. Bank and brokerage CDS are also markedly tighter. Wachovia and Citigroup are both about 25bps tighter, Lehman, Merrill, and Morgan Stanley are all at least 30bps tighter.

Perhaps the answer lies in some wishful thinking on the part of European banks. According to the Wall Street Journal, official Libor fixings have not reflected the real cost of intra-bank borrowing. 3-month Libor, for example, was fixed at 2.73% on Wednesday, but I have been hearing actual bank lending is happening at levels more like 3%. This had lead some to question whether the banks that help set Libor are being entirely honest about the levels being supplied.

This morning, 3-month Libor was fixed at 2.91%, suggesting that maybe these banks are starting to fess up.

I'm not going to comment on potential manipulation, since I'm in no position to speculate on such a thing. But Libor has been rising lately. After falling to 2.54% on March 18, the same day the Fed cut its target rate by 75bps, Libor has steadily risen to this moring's level of 2.91%. That obviously has an impact on swap spreads.

Since 3-month Libor is the floating side of a plain-vanilla swap, and Libor has been rising, it follows that the fixed side must rise as well. That explains why swap spreads are moving. But its doesn't explain why Libor itself has been rising, especially if it really should be even higher. How to reconcile the lack of liquidity implied by rising Libor with otherwise tighter credit spreads?

I think this signals a shift in the credit cycle. Until now the focus has been primarily on structured products: SIV, CDO, ABS, etc. Those are primarily the domain of the large financial institutions. I.e., the names that trade in CDS routinely, that get reported on CNBC every day, and by the way, the same names that have been taking all the write downs. The Lehman's and Citi's and Merrill's.

Maybe tighter CDS spreads in these names is indicating that those institutions have taken (or reserved for) most of the losses they are likely to take. But what about smaller banks? The regional and local banks that may never have been involved in a CDO, but might also have a lot more risk in a single borrower or category of borrowers. Perhaps 2.90% is in the right ballpark for Lloyds Bank, who is part of the Libor survey, but not for the local bank in Norwich.

And what about Europe in general? Libor is set by a survey of 16 banks, only two of which are American. It has long been said that Libor is really a indication of where European banks can borrow in U.S. dollars. So rising Libor may say more about tight liquidity in Europe than in the U.S. A combination of tough liquidity in Europe and among smaller banks would explain the divergence between CDS spreads and Libor spreads.

To me, this sends two cautions. First, it should remind anyone who thinks the liquidity crunch is over, that it ain't. Liquidity does seem to be improving in the U.S. bond market, which is a very positive sign. So maybe the worst case scenario has been taken out. But this will be a long process.

Second, it should caution those who are short the dollar. If the next phase of the credit crunch hits Europe as hard as it hits the U.S., then we may see the Bank of England and the European Central Bank get more aggressive with rate cuts. Indeed today there are stories that the BoE is working on a plan to inject more liquidity into the banking system. That would ease pressure on the dollar. Given how popular short dollar trades have been, any reversal may be violent.

By the way... please vote in the new polls. I'm curious.

Monday, April 14, 2008

Wachovia vs. Retail Sales: FIGHT!

I haven't read enough on Wachovia to make a lucid commentary. I'll only say that I'm suspicious when a bank shows a relatively small loss, but decides to raise a very large amount of cash.

Anyway, Wachovia bonds opened up mildly wider, say 3bps, but wound up about 6bps tighter on the day. Now about 20bps tighter than 3/31.

Bank/broker stocks got hammered today on the theory that Wachovia's writedown portends ugly things for upcoming earnings. There might have been an element of concern that more banks would be issuing new common shares as well. I am 100% with this line of thinking. Banks and brokers are going to take a long time to rejigger the business model. Its possible that this quarter is the last of the big writedowns, but that we see mediocre earnings growth from here. Therefore in order to buy bank/brokerage stocks, the valuation really has to be right.

In the credit complex, the big names were mostly unchanged to slightly tighter. Lehman unchanged, Citi unchanged, Merrill unchanged. Actually Lehman and Merrill's subnotes were quoted 5bps tighter on the day. Just glancing at CDS runs, it looks like more names are wider than not, although all moves are pretty small.

MBS were wider by about 6bps as swaps were 5bps wider. That's an unusually large move for swaps by recent standards. I haven't found anyone who seems to have a compelling theory as to why. Smells like people altering their hedges for whatever reason.

Treasuries were weak too, and steepened by 3bps. I still like steepener trades. The Fed isn't going to be hiking for several months, and that should anchor the short end. But as the economy starts to bottom out, inflation will become the bigger concern, pushing longer rates higher. That ain't happening tomorrow, but it will happen.

Friday, April 11, 2008

General Electric: The Krayt Dragon Call

Today was a very unusual day, when contrasted against the rest of 2008. We saw stocks get hammered mostly on GE's earnings, but in the bond world, spread product did OK. I see the CDX.IG about 1bp wider, and the CDX.HY 3bps tighter. CDS on GE itself moved 9bps wider, with similar moves for the brokers.

Swap spreads were unchanged. MBS and agency debt both about 1bps wider.

The municipal curve flattened, 10-yr rates fell 7bps and 30-yr fell 9bps. That compares favorably to Treasuries which fell 7bps and 5bps respectively.

Anyway, this is all notable because for most of 2008, anytime there was bad economic news, spread product of all sorts got hammered. I did a quick look at the other days in 2008 when the Dow fell 200 points or more, and then looked at what happened to the CDX.HY.

Pre-Bear Stearns Day
1/2 Dow -221, CDX +15
1/4 Dow -256, CDX +27
1/8 Dow -238, CDX -1
1/11 Dow -245, CDX -5
1/15 Dow -277, CDX +8
1/17 Dow -307, CDX +14
2/5 Dow -370, CDX +31
2/29 Dow -316, CDX +22
3/6 Dow -215, CDX +24

Post-Bear Stearns Day

3/19 Dow -293, CDX -25
4/11 Dow -256, CDX -4

That makes +15 the median move on the CDX.HY given a 200 point drop in the Dow pre Bear Stearns. I'm pretty sure if we did the same exercise for more staid securities, like municipals or agency MBS, we'd see a similar pattern, where severe days in stocks almost always resulted in ugly days for spread bonds.

This seems to support the idea that the liquidity crisis is slowly lifting. It isn't over, mind you, but its on the right path. We're left with a real economy recession, and the markets need to work out what the right price should be for various risks in a world where liquidity is slowly improving but the real economy is declining.

Today's move looks like pricing a real economy recession, rather than a financial crisis. Not great news for the stock investors reading this blog, but relatively good news for those hoping to avoid another Great Depression.

Wednesday, April 09, 2008

Rescap: Why are you still here?

In the last couple days, two particularly troubled mortgage originators got some good news on the capital front. Yesterday, Washington Mutual announced they will receive a $7 billion cash infusion with private equity firm TPG as the lead investor. To put the size of the capital infusion in perspective, WaMu's market cap was only about $9 billion as of Friday.

Along with announcing the new cash, WaMu also announced they were increasing their loss provision to $3.5 billion and expect 1Q net charge-offs of approximately $1.4 billion. Note that as of 12/31, WaMu's loan loss provision was $1.5 billion. So they have in essence charged off their entire previous loan loss provision and on top of that, have found another $3.5 billion in expected losses. Is it just me or does something not ring true here? Do we really believe that WaMu only saw $1.5 billion in losses on their loan portfolio in December, but then suddenly see $3.5 billion now? If I recall, the outlook for home prices was pretty negative in December as well, so it seems curious that the bank would see such a surge in expected losses now but not then.

In other news, Residential Capital, of "Lost another loan to Ditech" fame, got help from erstwhile parent GMAC in retiring $1.2 billion of debt. It was a very unusual transaction, where GMAC apparently bought the debt in the open market, at approximately 50 cents on the dollar. GMAC then traded the newly purchased debt to Rescap in exchange for preferred shares paying 13%. Rescap then retired the debt.

Monday, as news of the WaMu infusion was reported, Washington Mutual bonds tightened 100bps. WaMu's 7.25% issue due in 2017 is now bid at 575bps over Treasuries, about 250bps tighter than its recent wides. Rescap saw their 6.125% notes due this November rise 9 points to $85.

Given the disconnect between their words (i.e., their previous loss reserve) and their actions (raising $7 billion in cash), I can't get involved in the bond or the stock. But as skeptical as I might be about Washington Mutual's mortgage loan portfolio, the fact is that WaMu has a viable retail banking franchise which, if they have enough capital to withstand the onslaught of mortgage-related losses, should allow the bank to survive.

Rescap, on the other hand, has an obsolete business model. Its a non-bank mortgage origination firm. Is that a viable business model going forward? I really don't think so. To see what I mean, consider the following analogy. Forget about the legacy losses on poorly underwritten loans during the bubble years. Imagine you have the opportunity to start a new company, and your two choices are a retail bank covering high-growth areas in the west and northwest. Or you could start a mortgage originator with effectively no access to bank-type liquidity. Its obvious which you'd choose. So for my money, even forgetting about the loan losses which will inevitably hit Rescap, there just is no light at the end of the tunnel for them. No franchise worth saving.

As far as I'm concerned, this $7 billion may well save Washington Mutual. But GMAC is just throwing good money after bad with Rescap. Investors should avoid Rescap bonds, and watch out for high-yield mutual funds with significant Rescap exposure.

Tuesday, April 08, 2008

What of reports of unemployment massing near Sullust?

The reality is we are almost certainly in a recession right now. Friday's employment figures join a long line of coincident indicators supporting that conclusion.

The question is, how much should we really care about coincident indicators at this point? Readers of Accrued Interest are mostly investors, trying to figure out what to buy and sell. We aren't economists at the NBER trying to date the business cycle. Economic releases that tell us about the current state of the economy just aren't very valuable for investors.

Take unemployment. The historic data supports unemployment as a lagging indicator, especially for recoveries. For recessions, it has historically been a coincident to lagging indicator. A quick look at the 2001 recession shows what I mean. The following graph shows unemployment (red) and the S&P 500 (blue) from October 1999 to December 2003.

First let's focus on unemployment. From October 1999 to December 2000, the unemployment rate was between 4.1 and 3.9 every month. No leading indication that the economy (or the market) was about to turn south. During the official recession, March-November 2001, unemployment moved from 4.3 to 5.5.

Even after the economy started to recover, employment kept getting worse. Unemployment didn't actually peak until June 2003 at 6.3%, two full years after the recession was over.

So what's my point? The utility of an economic indicator, as a trader, can come in two ways. Either the number has predictive value, or correctly predicting the number can indicate how to trade the market. In other words, either you can use the number as an input predict future events. Or you can try to predict the number itself and then trade the market accordingly.

The last point is what I call the Crystal Ball test. That is, if you could be given advance knowledge of an economic statistic, say 6-months out, would that knowledge give you a trading advantage?

The 2001 recession shows that unemployment fails this test. Notice the two red shaded areas. In both cases unemployment was stable, but the stock market was falling precipitously. Then in the green shaded area unemployment takes another leg higher, yet the stock market rallied sharply.

Conclusion? During the last recession, unemployment predicted nothing useful to investors. Even had you been given a crystal ball and knew for a fact what future unemployment figures would be, it still wouldn't have consistently indicated the right market trade. In fact it often would have given you the wrong indication.

Of course, there is no sense denying reality. The first Friday of each month, when employment statistics are released, has become a high volatility day. So its a fact that employment is a market mover in the short term. But I strongly caution investors against putting too much weight on rising unemployment. The market is always forward looking, and may already be looking past ugly employment numbers.

Monday, April 07, 2008

Through the Bloomberg, credit spreads you will see

Credit Market Resources for non-bond investors

I've received several e-mails in recent weeks asking how one can follow goings on in the credit market if one is not a bond trader. Its true that it can be very difficult to follow bond spreads if you aren't active in corporate bonds. Dealer firms are loathe to give out information to non-customers, even to customers of a different department. After all, information arbitrage is the name of their game.

Anyway, here is a good place to start.

The CDX Index
The best place to follow general corporate bond spreads is by watching the CDX indices. The CDX is actually a series of credit default swap baskets. The two most important ones (in my opinion) are called "IG" for investment-grade, and "HY" for high-yield.

The indices are coded as follows: CDX.NA.IG.10, which stands for the North America, Investment Grade, index, 10th series.

Other versions of CDX include XO (cross-over), HVOL (high volatility IG names), HY (high yield), BB (BB-rated high-yield), B (B-rated high-yield), and EM (emerging markets).

Accessing the CDX: Non-Bloomberg Edition
The CDX is calculated by Markit, and is available here. You can click through the name of each index for graph of each index. I like to watch the spread, as opposed to the price, since the spread can be tracked as the indices roll over (i.e., there is a new series created every 6-months), whereas the price cannot.

The rolling over makes, it can be hard to follow over longer periods of time. For reference, the CDX.IG.9 was +139 and the HY.9 was +671 at the end of March.

You can find the names within the index by clicking the index name, then clicking "Constituents."

Markit only updates this daily, and it very late in the day by the time they actually do the updating.

Accessing the CDX: Bloomberg Edition
On Bloomberg, type GCDS

On the top left (the first drop down) select "CDS Indexes."

In the second drop down, immediately to the right, will be dozens of options, including all the CDX versions. This will show where the CDS are for each of the constituents.

If you want to see the index itself, select "Region, Sector, Rating" in the first box, skip over to the third box, and go all the way down to #38 (you'll have to hit Page Down) "CDX Indices." That will give you the level on the index itself. On the far right, you'll see check boxes, which allows you to run the graph on as many or as few of the indices as you like.

Bloomberg does update this page intra-day.

By the way, GCDS is a great way to watch CDS levels on various bonds, but beware. Bloomberg isn't necessarily accurate down to the last 5bps on CDS levels, especially for fast-moving names. For bonds which are trading with points-up-front, forget it. Bloomberg doesn't seem to understand those bonds at all. But broadly speaking, it gets the direction right.

Hope this helps.

Friday, April 04, 2008

They're digging in the wrong place!

I'm shocked by the bond markets initial reaction to the non-farm payroll report. As I write this the 10-year is up about 1/8 and the 2-year is flat. I would have guessed the 10-year to jump 1/2 a point given the NFP result. I'd also have expected a steepener, not a flattener.

Meanwhile stock futures are holding in OK, mildly positive.

Personally I've always felt that NFP was an over-rated statistic. Job growth is a well-known lagging indicator, whereas investment markets tend to be forward indicators. So as an investor, you'd think the NFP number isn't very useful. Despite this, the market continues to put a high value on the release, so you're left with little choice but to follow it closely yourself.

The way I handle it is to ignore jobs figures when thinking about longer-term moves, but when timing your moves, you can't ignore the first Friday of the month.

Anyway, credit spreads continue to move tighter. The CDX was in 9bps over night. I suppose that's the bigger deal, and that's why the Treasury market isn't able to move higher, at least at the outset.

If Treasuries were to finish lower today, I think that would be a very bearish signal for rates.

Thursday, April 03, 2008

What a strange person!

I'm getting some weird messages over my Bloomberg. There are words and phrases I cannot translate like, "I have buyers of corporate bonds" and "Broker paper on fire." What is this "rally" you speak of?

Don't get me wrong, one week does not a bottom make. But as evidenced by the relatively attractive terms Lehman was able to get on their convertible preferred, things do seem like they are thawing. There are real money buyers of credit starting to emerge.

Anyway, as much as I'd like to believe in a bottom in credits, we need to get through mid April with some strength. April is going to be a key month for bank/finance earnings (translation, writedowns) Here are some earnings dates to mark on your calendar. Remember that these firms are reporting for the quarter ending 3/31, which includes the ugliness of January and March, but not November.

April 15: Washington Mutual. The weakest of the big retail banks. I think they need to post a reasonable increase in their loss reserve or the market is going to punish them. They obviously have a weak portfolio of loans, and they need to convince us that they are being proactive about it. A small increase in loss reserve would come off like they're trying to fake their way through. Clearly not what the market wants to see.

Edit 4/8: WaMu basically pre-announced their earnings along with their new capital plan on 4/8.

April 17: Merrill Lynch. With 3 of their biggest competitors posting relatively strong earnings, the bar is set a little higher for MER. There are whispers that MER has more writedowns to post.

April 18: Citigroup, Bank of America, Wachovia. This should give us some interesting information on how prime loans are performing. It may also shed some light on the CFC/BAC deal.

Edit 4/8: BAC will announce 4/21

April 22: National City, SLM Corp. NCC is kind of like a smaller Washington Mutual. The difference is that WaMu is mostly west coast, where unemployment is low but the housing market bubble burst is hitting hardest. Nat City is more rust belt, where unemployment is high, but the housing market never got as hot. If WaMu's numbers impress the market, it might not matter much what Nat City does, at least from a bigger picture perspective.

Edit 4/8: SLM will announce 4/16 after market.

April 24: iStar Financial. Not a company on many people's radar, but its one of the biggest monoline commercial real estate lenders. They have a very large portfolio of condo developments, so their performance will be a good indicator as to how far the contagion has spread into commercial real estate.

Edit 4/8: SFI will report 5/2.

This is going to be a critical month.

Tuesday, April 01, 2008

April Fool's Rally

You can all see that stocks are moving higher. I'm also hearing that there are real money bids for IG corporates. Treasuries are getting crushed.

MBS are about 8bps tighter, with Fannie Mae 6% MBS outperforming the 5-year Treasury by 1/2 point.

Lehman paper is also gapping tighter, after they raised $4 billion in capital in a convertible preferred deal. The terms are being viewed as favorable, with a 7.25% coupon and a convert price of $49.87. It looks like senior bonds are about 50bps tighter today, and 200bps tighter than the day of the Bear bailout.

Less heralded was MGIC raising capital at surprisingly attractive terms. I thought a mortgage insurer would have had to pay through the nose, but all in all, 9% and a 20% convert premium isn't too terrible. Contrast that with what Citi paid ADIA: 11% and no conversion premium.

I've lowered my portfolio duration, and am likely to lower it further in coming days. I'm also not sure the Fed has more than 25bps in cuts left, and once they stop cutting, I expect a V-shaped move in short-term rates. More discussion to come.