Closing Comments September 15 2008

Prices of Treasury coupon securities exploded higher today as fears of financial Armageddon gripped investors around the globe. The bankruptcy of Lehman Brothers and the melting of equity value at AIG prompted a flight to the safety of government securities.The yield on the 2 year note has tumbled an incredible 45 basis points and rests at 1.75 percent. The yield on the 5 year note dropped by 37 basis points to 2.57 percent. The yield on the benchmark 10 year note has dropped 27 basis points to 3.45 percent. The yield on the Long Bond fell 19 basis points to 4.12 percent which puts it within shouting distance of the all time low yield of 4.10 percent attained in the spring as Bear Stearns imploded.

The 2year/10 year spread has widened by 18 basis points and is 170 basis points.

The 2year/5 year/30 year butterfly has jumped to 77 basis points .Swap spreads are wider but have tightened dramatically from levels seen this morning when spreads were wider by a dozen basis points or so. The 2 year spread has widened by 6 basis points and the 5 year spread is wider by about 3 basis points. Spreads in the 10 year sector are unchanged.

Why did spreads recover? One derivative salesman noted that many investors who had received in swaps from Lehman had unwound that risk and now had to receive anew to reestablish the position. Given the state of the market, those who had paid were content to mail a check to Lehman and then take their time about reestablishing that position.

Mortgages have lagged swap spreads by 12/32.

The Federal Funds Rate was a real sticking point today and it took $70 billion of intervention by the Federal Reserve to force the rate lower. Some of the stickiness of the funds rate would derive from the corporate tax payment date which typically drains reserves from the system. Today was also the settlement date for the reopened 10 year note and that would add to the upward glide of the funds rate.

None of that, however, can explain a 6 percent rate and the need for a $70 billion liquidity injection to get the rate back to the 2 percent target. The only logical explanation is that the high funds rate is a manifestation of the highly attenuated state of the markets and the reluctance of banks to lend to one another. It is called fear, I believe.

The IG 10 is closing today at 192 ½ after closing at 151 on Friday.

Agency spreads were wider by 7 basis points to 10 basis points between 2 years and 10 years.

Tonight should be interesting as Tokyo and Hong Kong were closed last night.


Originally published at Across the Curve and reproduced here with the author’s permission.