Wednesday, January 28, 2009

Bonds extend declines after Fed

Government debt prices extended declines Wednesday after the Federal Reserve said it is prepared to buy long term Treasurys but did not offer the specific details that many investors were looking for.

The U.S. central bank kept its benchmark target rate in a range between 0% and 0.25%, citing credit conditions that are expected to "remain extremely tight." The Fed also said it is "prepared to purchase longer-term Treasury securities" if necessary.

But the market was expecting the Fed to make a stronger statement on its plans to buy long-term Treasurys, said Kevin Giddis, managing director of fixed income Morgan Keegan.

Wednesday's selling "is mostly about the Fed not saying when they would start buying, if they were to start buying," Giddis said. The market was "counting on language that wasn't exactly there," he added.

Prices for longer-term bonds fell sharply as investors who had flocked to the 30-year note in anticipation of a more clear signal from the Fed rushed to unwind those positions, Giddis said.

Treasury prices came off their lows immediately after the announcement. But prices resumed their decline as investors focused on a major influx of supply expected to keep hitting the market.

Record-breaking auctions: The Treasury is scheduled to auction $135 billion worth of debt this week, on top of the $120 billion worth of debt brought to market last week.

Investors have been paying particular attention to the debt auctions recently as a way to measure demand.

On Thursday, the Treasury is scheduled to sell a record $30 billion worth of 5-year notes.

"Everybody is watching those new auctions to see whether past investor interest in buying those securities remains strong," said Michael Herbst, mutual fund analyst at Morningstar.

On Tuesday, the government auctioned a record $40 billion worth of 2-year notes. But prices rose because the bid-to-cover ratio for the auction was 2.69, meaning there was over $100 billion worth of bidders for $40 billion of debt. Even with the tremendous supply of debt, there is still healthy demand.

The government also auctioned $32 billion worth of 28-day bills Tuesday. On Monday, the government auctioned $29 billion worth of 13-week bills, $28 billion worth of 26-week bills, and $8 billion worth of 20-year TIPS (Treasury Inflation-Protected Securities).

Stimulus and supply: President Obama and House Democrats have come up with a stimulus package for the economy focused on job creation through rebuilding the nation's infrastructure. The $825 billion package, which includes $550 billion in spending and $275 billion in tax cuts, will be voted on by the House of Representatives later on Wednesday.

"There has been so much issuance of Treasurys lately to finance the bailout activity and indications seem to point to that there is more issuance to come," said Herbst. "How that impacts the purchasing of Treasurys is something that the market is looking for more clarity on."

The threat of such massive torrents of supply has already lifted yields significantly since December. At the end of 2008, the 30-year traded above 140 and its yield reached down toward 2.50%. The yield on the 30-year longbond was near 3.25% Wednesday.

"The supply dynamic is a massive issue that will have to be dealt with in 2009," said Brian Edmonds, head of interest rate trading at Cantor Fitzgerald.

Debt prices: The 10-year benchmark Treasury edged 2/32 lower to 109-24/32 and its yield rose to 2.6% from 2.53% late Tuesday. Bond prices and yields move in opposite directions.

The 2-year note, meanwhile, was 6/32 lower at 99-28/32 and its yield rose to 0.91% from 0.81%.

The yield on the 3-month note jumped to 0.19% from 0.14% late Tuesday. The 3-month bill has been used as a gauge of confidence in the marketplace because investors tend to shuffle funds in and out of the bill as they assess risk in other places - the lower the yield, the more risk they see.

Meanwhile, the 30-year bond fell 2-4/32 to 121-15/32 and its yield rose to 3.34% from 3.23%.

Conventional home mortgage rates move in close connection to the yields on the long-term Treasury maturities. When Treasury prices hit record highs and yields sunk to record lows at the end of 2008, mortgage rates sunk. Lower mortgage rates help stimulate the housing sector. As government debt yields rally, so have mortgage rates.

"More drastic efforts will be necessary to stabilize the housing market and one key part of that is to bring mortgage rates down to encourage buyers to buy a house and enter into new mortgages," said Herbst.

Lending rates: The 3-month Libor rate edged slightly lower to 1.17% from 1.18% Tuesday, according to data on The overnight Libor rate, meanwhile, held steady at 0.22%, even with Tuesday.

Libor, the London Interbank Offered Rate, is a daily average of rates that 16 different banks charge each other to lend money in London, and it is used to calculate adjustable-rate mortgages. More than $350 billion in assets are tied to Libor.

Two credit market gauges were mixed. The so-called "TED" spread narrowed to 0.98 percentage point from 1.04 percentage points Tuesday. The bigger the TED spread, the less willing investors are to take risks.

The rate surged as the credit crisis gripped the economy, but has since fallen off as central banks around the world have lowered interest rates and pumped the economy with liquidity.

Another market indicator, the Libor-OIS spread, was unchanged from Tuesday at 0.95 percentage point. The Libor-OIS spread measures how much cash is available for lending between banks, and is used for determining lending rates. The bigger the spread, the less cash is available for lending.

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