February 2008 Archives

I never realized that almost all the major Investment Banks in Tokyo are located in three locations, 1) Marunouchi/Otemachi/Nihonbashi (Chiyoda/Chuo), 2) Akasaka/Roppongi/Toranomon (Minato), and 3) a patch of Roppongi slightly farther away. 

And for some reason Morgan Stanley is in Ebisu.. hmm don't ask me.

InvestmentBanks.bmp

USD Treasury Curve Steepening... Further steepening?

 Historical Treasury Yields

Graph: treasuryyields20080222.bmp  - Data: TYDs.xls

Source:http://www.treas.gov/offices/domestic-finance/debt-management/interest-rate/yield_historical_main.shtml

 

  20080220 FT - Dealers keep the faith about their sure-bet trade in US Treasury debt.pdf

Dealers keep the faith about their sure-bet trade in US Treasury debt
By Michael Mackenzie in New York
Published: February 20 2008 02:00 | Last updated: February 20 2008 02:00

The sure-bet trade in the US Treasury bond market this year has involved owning the two-year note and selling long-term debt.

Like all popular strategies that enjoy profitable runs, the yield curve steepening trade is a hot topic for debate among traders, analysts and investors.

In terms of momentum, the trade could suffer as some investors begin to take profits, however the mood among many dealers remains overwhelming bullish on a still steeper curve.

Since the start of the year the difference in two-, and 10-year Treasury note yields has risen from 0.98 percentage points, or 98 basis points, to a recent peak of about 190bp. This represents the steepest difference in the benchmark curve since the summer of 2004.

"Without exception, there is a lot of talk about the steepening trade among dealers," says Michael Kastner, portfolio manager at SterlingStamos. "They are all saying the curve has more room to steepen."

Some dealers such as Tom di Galoma, head of Treasury trading at Jefferies & Co, expect the curve will steepen towards 210bp and 220bp.

The drivers of the yield curve are the different dynamics that underpin how investors value short- and long-term Treasury debt.

The two-year note is largely influenced by expectations of the Federal Reserve's interest rate policy.

Interest-rate futures reflect a Fed funds rate of about 2 per cent in the coming months and the yield on the two-year note is at 1.99 per cent.

If the spreading credit crunch prevents a rebound in the economy, the prospect of rate cuts below 2 per cent will grow, resulting in further steepening of the curve, traders say.

When investors look at the 10-year note and the 30-year bond, value is driven by expectations of future inflation, as rising prices over time erode the fixed returns of a bond.

Recently, the steepening trend has been driven by rising long-term yields, while the two-year note has remained anchored about the 2 per cent mark. This is a change from when the curve began its

steepening run last year, which saw yields fall across the market but the two-year note's yields falling faster than others.

Now, the investors who expect a steeper curve are focused on long-term rates and the prospect of persistent inflation leading to interest rate rises in the future.

"The front end is locked down," said Dominc Konstam, head of interest rate strategy at Credit Suisse.

"The steepener trade is a bearish view on the back end, due to worries about inflation."

The prospect of a recovery in the economy thanks to interest rate cuts and fiscal measures, which will also boost the supply of Treasury debt this year, makes shunning long-term Treasuries a logical choice say traders. Inflation expectations have been rising, but they remain below peaks set two years ago.

Further ammunition for selling long-dated bonds comes from the Pension Benefit Guaranty Corporation, which insures US pensions. It plans to reduce its holdings of bonds from 72 per cent of its portfolio to 45 per cent, a move that could result in some $15bn of long-dated sales, say traders.

"It's a negative for the market, but there has been talk that this was coming," says Mr di Galoma.

That may explain why the yield on the 30-year bond has risen towards 4.70 per cent from a record low of 4.10 per cent last month.

The yield on the 10-year note has neared 3.90 per cent, up from 3.40 per cent in late January.

At present levels, however long-term yields are starting to look attractive and with the two-year anchored, the curve could flatten back towards 150bp, says Mr Kastner.

Copyright The Financial Times Limited 2008

20080220 FT - Americas economy risks the mother of all meltdowns.pdf

Mentioned in article:
Nouriel Roubini | Jul 17, 2006: A Coming Recession in the U.S. Economy?
Certainly There is Now a Much Higher Risk of One...
http://www.rgemonitor.com/blog/roubini/136692

Nouriel Roubini | Feb 08, 2008: Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not.
http://www.rgemonitor.com/blog/roubini/242906

FT REPORT - FUND MANAGEMENT: The world of municipals and Mr Buffett
By Gary Vaughan-Smith
Published: Feb 04, 2008

Berkshire Hathaway's recent entry into the obscure world of municipal bond insurance raises an interesting question: what has attracted Warren Buffett to this business area?

To answer this, one needs to understand the perverse way rating agencies systematically
under-rate municipals. Their bizarre approach has resulted in municipals, for which read
taxpayers, paying up billions of dollars each year for insurance they do not need. And this has been going on for more than three decades.

The important point to understand is that a credit rating will mean something different for
different types of borrowers. When a rating agency rates a municipal single-A, that does not
imply the same default risk as a corporate or collateralised debt obligation that is also rated
single-A.

To take an example, a study by Standard & Poor's showed the 10-year cumulative default rate on single-A rated municipals was 0.04 per cent; on corporates it was 1.8 per cent; and on CDOs it was 2.7 per cent. In fact, this low default rate for single-A rated municipals was even better than that of corporate triple-A rated bonds, which recorded a rate of 0.44 per cent.

Additionally, when municipal bonds default the expected recovery rate is 90 per cent compared with 50 per cent on corporate bonds. Moody's, in a recent study, said if states were evaluated in the same way as corporates, 49 of them would be rated triple-A.

How about municipal bonds rated non-investment grade or "speculative" by the rating agencies (that's "junk" to you or I)? Taking BB bonds as an example, the Standard & Poor's study showed the cumulative default rate for these bonds was 1.35 per cent, better than those "investment grade" single-A rated corporate bonds. Looking at it another way, the cumulative default rate for corporate BB bonds was about 18 per cent, nearly 13 times higher than the municipals with the same rating.

Confused? So are we.

The rating agencies long ago abandoned the principle of rating a bond by its risk irrespective of who the issuer is. It is unclear why rating agencies have systematically under-rated municipals but one fact is clear: municipals do not pay as much as corporates to get a rating. And corporates, in turn, do not pay as much as CDOs. The more you pay, it seems, the better your credit rating.

Of course, once the municipals have been given the discounted rating, the next step is to
persuade them to buy insurance to lift their rating to triple-A.

Step forward the monoline credit insurers. And why not? Selling insurance to people who do not need it has to be a great business. Here's the pitch: "You're a municipal that should be rated triple-A but the rating agencies have given you a single-A rating. Don't worry, pay us an insurance premium and we will insure your bond to be triple-A. Our balance sheet? We have
net assets less than 1 per cent of the amount that we have already insured. But don't worry,
hopefully our other clients didn't need the insurance either."

And it is a decent-size insurance segment as well. About half the $2,500bn (£1,257bn,
€1,684bn) municipal bond market is insured and the insurance premiums are, conservatively, in the $2bn-$3bn per annum range. That's $2bn-$3bn of taxpayer money.

For some municipals, credit insurance makes sense. It may help them in their fund-raising and may work out cheaper overall than issuing the bond without the insurance. On the other hand, it is hard to escape the feeling that municipals, hospitals and schools are overpaying for this insurance because of they are rated.

The rating agencies are under some scrutiny for their role in the subprime mess. We would expect their treatment of municipals to also come under the harsh glare of public scrutiny. We would also guess Berkshire Hathaway's business plan growth assumptions will be difficult to meet as municipals wise up to this waste of taxpayers' money.

Gary Vaughan-Smith is chief executive of SilverStreet Capital
Copyright The Financial Times Limited 2008

Here's another one, a bit more in depth about the direction of trade processing of OTC Derivatives, and the more or less direction towards consolidation...

"The challenge to automate processing has caused a proliferation of specialist service vendors, but now banking consortiums are pushing for consolidation. Markit Group is one result of efforts to establish transparent, efficient and independent service providers, writes James Norris"

20080201 GIM - Market Pushes For Consolidation.pdf