Fixed Income Economics
April 7, 2009 Provided by MF Global
Treasury Market Commentary
Treasuries (at least nominals) posted moderate gains Tuesday in another day of sluggish trading, with another pullback in stocks providing support against the week’s heavy supply. The first round of supply was a weak 10-year TIPS reopening Tuesday, and while this pounded the TIPS sector after Monday’s strangely strong performance, the spillover to nominal Treasuries was minimal, though it remains to be seen how much of a bid the market can sustain as we move next to the 3-year auction Wednesday and 10-year auction Thursday. Even with the stable to (at the front end) modestly stronger market tone over the past couple days, this week’s issuance does seem to be preventing Treasuries from showing more substantial upside in response to the stock and other risk market softness. At least this has been suggested by a much better showing by mortgages over the past couple days (though not by a widening in swap spreads), with a solid rally Tuesday that again well outpaced Treasuries. Meanwhile, as we move into the beginning of earnings reporting season for the first quarter, it’s starting to look as if we might be on the verge of a repeat of what happened in January, when a strong stock market rebound off the November lows was reversed by the harsh reality of a dismal run of earnings reports for Q4.
At 3:00, benchmark yields were 3 to 5 bp lower, with the 3-year slightly outperforming ahead of Wednesday’s auction, a pattern seen to a much greater extent in 10-year TIPS Monday that did not work out well at the auction. The 2-year yield fell 3 bp to 0.92%, 3-year 5 bp to 1.32%, 5-year 4 bp to 1.86%, 7-year 4 bp to 2.50%, 10-year 3 bp to 2.91%, and 30-year 3 bp to 3.73%. After posting small gains Monday as Treasuries mostly sold off, mortgages did quite well again Monday, with 4% MBS rallying about a third of a point to again easily outpace Treasuries and continue to reverse some of the weakness this sector posted last week as the belly of the Treasury curve took a substantial hit. Tuesday’s further gains lifted 4% mortgages back somewhat a bit above par, thus lowering yields slightly back below 4% and reversing the majority of last week’s sell off to leave yields not too far from the three-month lows hit a week ago. Agencies also outperformed again even with more supply also coming in this sector, with a $6 billion 2-year scheduled to price Wednesday. The 10-year TIPS reopening was weak, with Monday’s weird substantial outperformance by TIPS even with the auction looming and commodity prices falling certainly not helping. The $6 billion issue, bringing the total size to $14 billion, was awarded at 1.589%, 3 bp higher than pre-auction levels even after a substantial cheapening into the auction relative to Monday’s 1.49% close (and stronger opening levels) while nominals were rallying. The overall bid/cover was respectable at 2.25 but only because of solid dealer demand. Participation by final investors was unusually light. Only 26.1% of the competitively awarded amount went to indirect bidders, a two-year low for 10-year TIPS and far below the long-term average of 42%. Note that unlike for nominal auctions, historically there hasn’t been much difference on average between indirect bidding at new issue and reopening auctions for TIPS. Even though the 10-year TIPS never actually traded as weak as the auction award, TIPS underperformance on the day was still substantial, with the 5-year yield up 4 bp to 0.91%, 10-year 8 bp to 1.56%, and 20-year 1 bp to 2.20%. This took the benchmark 10-year inflation breakeven down 11 bp to 1.35% after Monday’s 5 bp increase, but this is still not too far from the highs seen since last fall.
A pullback in stocks again helped support Treasuries against supply pressures, with the S&P 500 moving down another 2.4%. In contrast to the past two day’s equity weakness, credit continued to hold little changed, with the investment grade CDX index holding near 189 bp in late trading for a third straight day and the high yield also flat after barely moving Monday. Meanwhile the assets most directly impacted by the Treasury’s bad bank plans continued their recent weakness. The steady meltdown in the subprime ABX market continued, with the AAA index falling a half point to a new record low of 23.13. And while at least the highest rated portion of the CMBX market remains a good ways from all-time wides and is still net stronger since the Treasury’s plan was announced last month, Tuesday’s losses were more pronounced than those seen in the previously more badly struggling ABX market. The AAA CMBX index widened 45 bp to 622 bp, still 125 bp better than the close on March 20 before the Treasury’s plan was launched, but up nearly 100 bp from the tights seen a couple weeks ago. On the other hand, the lower rated portions of this market have done far worse recently and took major losses Tuesday. Indeed, the junior AAA, AA, A, BBB, BBB-, and BB CMBX indices all gapped to all-time wides at the day’s close. For some reason the carnage in the BBB and BBB- indices has been particularly severe this week, with the former having widened 445 bp the past two days to 6263 bp and the latter 581 bp to 6750 bp.
We released our monthly economic forecast update Tuesday, but changes were very minor this month. We continue to see real GDP declining 3.3% in 2009 on a calendar year basis and 2.3% on a Q4/Q4 basis. The slightly weaker trajectory we now see for Q1 growth (-6.0% v. -5.5% a month ago) is mostly in inventories, which we now see knocking two and half points off Q1 growth, suggesting little if any additional drag in Q2 even if in absolute terms inventories continue to be liquidated at a rapid pace to try to keep pace with the plunge in demand. As a result, we offset the modest downside we now see in Q1 versus a month ago with a slightly less negative -3.5% estimate for Q2, up from -4.0% last month. We continue to see the economy shrinking a much more mild 1.0% in Q3 and then posting a very sluggish recovery starting in Q4, with GDP in the five quarters through the end of 2010 expected to expand at a 2.9% annual rate, which would be an extremely weak rebound from what is shaping up to be the longest and deepest post-war recession. Recent policy actions have upped the ante on fighting recession and deflation risks, but fiscal stimulus and QE won’t get substantial traction until there is more progress in restarting the securitization markets and in fixing the banking sector — and that progress will take time. While it appears that the most intense phase of the recession has ended as we move past the Q4/Q1 meltdown, we think the ongoing credit crunch will stymie pent-up demand and prevent anything approaching a V-shaped recovery. We do think that fiscal stimulus, repair of the financial system, and monetary ease will help to promote positive U.S. growth late in 2009 and sustainable, if mild, recovery starting in 2010. But the key to policy traction lies in breaking the credit crunch, with sequencing flowing from funding to credit markets, and progress here remains limited so far. See the note “U.S. Economics: Aggressive Policy Counters Still Strong Headwinds” by Richard Berner and David Greenlaw for details.
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