How Much Has the Fed Lost?
We spent much of yesterday looking at the potential for 3% on the 10-year Treasury and the Fed’s treasury position.
For those of you who asked the Fed had lost $105 billion on the $1.6 trillion on the bonds they owned in early March. Since the 10 -ear was about 2% back then and the Fed added another $300 billion of bonds since then, almost all at lower yields, the mark to market loss since early March has to be close to $125 billion. Not that it matters as the Fed isn’t mark to market, but probably a good indication of why we will see reduced purchases soon, and why actual selling is a long way from happening.
Have Treasury Yields Peaked?
We don’t think so. We are still looking for the 10-year to take a run at 3% and spike through it as all the red flashing headlines hit the tape. Ultimately we will be buyers on the back of that, but we are growing a little concerned that we may already have peaked.
10year Treasury Intraday Yields
We had every excuse we could have wanted to reach new highs yesterday.
Stock futures were up nicely on what seemed like a reduced probability of Syrian airstrikes.
PMI came in a bit under expectations but still at 53.1. Then we saw Construction Spending report a nice beat and a big upward revision to the prior month. Then ISM came in with a big beat. 55.7 was better than expectations and even beat the prior month. The ISM Prices Paid also came in relatively high at 54. Possible signs of inflationary pressures?
So with all that, Treasuries didn’t breach the level hit back on August 23rd which didn’t breach the level set on August 22nd.
It makes me nervous that treasuries had every excuse in the book to sell off but didn’t really capitulate. Yes, it was more on Syria that caused Treasuries to rebound, but the market seemed to trade shorter than I would have liked.
So while keeping our call for higher yields on that brief spike, we are getting more nervous that it is a very crowded trade and that the next gap could be down to 2.5%. We will need some evidence that the economy is slowing for that too happen.
Have Credit Spreads Peaked?
Here we offer a more definitive view. No. Credit Spreads haven’t spiked, particularly CDS spreads.
IG20 CDX
For now we won’t focus on the abysmal volumes that we’ve seen in the CDX indices. There were a few days in August where there was greater volume in the High Yield ETF’s than in the HY CDX. That validates our belief that more and more institutional investors are hedging with the ETFs as they feel it better matches their portfolio. On an average day the HY CDS volumes are still much higher but we expect that gap to continue to narrow over time.
We will focus on the fact that we are roughly at the mid-point of IG20’s price range. We saw it spike above 95 back in June but so far it has struggled to go above 85. We think it will breach that (which was our original target when it was below 80) and will break 90.
Our reasoning is pretty simple:
• Higher Treasury yields put pressure on corporate bonds in this environment, putting pressure on credit spreads (even when stocks do well)
• Stocks have been weak and continue to remain weak
• No one wants to sell a bond. Those selling bonds still expect to buy them back and they know what a pain that can be. So CDS will be the victim of choice.
• Bank hedging desks may not be buying protection but they seem to be done selling protection for now
• The roll is coming up. Many are reluctant to buy ahead of the roll. I think that is why the market isn’t already higher and why I believe it is still under hedged.
So being short IG CDS remains a good trade.