Nothing Is Better Than Something

The Fed stirred up market festivity,
In spite of low business activity,
From the joy that relates
To their keeping the rates
At zero, as is their proclivity.

With rates so depressingly low,
Fixed income has nowhere to go
So the stock market beckons
To each one who reckons
The chance that their nest egg may grow. 

It highlights how hard to discern it is
To know when the bond market's turn it is,
But with rates to be found
At the null lower bound,
The Dow lacks investment alternatives.

Doves & Hawks Together

Thoughts diverge in the FOMC
On how long to hold on to QE,
But in case of deflation,
Without hesitation,
They'll ease up unanimously.

Market Correlation

Some analysts set about crunchin'
A proven statistical function
For why stocks and debt,
Which used to offset,
More recently move in conjunction.

At the end of it all they succeeded,
Having crunched all the data they needed,
Finding no other fact
So truthfully tracked
As expected expanse of QE did.

Inflated Expectations

The specter of higher inflation
Makes investors want more compensation,
Thus driving up yields,
While prices of deals
Will fall, in an inverse relation.

The longer the stated maturity
Of a given fixed-income security,
Then all the more great
The effect of the rate,
As the market may show us with surety.

Bond prices tend to be countercyclical with stock prices and the economy as a whole.  In good times, or when inflation is elevated (or when both happen at once), bond prices tend to fall because rates are rising.  In bad times, or when investors show aversion to risk, there is a "flight to safety" that pushes them into bonds, driving up the price - and thus lowering the yield.  As The Wall Street Journal never fails to remind us: "Bond yields fall when prices rise." These dynamics were prominently on display in January, when 10-year bond prices fell 2.6% while the S&P 500 gained 5%.  In part, the bond selloff reflected more economic optimism and relief over the (partial) resolution of the fiscal cliff.  The higher yields also responded to awakening inflation anxiety, as the Fed's long-term inflation projection crossed over 3% for the first time in many moons.  Going forward, there is plenty for bond investors to feel anxious about - from the US debt ceiling to the eurozone - and little prospect for rapid economic growth, so inflation fears may not be driving rates any higher (and prices lower).

The Bonds That Divide Us

At the Fed, there are three schools of thought
On the bonds that Bernanke has bought:
A) keep on going,
B) begin slowing,
Or C) we would rather have not.

Minutes of the Federal Open Market Committee's December meeting were released on Thursday, and they reveal the divisions among the members on the Fed's policy of buying mortgage and Treasury bonds to stimulate the economy. Following that meeting, on December 12, the Fed announced that it would continue with the bond purchases until the pace of job creation improved. Yet, the minutes show that the "hawks" on the committee fundamentally disagreed with the entire program and, even among those who supported it, there was disagreement over its timeline. Those who wanted an open-ended monthly commitment to add $85 billion to the Fed's balance sheet were most concerned with allowing the stimulus to have its intended effect, while those who worried about the risk of adding so much to the Fed's own investment portfolio wanted to bring the program to a mid-2013 close.

However, Diane Swonk of Mesirow Financial tells the New York Times that "there’s still a huge bias toward buying." Any appearance of dissension, according to Ms. Swonk, reflects merely "modest misgivings in the middle of the most aggressive effort the Fed has ever undertaken to stimulate the economy."

Monetary Policy Shift

The Fed made a policy shift
To render employment a lift
By buying more bonds,
As liberals and cons
In Congress are "fiscally cliffed."

Said Bernanke: "This monetization,
Which we do without sparking inflation,
Will terminate when
I'm happy again
With the pace of employment creation."

He continued, dispensing liquidity
To the bankers within his vicinity:
"Let the buying commence
Without the pretense
Of an end-date to QE Infinity."

The Federal Reserve Open Market Committee ended its latest two-day meeting with a blockbuster announcement: Chairman Ben Bernanke and colleagues will keep interest rates super-low until the unemployment rate falls below 6.5%. It's the first time that an explicitly quantitative criterion has been publicly articulated for the setting of interest rates. According to the Fed's own labor market projections, we can therefore expect near-zero short-term rates until 2015. Mr. Bernanke expressed frustration with the slow pace of the recovery, as well as the additional roadblock created by the fiscal cliff. "If we could wave a magic wand and get unemployment down to 5% tomorrow, obviously we would do that," he said.

Message from the Fed

"To counter employment fragility,
We promote cheaper funding ability,
But investors who yearn
For a decent return
Must accept more default probability."

The Fed Open Market Committee announced the details of its latest stimulus program on Wednesday, and it's a doozy: under the 3rd round of quantitative easing, the Fed will purchase up to $40 billion a month of mortgage bonds and Treasuries, in addition to its $45 billion of monthly machinations under the Operation Twist program. This massive QE3 intervention is intended to lower long-term interest rates, as the Fed long ago did for short-term rates. Chairman Bernanke and colleagues hope to drive the 10-year T-note, currently yielding 1.75%, back to its July low of 1.38%.

For bond investors, all this rate compression inflames an already acute yield pressure. Those who want to earn an attractive yield must either shift into riskier bonds, or reduce their fixed income allocation in favor of stocks or other more volatile asset classes. As one CIO expressed it to the Wall Street Journal, retail investors "are practically walking around in a daze; they don't know what to do. There is no safe yield out there, so they are redefining what is safe, which is a dangerous thing to do."

One Bond to Ring Them All

A Eurobond's needed because
It's one of the euro zone's flaws
That investment was hot
Where the wanting was not
And decidedly cool where it was.

In his latest blog post on saving the euro zone, Reuters' Felix Salmon gets to the heart of the matter:

The solution to this problem is eurobonds. If all the eurozone countries funded themselves jointly and severally, then the yields on European government debt would be very low, and there would be no fiscal crisis in Spain.

As it is, the combination of a single currency and separate fiscal authorities encourages the flow of of government bond investment in the wrong place at the wrong time, if European stability is the desired outcome. Thus, says Felix, "Fund managers at French and German banks were busily moving funds into Spanish and Greek bonds a number of years ago in search of higher yields, and Spanish and Portuguese fund managers are now buying German and Dutch government bonds for added safety, all without incurring foreign exchange risk." It's as if the United States had no Treasury bonds, and all the public debt issue were at the state and local level. The question is: how long before Europe bows to the inevitable, and decides to go joint and several?

Reversal of Fortune, Part I

Said an equity trader named Corso:
"After last week, I certainly swore so
That the Dow was at pains
To give up its gains,
But this week it looks even more so."

The Dow Jones Industrial Average suffered its worst one-day drop for the year to date on Tuesday, falling 213.66 points, or 1.7%, to 12715.93. On the heels of a disappointing, holiday-shortened previous week, that made for a 4% decline over five trading days. After celebrating its best quarter in a decade, it's as if the market paused for reflection, looked around and didn't like what it saw. The Fed seemed to hint last week that no further stimulus would be forthcoming, and the European debt crisis heated up again on Tuesday, with rising Italian and Spanish bond rates reflecting renewed risk fears. Perhaps the rudest shock of all came from China, where we learned that sales of Caterpillar plunged 50% in March, casting doubt on both the company's prospects and the Chinese growth outlook.

Slow Week

Said a stock market man named O'Toole:
"Never trade in the week after Yule;
For liquidity's thin
When the traders aren't in,
Which, for now, is the general rule."

Discussion of stock market trading in the week between Christmas and New Year's invariably touches on the low market volume. For example, Tuesday's New York Stock Exchange volume, at two billion shares, was half the normal daily figure of 4.3 billion shares traded. This is caused not only by the fact that half of the market participants are on vacation, but also by the fact that most of them will have already "cleaned up" their balance sheets for year-end financial and regulatory reporting, and are loath to untidy them again. Interest rates for short-term funding over year-end can be volatile and expensive as well, another encouragement simply to take the week off.

Corzine's Congressional Testimony

"A billion-point-two, evidently,
Has failed to be found, accidentally;
Though we foundered, it's true,
When our funding withdrew,
Our finances were fine, fundamentally."

Ex-MF Global CEO Jon Corzine told the House Agriculture Committee that he was "devastated by the enormous impact on many people's lives" when the giant futures broker went bankrupt. In his first public appearance since the firm's collapse, Mr. Corzine expressed regret but not remorse. MF Global's failure was, in his view, precipitated not by his misjudgment in holding a $6.3 billion leveraged position in European bonds, but rather the market's sudden lack of confidence in in the firm's balance sheet. Regarding the notoriously missing $1.2 billion in MF Global customers' funds, Mr. Corzine testified: "I simply do not know where the money is."

Those M*F* Risk Controls

A risk manager, naturally prone
To deny an improvident loan,
Heard the boss say: "We're wishin'
To cut this position;
Not that of the loan, but your own."

The Wall Street Journal reports that the Chief Risk Officer of MF Global found himself out of a job after he questioned that firm's big bet on European bonds, arranged by CEO Jon Corzine (pictured). CRO Michael Roseman had argued that the "repo to maturity" trades - in essence, leveraged long bets on treasury bonds of Italy and other sovereigns - could endanger the firm's capital if markets went strongly against them. Both privately and in front of the MF Global board, Mr. Corzine had responded that Mr. Roseman's dire scenarios were unlikely or even impossible. Eventually, Mr. Corzine is said to have grown annoyed with the CRO's persistence; whatever the reason, Mr. Roseman soon found himself assisting in the transition to his successor. Of course, soon afterward, his impossibly dire scenarios came true and the firm was bankrupt.

Overheard Somewhere in Rome

"The euro zone debt crisis, gen'rally,
Is more easily overcome fed'rally,
If those on the Rhine
Would say "Ja" and not "Nein"
To issuance jointly and sev'rally."

As the European debt crisis drags on with no end in sight, some trial balloonists at the European Commission are set to come out with a paper that explores the potential of bonds issued or guaranteed by all of the 17 euro zone members. One immediate obstacle is the resolute opposition of the Germans, who fear liability for the debts of spendthrift neighbors such as Italy. However, combined euro zone debt issuance would carry much more weight in the market than the European Financial Stability Facility (EFSF), which does not appear up to the task of stabilizing the market for Italian treasury bonds.

Dim Sum Debt

The market for bonds in renminbi
Heretofore has been traded quite thinly,
Though it's possible, thanks
To the world's central banks,
For yuan to be all that it kin be.

The Wall Street Journal reports that bankers pushing for the development of the offshore market for yuan-denominated bonds - so-called "dim sum" bonds - have homed in on a new target group: central banks and sovereign wealth funds. The appeal to many such institutions may be the diversification of their foreign reserves away from US dollars. Though the current outstanding dim sum debt is a paltry CN¥198 billion ($31 billion), larger issues such as this past August's CN¥15 billion ($2.3 billion) notes of the Chinese Finance Ministry have begun to expand the market beyond small investors.

From Deep Pool to Bottomless Pit

When volume and confidence rise up,
Investors approvingly size up
The debt of a nation
In great circulation;
Less so when liquidity dries up.

Now that the Athenian contagion has spread to Rome, the thing that made Italy's sovereign debt so attractive - namely, the shear amount of it - has become a focal point for investor fears and issuer nightmares. At €1.9 trillion ($(2.6 trillion), Italy ranks behind only the USA, UK, Germany and France in the league table of sovereign debt. As the Wall Street Journal noted, big investors felt comfortable with Italian bonds, despite the country's 120% debt-to-GDP ratio, because they knew they could always sell their position. Suddenly, this is no longer true, and Rome must figure out how to roll over the next €300 million of maturing bonds, which the market now prices at over 7%.

MBS Q&A

Tell me how can we state with finality
When the mortgage bond crisis finale be?
When loans finish tanking
In ledgers of banking
To prices reflecting reality.  

Freddie Mac has inspired the foregoing Q and A with the news of its first quarterly profit in over 3 years. The $676 million profit stems from FHLMC's having arrested the slide in the collective value of the mortgages and foreclosed homes on its balance sheet, begging the question of whether the valuation is realistic, and whether it may yet fall further. As Freddie Mac CFO Ross Kari cautioned: "We're encouraged by the trends, [but] we're not putting up a 'mission accomplished' sign on the front of the building either."

Fed-Up Stock Market

Sinking rates was the Fed's one desire
In becoming a big T-note buyer;
Though for naught they did meddle
In bonds, they can settle
For driving stock indices higher.   



The Wall Street Journal's Ahead of the Tape columnist, Kelly Evans, notes that "QE2" (the second round of quantitative easing) failed in its goal of lowering long-term interest rates, but has been correlated with a 19% increase in the S&P 500 index since August.  Should we take stimulus any way we can get it?

Bond Vigilantes vs. the Tax Deal

Hitting federal finances adversely,
It caused T-bonds to tumble down tersely;
The effect on bond yield
Of this tax-cutting deal  
In relation to price, went inversely.

The tax rate compromises agreed upon between President Barack Obama and Congressional Republicans sparked a sell-off in the Treasury bond market.  Sellers, characterized as "bond vigilantes" for their willingness to call politicians to account, demanded higher yields for the perceived higher risk of a future US fiscal crisis.

Overheard at the Retirement Fund

"The mortgage-backed bonds in our pension,
A source of regret and contention,
May yet be unwound
If they're legally found
To have flouted the 'true sale' convention."

Hopes are awakening in the hearts of institutional investors that sloppy and even fraudulent practices in the origination and sale of mortgages to bond trusts may give investors legal grounds to put them back to the originating banks and thereby recoup some losses.

Opposites Don't Attract

Said an analyst, mulling a deal, 
"Fixed income is losing appeal; 
If inflation would grow 
Then prices would go 
In the other direction from yield."