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Paris, Friday, February 4, 2000 U.S. Bond Market Is Unsettled By Scramble for 30-Year Issues
---------------------------------------------------------------------- ---------- By Mitchell Martin International Herald Tribune
LINK: http://www.iht.com/IHT/TODAY/FRI/FIN/yield.2.html ---------------------------------------------------------------------- ---------- NEW YORK - A buying frenzy for long-term Treasury bonds erupted Thursday, unsettling financial markets even as it drove down interest rates. The New York Federal Reserve Bank took the unusual step of denying rumors it was arranging an emergency meeting to discuss losses at a bank or a hedge fund, reminiscent of its 1998 role in rescuing Long- Term Capital Management LP, whose liquidity crisis threatened global financial stability.
The hyperactive demand for long-term Treasury bonds ''caught the vast majority of market players positioned the wrong way,'' said Ward McCarthy, managing director at Stone & McCarthy in Princeton, New Jersey. The Federal Reserve Board has been raising interest rates, he noted, and in such an environment bonds issued by corporations and government agencies tend to outperform Treasury issues.
The catalyst for the unusual market activity was the Treasury's announcement on Wednesday that it would reduce sales of its 30-year bond, the benchmark for global credit markets since regular issuance began in 1977.
Although the general plan had been known, President Bill Clinton's announcement last month that all the publicly held Treasury bonds could be paid off in 2013, two years earlier than had been expected, combined with the financing details released on Wednesday to ignite investor demand for long-term government issues.
The 30-year Treasury bond rose by more than a point and a half, pushing its yield down to 6.15 percent from 6.30 percent late Wednesday and a recent closing high of 6.74 percent on Jan. 18.
Investor demand for long-term bonds exacerbated what is called a yield-curve inversion. The yield curve (it is actually more of a diagonal line) usually slopes upward: Short-term bonds have lower interest rates than long-term bonds, which must pay investors a premium to offset the risk that inflation will reduce their value over time.
On Thursday, however, the 30-year yield was below other active maturities, all of which had lower yields on the day. For example, five-year bonds were yielding 6.52 percent, and 10-year issues offered 6.45 percent.
Mr. McCarthy said it was the first time the curve had inverted because short-term rates were rising and long-term rates were falling. In prior inversions, which are rare, rates would be moving the same way but more dramatically at one end of the yield curve than the other. An inversion has historically meant investors were betting interest rates would fall, but the current pattern at least in part reflects the scarcity value of long-term issues.
Although other kinds of bonds generally rose in price Thursday, their gains were not as sharp as those of Treasury bonds. This led to wider differentials in yields. These yield spreads are important to dealers and investors, notably hedge funds, who sometimes base trading strategies upon them.
Improper hedges involving Russian bonds were said to be the root of the problems at Long-Term Capital Management that caused worldwide tensions and led the Fed to reduce interest rates in the autumn of 1998.
Last year, it recouped its three quarter-point short-term rate cuts, and on Wednesday it added another quarter-point increase to try to limit economic growth to levels at which demand for goods and services would not exceed their supply.
Underscoring the strength of the U.S. economy, which grew 4 percent or more in each of the past three years - above the 3 percent to 3.5 percent that economists have said is probably its limit for noninflationary expansion - the Commerce Department said Thursday that factory orders surged a greater-than expected 3.3 percent in December, bringing the 1999 increase to 6 percent.
If factories are unable to keep up with their orders, buyers can be expected to raise the prices they would pay for goods they need, a clear case of inflation.
Mr. McCarthy said the long-term bonds were not trading according to economic fundamentals but on a basis of supply and demand. ''There are natural investors for this sector who need to buy long-term debt, insurance companies probably being the most obvious case.''
This kind of trading, he said, was reminiscent of Internet stocks, which also trade based more on how much people want to own them than on fundamental considerations such as earnings.
Internet and other high-technology stocks did well Thursday, at least in part because the Fed's plans to slow economic growth will have less effect on the Internet than on other sectors of the economy.
Intel, Oracle, Microsoft and Cisco, all Internet-related, were among the active gainers.
The Nasdaq composite index, which is dominated by technology issues, closed up 137.06 points, or 3.4 percent, just shy of a record at 4,211.02, while the Dow Jones industrial average rose 10.24 points to 11,013.44.
-- Bill P (firstname.lastname@example.org), February 04, 2000.
US Treasuries turmoil forces change on MBS investors By Aleksandrs Rozens
NEW YORK, Feb 3 (Reuters) - A dramatic inversion in the U.S. Treasury yield curve has decoupled mortgage-backed securities (MBS) from the government debt market and promises to change the way investors value and hedge positions.
Dealers said they are relying more on the London Interbank Offered Rate (LIBOR), a lending rate among banks, when valuing mortgage debt rather than using Treasuries.
For hedging purposes, MBS investors said they also are being forced to rely more on agency debt, swaps or other mortgage products.
These changes are driven by the distortions to the usually upward- sloping U.S. Treasury yield curve, which has flipped to an inverted curve since the government announced its debt buyback program.
This yield curve inversion has contributed to MBS spreads widening sharply over the past two weeks. The current coupon for mortgage- backed issues is 156 basis points over the 10-year Treasury note, up 34 basis points from Jan. 21, according to Art Frank, head of mortgage research at Nomura Securities International Inc.
Stunning moves in Treasury prices on Thursday, particularly the long- end of the curve, made it difficult for investors to hedge their mortgage debt, participants said.
``The Treasury curve has been very seriously distorted by the Treasury buyback and investor reaction to the Treasury buyback,'' Frank said.
Thursday, U.S. MBS prices saw gains of as much as 12/32. But in the Treasury mart, the 30-year bond was up 49/32 at 99 12/32 to yield 6.17 percent and the 10-year note was up 19/32 at 96 18/32 to yield 6.49 percent.
According to Ken Hackel, head of mortgage research at Merrill Lynch & Co. Inc., the mortgage market's decoupling from U.S. Treasuries has occurred on occasions such as the financial crisis of fourth quarter of 1998.
At that time, the spread ballooned to 195 basis points over comparable Treasuries.
And, since news of the buyback circulated in recent weeks, this decoupling has returned.
Hackel explained that MBS investors can hedge one of three ways: short Treasuries against mortgage-backed portfolios, use interest rate swaps, or short other types of MBS.
In the current environment, where news of a Treasury buyback has sent prices higher, shorting Treasuries ``would have been a painful experience,'' said Hackel, while the other two hedge tactics -- interest rate swaps and hedging of other MBS -- should have been effective.
Dale Westhoff, head of mortgage-backed research at Bear Stearns & Co. Inc., agreed that investors are not relying as much on Treasuries: ``They're hedging more with agency debt, swaps or other mortgage products. The pricing on these other products will be more correlated with MBS than Treasuries.''
Hackel pointed out that most market players should have learned over the course of the last couple of years that interest rate swaps or shorting other types of MBS are more effective hedges in times volatility.
Meanwhile, Westhoff said the inversion of the yield curve has big implications for mortgages. ``It really changes the valuation process of mortgages.''
Westhoff explained that the Treasury curve -- the relation of short- term interest rates versus long-term interest rates -- is used to generate assumptions about future interest rates.
``Typically when we're trying to value the prepayment option in mortgage products we use the Treasury curve to generate implied forward rates. A downward sloping curve implies that there should be a rise in prepayments because the implied forward mortgage rates are also downward sloping,'' said Westhoff.
Westhoff said the curve inversion is technically driven because it comes in the wake of the buyback announcement, begging the question: ``Is it really correct to use the Treasury curve as a basis for valuation models?''
As a result, option adjusted spreads (OAS) derived using LIBOR have become more useful to investors because the Treasury curve has been affected by unusual factors.
``We have, for over a year, run LIBOR OAS and Treasury OAS. But now we are paying more attention to LIBOR OAS,'' said Frank.
According to Westhoff, the LIBOR curve is upward sloping so the forward rate paths have a more normal pattern," suggesting that refinancing activity will not rise.
However, if one were to look at the Treasury curve, there would be expectations of an increase in prepayments because of a downward slope in U.S. interest rates.
But, as market players pointed out, mortgage rates have not fallen so refinancings are not expected to rise.
``We look at both LIBOR-based option adjusted spreads (OAS) and Treasury-based OAS. We think LIBOR-based OAS makes more sense,'' said Westhoff.
-- Bill P (email@example.com), February 04, 2000.
In June of 98 Greenspan had about 3 1/2 million invested in the stock market,I also heard at the end of 99 he had none in the stock market but had 4 1/2 million ALL invested in T-bills.
-- J (firstname.lastname@example.org), February 04, 2000.