Market Update: Treasuries mixed on poor economic data

 

Bonds are mixed this morning on a morning packed with news.  Right off the bat we see Wells Fargo step in front of Citigroup and pay more for Wachovia and do it with no government help.  The FDIC had forced Wachovia to find a partner last week and Citigroup was getting an FDIC backstop on losses above $42 Billion.

Wells is paying more and doing the deal alone. 

 

Stories are coming out that California is giving the Treasury a heads up that the state might need an emergency loan to the tune of $7 billion as the credit crisis dries up funds that they normally use to fund operations.

 

Fed Funds are trading at ½% this morning.  Oil is trading at $94 a barrel.  Treasury prices are actually falling a bit this morning.  There has been a lot of pressure on Treasuries in the flight to safety that we’ve seen over the last few weeks so we may see some noise in Treasury prices as the economic data gets released.

 

Yesterday the Fed hit a single day record for the amount of money lent to financial institutions.  Commercial banks and brokerages borrowed a combined $342 billion from the Fed yesterday…that’s up 60% from a week ago.

 

 

 

 

 

There has been so much focus on the bailout bill that it’s been easy to ignore the economic data.  The economic data is the drumbeat that moves the fixed income world and it’s getting ugly.  This morning’s numbers are listed in WHITE font in the chart below.  I included all data released since October 1^st for reference.

 

When the change in non-farm payrolls number was released I could actually hear a gasp come from my trading desk over the speaker system we use to communicate with each other throughout the day.  The survey expected a loss of 105 thousand jobs, but we actually posted a loss of 159 thousand jobs.  The unemployment rate was unchanged, but it was unchanged at a level that is elevated to begin with.  As you look through the numbers that were released this week you’ll see a lot of data that is not positive.  Once we get past this bailout bill we will begin to see people get back to looking at the fundamentals.  At the moment those fundamentals do not paint a picture of a strong economy.

 

 

 

 

 

The Fed Funds futures market is pricing in more aggressive cuts by the Fed.  That market is currently pricing in a 100% chance of a cut at the October 29 FOMC meeting with 88% probability placed on a 1.50% level and 12% probability placed on a 1.25% level.  The December contracts place the odds of a 1.25% level at 47%.

 

Now what good would it do to cut the overnight rate when Fed Funds is trading at one-half of one percent?  The only outcome I can see is that it would lower the Prime Rate.  The Fed is desperately trying to keep enough liquidity in the system to keep borrowing rates between banks low, to keep liquidity lines between firms from drying up so they can fund their inventories…they don’t need the Prime Rate to drop.  They need to flood the market with cash, and that is why we’ve see them use all of their various new lending facilities to such a great extent.  This is also why we saw them stay put on rates at the last meeting despite what the futures market expected.  In the words of the St. Louis Fed President Bullard lowering the target rate to fight this problem is like using a blunt instrument where a scalpel is called for.

 

We’ve got a month until the meeting.  Some think that the Fed will lower to help the psychology of the market.  Sentiment in the futures market has seen a seismic shift toward the negative based on the economic data.  The Fed seems to be committed to using alternative means to fight these problems, and may want to keep it’s powder dry on cutting rates…they may need those rate cuts for more than psychological reasons next year. 

 

 

 

 

 

What does it look like when banks hoard cash?  The graph below is a perfect example.  The Fed has been pumping $620 Billion into the international markets, flooding them with cash to try to drive down Libor.  The GSE’s fund off the Libor curve and since this curve spiked up recently they’ve been experiencing higher borrowing costs…you can see that in the form of the 3 month bullets at 3.25% they’ve been issuing.   Libor is the London-Interbank-Offered-Rate.   It is the rate at which foreign banks will lend US dollars to each other, it is essentially a dollar denominated swap curve.  These are loans between banks so there is credit risk on this curve.  In a market like this you can see how banks might become hesitant to lend to each other…nobody knows who has exposure to what.