January 25, 2010

Top Stories: Bonds

Treasury Rally on Borrowed Time as Options Anticipate Fed Prone to
January's surprise rally in Treasuries may prove fleeting,
as options traders bet on bigger price swings in bonds and
waning volatility in stocks for the first time since 2006.
Barclays Capital indexes show interest-rate volatility rose
from a six-month low in November on speculation borrowing costs
will increase as the improving economy allows the Federal
Reserve to remove the unprecedented cash it pumped into the
financial system. At the same time, confidence in the outlook
for profits helped push the Chicago Board Options Exchange
Volatility Index to an almost two-year low this month. The
correlation was negative in 2006, the last time policy makers
were increasing the target rate for overnight loans between
banks. Yields on 10-year Treasuries increased 0.75 percentage
point in the first half of that year, sparking a loss of 3.9
percent, according to Bank of America Merrill Lynch indexes,
while the Standard & Poor's 500 Index rose 1.8 percent. Fed
officials meet this week to discuss monetary policy. ``We've
probably seen the great secular bull low in yields,'' said
Mitchell Stapley, who helps oversee $13 billion of debt as
chief fixed-income officer for Fifth Third Asset Management in
Grand Rapids, Michigan. ``Earnings don't seem to be a concern
on anyone's plate right now. The level of rates, what happens
in the housing market, that's on the forefront of people's
minds and why we are getting fixed-income volatility spikes
that haven't made it over to the equity markets.''

Corporate Bond Sales Cut in Half by Widening Yield Spreads: Credit
Corporate bond sales are falling and borrowing costs are
increasing for the first time in eight weeks amid investor
concerns about the pace of the economic recovery. Bond sales
worldwide fell 52 percent last week to $48 billion from $99.8
billion in the previous period, according to data compiled by
Bloomberg. So-called yield spreads widened for the first time
since the five days ended Nov. 27, based on Bank of America
Merrill Lynch's Global Broad Market Corporate Index. Reports
showed U.S. retail sales and housing starts unexpectedly
declined in December, while German investor confidence dropped
more than economists estimated this month. President Barack
Obama's plan to limit the size of banks raised investor
concerns that earnings growth may be curbed. Dallas- based
Energy Transfer Equity LP, which controls the third- largest
U.S. pipeline partnership, pulled a $1.75 billion high- yield
offering and Vietnam delayed a sale to this week. ``The market
feels as though it had lost sight of reality, with the
indiscriminate buying of risk while ignoring the economic
fundamentals,'' said Simon Ballard, the head of European credit
strategy at RBC Capital Markets in London. ``The wider
macroeconomic picture and a couple of recent events have made
investors sit back a bit and take stock.''

Treasuries Decline Before This Week's Growth Report, Three Debt Auctions
Treasuries fell, pushing yields up from a one-month low, on
speculation a U.S. report this week will show the world's
largest economy expanded in the last quarter of 2009 at the
fastest pace in almost four years. Bonds due in 30 years also
dropped as traders bet Federal Reserve Chairman Ben S. Bernanke
will win confirmation for a second term to pursue policies for
spurring the U.S. economy. The Treasury Department prepared to
auction a record-tying $118 billion of two-, five-and
seven-year notes starting tomorrow. ``The GDP figure will be a
good number,'' said Kazuaki Oh'e, a bond salesman in Tokyo at
Canadian Imperial Bank of Commerce, the nation's fifth-largest
lender. ``It's not good for long-term bonds because of
inflation fears. If the markets rise, that's a good time to set
a short position before the auctions.'' A so-called short is a
bet prices will fall. The benchmark 10-year note yield
increased two basis points to 3.63 percent as of 6:29 a.m. in
London, according to data compiled by Bloomberg. The 3.375
percent security due in November 2019 fell 5/32, or $1.56 per
$1,000 face amount, to 97 30/32. Yields declined to 3.58
percent on Jan. 22, the lowest level since Dec. 21.

U.S. Consumer's Demise May Be Offset by China, India, Nomura's Sheard
Developing countries led by China and India will supplant
the American consumer as the source of ``natural growth'' for
the global economy, according to Paul Sheard of Nomura
Securities International Inc. There will be ``less exuberant
and robust consumption than we had in the past few years'' in
the U.S. because the American household will continue to
``tighten its belt,'' New-York based Sheard, global chief
economist at Nomura, said in a Bloomberg Television interview
in Hong Kong today. ``There are other parts of the world,
though, that can take up some of that slack,'' such as China
and India, he said. U.S. consumer spending, which accounts for
about 70 percent of its economy, probably dropped 0.6 percent
last year, according to the median estimate of 59 analysts
surveyed this month by Bloomberg News. The jobless rate held at
10 percent in December as discouraged workers stopped looking
for work. ``There is a legacy of all that debt, and if you
like, overconsumption that built up in the U.S. in the few
years riding up to the crisis,'' said Sheard, referring to the
collapse of the nation's housing market.

Treasury Asks Dealers About Impact of Fewer Fed Purchases of Mortgage
The U.S. Treasury Department asked bond dealers about the
potential market impact from the end of the Federal Reserve's
mortgage-backed securities purchase program, according to a
survey the department released in Washington today. The agenda
for Jan. 28 meetings shows the Treasury's effort to watch for
market disruptions and manage record borrowing. The U.S. is
braced for a second consecutive year of $1 trillion-plus budget
deficits amid debate over the federal debt limit, which stands
at $12.4 trillion and could be breached within weeks unless
lawmakers approve an increase. If Congress raises the debt
limit by $1.9 trillion, as the Senate is considering, the
Treasury would have room to borrow until early 2011, an
administration official said today. Meanwhile, debt managers
are asking whether the market expects turmoil from the end of
the Fed program, on track to happen three months after the
Treasury ended its own MBS purchases. ``The Federal Reserve has
frequently stated that its purchases of agency mortgage-backed
securities and agency debt will be executed by the end of the
first quarter of 2010,'' the Treasury told the dealers in
today's survey.

Sell Fannie Mae Mortgage Securities on Prepayment Risk, Declaration Says
Investors should bet against some Fannie Mae and Freddie
Mac securities because of the prepayment risk for those trading
above par, said Jim Shallcross, who oversees $12 billion at
Declaration Management & Research LLC. The government-supported
companies are set to buy delinquent mortgages out of the
securities at a faster pace, paying down the bonds at face
value, the 49-year-old director of portfolio management said in
a telephone interview. ``Right now, I think you're playing with
fire'' owning the securities, said Shallcross, who made $117
million for investors in two distressed-asset funds closed last
month. Securities to ``short'' with contracts to sell them in
future months include 30-year Fannie Mae mortgage bonds with
coupons of 5.5 percent, 6 percent or 6.5 percent, said
Shallcross, who is based in McLean, Virginia.

Bernanke Will Win Senate Reconfirmation, Republican Leader McConnell
Ben S. Bernanke will keep his job as Federal Reserve
chairman, the White House and the Senate's senior Republican
predicted two days after wavering support among some Democrats
helped drive stock prices lower. President Barack Obama ``is
very confident that the chairman will be confirmed,'' David
Axelrod, a senior White House adviser, said on CNN's ``State of
the Union'' program. Senate Republican leader Mitch McConnell
said on NBC's ``Meet the Press'' that Bernanke will have
``bipartisan support in the Senate'' even as a number of his
party are opposed. The assurances followed declarations of
support for Bernanke from the top two Democrats in the Senate,
Nevada's Harry Reid and Richard Durbin of Illinois, who earlier
said they were undecided. John McCain, the Republican 2008
presidential nominee, and John Cornyn, who runs the party's
senate campaign committee this year, are against him. Online
traders yesterday raised the odds of approval to 92 percent
from as low as 65 percent on Jan. 22. ``We've dodged the bullet
on this one,'' said Greg Valliere, chief policy strategist at
Potomac Research Group in Washington. ``People were aghast by
what happened in the markets on Friday, and do they really want
to get angry letters from constituents who have lost money in
the stock market because of the Bernanke vote?''

Mexico Debt to Post Best Rally Since 2006 as Economic Rebound Takes Hold
Mexico's benchmark local bonds are poised for the biggest
annual rally in four years after underperforming regional debt
in 2009 as the economy recovers and the peso gains, Stone
Harbor Investment Partners said. The yield on Mexico's 10
percent peso bond due in December 2024 may plunge about 40
basis points, or 0.40 percentage point, in 2010, to 7.80
percent, said Pablo Cisilino, who manages $11.5 billion in
emerging-market assets at Stone Harbor in New York. That would
be the biggest one-year drop since 2006. Mexican domestic debt
returned 7.7 percent last year, less than the 10 percent return
posted by Latin American local bonds on average, according to
JPMorgan Chase & Co.'s ELMI+ index. The region's second-largest
economy will grow 2.95 percent in 2010 after contracting 7
percent last year, the most since 1932, the median forecast of
19 economists in a Bloomberg survey shows. ``People were too
pessimistic on the growth outlook for Mexico and very
pessimistic about the peso,'' Cisilino said. ``Things are
changing. They're starting to come around.''

U.K. Index-Linked Bond Sale to Attract `Spooked' Buyers, Threadneedle
Britain's accelerating inflation is likely to spur
investors into buying 30-year index-linked bonds at a sale this
week, according to Threadneedle Asset Management. The Treasury
plans to sell an undisclosed amount of inflation-protected
bonds due in 2040 through banks as early as today, according to
the U.K. Debt Management Office. Consumer prices climbed 2.9
percent from a year earlier, 1 percentage point more than in
November, the Office for National Statistics said on Jan. 19,
the first time since May that the rate has exceeded the Bank of
England's 2 percent target. Inflation is accelerating after
policy makers printed as much as 200 billion pounds ($323
billion) to buy bonds as part of their so-called quantitative
easing policy, designed to drive down borrowing costs and lift
the economy out of the recession. ``Some investors must have
been spooked by the recent inflation data,'' said Sam Hill, a
money manager in London at Threadneedle, which oversees $94
billion. ``All evidence suggests there will be strong interest
for this bond, especially from long-term investors such as
pension funds.''

German Bunds Rise; Greek Auction This Week Stirs Peripheral Risk
German government bonds rose as investors sought the safest
securities amid concern Greece may struggle to sell debt this
week, stirring concern about budget- financing problems for
other nations that use the euro. The gains pushed the yield on
the 10-year bund down to within two basis points of the lowest
since Dec. 21, while the two-year note yield remained within
three basis points of the lowest since Sept. 8. Greece's
national debt agency said Friday it had hired six banks to sell
at least 3 billion euros ($4.2 billion) of five-year bonds.
``Bunds gained as uncertainty in market sentiment remains
high,'' said Sean Maloney, an interest-rate strategist at
Nomura International Plc in London. ``Concern about Greece and
potential contagion effects continue to plague the euro area,
and this week's five-year syndication deal may prove to be
make- or-break for non-core markets.'' The yield on the 10-year
bund, Europe's benchmark government security, fel1 1 basis
point to 3.21 percent as of 7:39 a.m. in London. The 3.25
percent security maturing January 2020 rose 0.06, or 60 euro
cents per 1,000-euro ($1,415) face amount, to 100.35. The
two-year note yield was unchanged at 1.11 percent.

Saudi Arabia to Spend More on Boosting Economy, Keep Interest Rates Low
Saudi Arabia, the Arab world's largest economy, is in no
rush to raise interest rates and will keep plowing its oil
revenue into kick-starting growth. Central bank Governor
Muhammad al-Jasser said in a Jan. 23 interview he's not
planning to raise interest rates because inflation isn't a
concern and demand isn't strong enough to require higher
borrowing costs. Finance Minister Ibrahim al- Assaf told an
investors' conference in Riyadh yesterday that a ``continuous
stimulus'' is needed even as the economy rebounds from last
year's stagnation. Saudi Arabia's economy will grow more than 4
percent in 2010 after expanding less than 0.2 percent last
year, the finance minister said. Gross domestic product
increased 4.3 percent in 2008. The kingdom, the world's largest
oil exporter, last year announced that it would spend $400
billion on infrastructure over a five-year period to bolster
the economy, the largest stimulus package in the Group of 20
nations. The country is allocating almost $70 billion to
investments this year, a 16 percent increase on 2009. Rising
oil prices, which have rebounded to around $75 a barrel from
less than $35 in February, are also likely to boost growth this

Corporate Bond Risk Increases in Europe, Credit-Default Swap Prices Show
The cost of insuring against losses on European corporate
bonds rose, according to traders of credit-default swaps.
Contracts on the Markit iTraxx Crossover Index of 50 companies
with mostly high-yield credit ratings climbed 7 basis points to
455, according to JPMorgan Chase & Co. prices at 7:25 a.m. in
London. The index is a benchmark for the cost of protecting
bonds against default and an increase signals deterioration in
perceptions of credit quality. The Markit iTraxx Europe Index
of 125 companies with investment-grade ratings rose 2 basis
point to 83.25, JPMorgan prices show. A basis point on a
credit-default swap contract protecting 10 million euros ($14.1
million) of debt from default for five years is equivalent to
1,000 euros a year.

Japan's 10-Year Bond Futures Fall as Stocks Pare Loss, Debt Supply Rises
Japanese 10-year bond futures fell after local stocks pared
losses, drawing investors away from lower-yielding government
debt. Benchmark 10-year yields also climbed on speculation
Prime Minister Yukio Hatoyama's administration will issue more
debt to pay for stimulus measures as falling prices and
unemployment threaten the economic recovery. Japan's national
debt will likely reach 973 trillion yen ($10.8 trillion) in the
fiscal year ending March 2011, according to budget-related
documents on the Finance Ministry's Web site. ``The JGB market
is being led by futures, which is following equities,'' said
Keiko Onogi, a strategist in Tokyo at Daiwa Securities SMBC Co.
``Since the equity market seems to be heading up, that's been
weighing on futures.'' Ten-year bond futures for March delivery
declined 0.15 to 139.08 at the 3 p.m. afternoon close in Tokyo.

Indian Bonds Decline Most in a Week Before Central Bank's Policy Meeting
India's 10-year bonds fell the most in almost a week on
speculation the central bank will act to curb money supply at
its policy meeting on Jan. 29 to slow inflation. Yields rose as
the Reserve Bank of India will probably ask banks to set aside
a greater proportion of their deposits as reserves, a Bloomberg
survey showed. The central bank will raise the cash reserve
ratio by 50 basis points to 5.5 percent, a median of estimates
by 16 economists showed. ``Investors are paring their positions
because bond prices have rallied a quite a bit over the past
week,'' said S. Srikumar, chief of fixed-income at state-owned
Corporation Bank. ``There will be an element of caution in the
run up to the policy meeting.'' The yield on the 6.35 percent
note due January 2020 rose two basis points to 7.57 percent as
of 10:32 a.m. in Mumbai, according to the central bank's
trading system. The price fell 0.13, or 13 paise per 100 rupee
face amount, to 91.58.

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