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After much deliberation and amendments, Congress finally passed the 700 billion “financial rescue” plan that had been the focus from Wall St. to Main St. As the final vote on the bill was being tallied, the stock market started getting weak at its knees and proceeded to give up the day’s gains. The Dow managed to erase over 300 points in gains and actually ended up closing near the lows around 160 points lower than yesterday. Once the tide had turned for stocks Treasury buyers came back into the market pushing the front end of the yield curve back to recent lows. The US 2yr note managed to rally from 1.80% through 1.60% showing short Treasuries continue to be the asset of choice amongst investors in this credit induced crisis. It is hard to find value with such little yield in Treasuries these days but like many investors say, return of principal is better than return on principal. With gold now off its highs, US Treasuries, along with sovereign debt of other G7 nations like Germany and the UK , are the only financial assets that are going up in value during this crisis.

There has also been rampant speculation the Fed will follow the passage of today’s bill with a rate cut to boost the economy. The following chart shows the difference in yield between the US 2yr note and the 10yr note.

The current spread is around 202 bps, or 2.02% in terms of yield. The higher this spread, the more market participants is favoring owning 2yr over 10 yrs. This is typically the case during recessions and when the Fed is in a rate cutting regime to restore the economy. Short maturity Treasury paper benefit from the lower Fed Funds rate and as a result it’s yield collapses. On the other hand, when the Fed induces cheaper lending into the economy this policy can prove to be inflationary in the future and as a result investors demand to be compensated more in yield for taking this risk. Additionally, the current US Government deficit and future deficit will likely result in increased issuance of longer term paper (between 10-30 years) which will increase yield through the threat of additional supply. These reasons listed above are whats keeping the yield curve very steep, and we are about the test the highs last reached during the Bear Sterns debacle.

as of  4:37pm EST

2yr  1.59%  -2.6 bps

5yr  2.63%  -3.1 bps

10yr 3.60% -2.4 bps

30yr 4.09% -5.9 bps

In a Congressional session reminiscent to a month or two ago when Treasury Secretary Henry Paulson asked law makers for a Bazooka to fight our economic woes, today’s request was the mother of all Bazookas. Mr. Paulson is asking Congress to approve a bill giving the Treasury the authority to buy 700 billion in toxic MBS securities from Wall Street institutions to relieve them from their financial misery. I expected nothing less from the former Goldman Alumni as the bank is probably the Bazooka of all investment banks, often using their weight to push around markets in which they trade. You see, Paulson’s argument is that the psychological impact of having 700 billion at his disposal will put a floor in the MBS markets and therefore, as his argument goes, having the bazooka will entice the market to not allow him to use it. I’m not sure how much the Congressional leaders bought into his argument since he’s already fired a rocket or two from the last bazooka Congress gave him.

Stocks have given up most of the gains since this plan became breaking news late last week. At the same time, Treasury yields have exploded higher with US 10yr notes rising 40 bps since last Thursday, taking out much of the recent flight to quality gains. When all is said and done, over a trillion dollars of the Fed’s balance sheet will have been dedicated to eradicating the subprime/housing problem and Treasury market participants expect a deluge of issuance going forward to finance this. As a result, some economists have started calling for the end to the great Bull market in Treasuries that has taken place in the past two decades where yields have consistently fallen. Only time will tell.

As of 5pm EST

2yr  2.07%  -5.8 bps

5yr  2.99%  -6.2 bps

10yr 3.80% -3.6 bps

30yr 4.38% -4.0 bps

  US Stocks rallied the most in 6 years as Government institutions around the world intervene to calm markets. In Russia and China the governments has been or is about to use state funds to prop up battered markets via share purchases. The Fed also coordinated with central banks around the world to inject more liquidity into the markets before Thursday’s NY open. In addition, the UK regulators followed the steps of the Securities and Exchange Commission and made it more difficult for short sellers to conduct their business, again propping up the fragile equity markets. Non of these things seemed to really have an impact on US stocks during Thursday’s session until Charlie Gasparino reported on air that Henry Paulson and Ben Bernanke are working on a more significant plan to inject capital into the financial system, fighting off a potential collapse of the banking sector. This caused a near 4% rally in all the major stock indicies and with the market actually closing near intraday highs.

As expected, Treasuries sold off hard into what many hope will be the bottom in financials and stocks. Through out the week, gold and Treasuries continue to be the only assets investors were piling into as fear takes grip of global markets. Demand for Treasuries were so high that 1 month T-bills actually yielded nothing yesterday if an investor was to buy it. During times like this principal preservation is the name of the game. The front end of the yield curve has dramatically outperformed as a result of all this feverish buying in short maturity Treasuries as a flight to safety trade. As you can see in this chart,

the yield of the 2yr/10yr spread  is now trading near 184 bps, with a rather large spike during the past week. This behavior is very consistent with a panick in the market and as a result Street refers it to a “flight to quality” trade. Interestingly enough, despite the rally in stocks and the flurry of positive equity news during Thursday’s trading session this curve ended the day unchanged. As a result, one can conclude the bond market does not seem to share the enthusiasm and positive outlook on risky assets as stock investors do. I guess only time will tell who will ultimately be right…..

as of 5pm EST

2yr  1.69%  +5.6bps

5yr  2.63%  +11 bps

10yr 3.54% +13 bps

30yr 4.19% +11.5 bps

It looks as if some of Lehman Brothers will live on as Barclays was able to acquire its US investment banking business and preserve some 10,000 jobs on Wall Street. This is good news for Lehman, for Barclays, and for New York City. Click here for the story

Now the unthinkable has happened, where do we go from here? Having been in the markets for a number of years and personally worked at Lehman Brothers for much of that time, today is a very sad day for me. Its not only sad to see the demise of a truly great firm with tons of talented people, but the potential destruction to America seems under appreciated by the media and the press. As of my writing this afternoon the spotlight has already moved away from the carnage at Lehman and is now solely focused on the insurance giant AIG. However, the true implications of the bankruptcy will not be felt for weeks if not months to come.

Needless to say in this environment all asset values will continue to decline with the exception of Gold and US Treasuries. As much as I would have liked to see a Government bailout of Lehman Brothers I do have to commend the politicians for not keeling to the pressure. If the Government did not draw a line in the sand, then eventually all of Wall Street will be owned by the tax payers and the possibility of casting a credit doubt on the US Treasury itself will be the endgame. It is not clear where Treasury yields will go from here as the situation is very fluid and all technicals have been broken. We will wait for tomorrow’s FOMC decision to assess the situation going forward. The market is currently assigning as much as 60% possibility of a Fed Funds rate cut tomorrow.

as of  4:08 pm EST

2yr  1.75%  -45.6 bps

5yr  2.59%  -36.0 bps

10yr 3.44% -27.4 bps

30yr 4.09% -22.6 bps

Since the large sell off in Treasury prices we saw post GSE conservatorship, the market has made back most, if not all, its losses. There’s no doubt we are going through unprecedented times in the financial markets and as a result there has been enormous volatility. The Treasury market opened well bid this morning as concerns regarding financial companies continue to weigh on the stock market. As a result of this Treasuries has traded with a positive tone but is having a hard time breaking through 4.57% on 10yr notes. Stock investors also look very confused with the broader indicies continue to gyrate intra-day as the bulls/bears play tug of war for the most of the session. We are probably due to get a little bit of a correction in Treasury prices as the market does feel a little tired and is running out of steam. However, with the 10yr note auction today showing good demand (auction came 1 bps better than market expectations) the asset du jour continues to be securities backed by full faith and credit of the United States government.

We shall see what kind of a lasting effect all this government interventions have on the market but so far very little has been accomplished. Fears of our financial system continue to mount while private sector bailouts simply lead to more need for further bailouts. In my opinion this shows the efficiency of the capitalism model at work as Adam Smith’s “invisible hand” continues to dictate the market despite the Juggernaut known as the US Government trying to get in its way. And lastly, whats up with the Treasury buying MBS securities to keep rates artificially low for borrowers? Isn’t that what got us to the problems we have today as a society in the first place? The government should just leave things alone and let the dynamics of supply and demand dictate market direction….even if it involves the idea of home ownership. Keeping rates artificially low will only get someone into a house they don’t belong and we’ll wake up one day to relive this never ending nightmare.

As of 3pm EST

2yr 2.18%  -1.7 bps

5yr  2.89%  -0.7 bps

10yr 3.62% -0.8 bps

30yr 4.21% -1.7 bps

Ok, so the GSE bailout is something totally different than what is being depicted in this picture above….or is it? In a way, the pilot in the picture has many similarities with our Federal Government who engineered a bailout of Fannie and Freddie this Sunday. Both were fast moving and set on a course that will eventually crash and burn. Both had an audience curious to witness the pending blowup. Finally, both the pilot’s and the GSE’s saga ended with the action of one swift and decisive pull, and in the case of the GSE’s came from a tug from Treasury Secretary Henry Paulson and the Bush Administration.

The surprise move by the  government was hinted to the market by the press late last Friday and caused an avalanche of selling in the already weakened Treasury market. After the official press release of the  anticipated bailout info on Sunday, the Treasury market got crushed in overseas trading as Asian investors dump bonds in anticipation of a stock market surge and potential increases in future issuance from the Treasury to finance the bailout. Just to give you a sense of the volatility, US 10yr notes traded at 3.55% after last Friday’s unemployment report and by Sunday evening NY time bonds were clearing at 3.82%…nearly a 30 bps sell-off. As of this writing after Monday’s NY session 10yrs retraced half of the move and ended around 3.672%. Who says bond trading is not exciting???

So why the turn around in yields from the highs reached during Asian trading hours? Didn’t it make sense for Treasuries to continue its weakness if the Government just removed a huge uncertainty from the market place and liquidity premium decreases? As it turns out, the bailout created a large rally in GSE backed MBS bonds (declining yields = more refinancing potential) and as a result certain investors had to readjust their prepayment expectations accordingly Since the expectations are now adjusted faster, then theoretically the expected duration of the securities are now shorter and as a result, investors had to come into the market to purchase more duration to offset the decline. This led to the overall need to buy Treasuries and other fixed income assets in the market. Magically, the Treasury had managed to reduce mortgage rates in this country by 50 bps in one quick scoop.

as of 5pm EST

2yr  2.30%  -0.00bps

5yr  2.98%  -.007bps

10yr 3.67% -2.4bps

30yr 4.27% -3.6 bps

The interest rate market ended the week off today’s intra day highs despite a worse than expected Payroll report and a 6.1% unemployment rate. The US 10yr note touched briefly 3.55% before backing up to 3.639% at the time of writing as stocks managed to recover from triple digit losses on the DOW. We are now testing resistance levels in Treasuries we haven’t seen since the Bear Stearns debacle as traders once again look for the Fed to potentially cut rates to prevent the recession from extending. Overseas investors also continue to liquidate their Agency backed debenture and MBS holdings in favor of UST’s which is further fueling Treasury market strength. In his monthly Investment Outlook, Bill Gross discusses how virtually every asset is in a bearish trend as a result of global “delevering” which in my opinion leaves investors with very little place to hide except in Treasuries. He even noted that the current decline collectively between Housing, Equities, and Bonds (credit spreads) of -10% year over year have not been seen since the Great Depression. Since financial deleveraging like the one we’re currently experiencing is unlikely to end anytime soon, it is likely we will continue towards our current path of lower interest rates for the foreseeable future, especially with inflation less of a concern. Weakness in UST’s are an opportunity to get long the only product in the world besides Gold that is truly credit risk free.

As of 3:50pm EST

2yr 2.23% +5.6 bps

5yr 2.91% +5.7 bps

10yr 3.65% +2.9 bps

30yr 4.27% +1.1 bps

Market participants found themselves shaking off the summer blues today as the summer break officially ends. Financial markets, however, did not see the deluge of liquidity that participants were hoping for. Instead, we had such a huge swing in both the equity and bond markets that by noon traders were wondering how much better their P&L would’ve been if they just stayed on vacation. Many of last week’s trends broke down with equities reversing a large rally by 10am EST and bonds going decisively the other direction with prices up. There has been consistent talk in financial circles that Treasury bonds are overvalued and especially given the recent stability in credit markets as well as lack of substantial damage from Gustav. We did see selling from Asian investors before NY open who pushed our prices lower but soon Treasuries staged an impressive rally off the lows with the 10yr going from 3.86% to a closing level of around 3.73% near NY close. The 2yr note fared even better today, outperforming 10yr notes by around 3 bps as the market continued to focus on economic weakness being the dominant theme. With the GSE situation unclear and large international investors nervous to add to their exposure the Treasury market stands to benefit as it continues to be the best place to hide cash during the Great Credit Crunch of 2007/2008.

as of  4:30pm EST

2yr  2.26%  -10.5 bps

5yr  2.99%  -10.5 bps

10yr 3.73% -7.9 bps

30yr 4.35% -6.9 bps

Despite some signs of strength in the economic numbers the past few days Treasuries has been trading stronger and today was no exception. With oil prices retreating (collapsing, really) consumer confidence edged up a bit for the second month in a row. So how come Treasury yields have been coming down despite the strength in economic numbers and a relatively stable stock market? The answer is simply the fact that now the US has sneezed, the rest of the world has caught the cold. And no, I did not come up with the analogy, but for all the “its different this time” of the worlds….well, its not. The world has caught the cold and the fear is that its gonna spread through out the world economy, killing all in its path (exaggeration!). For better or worse, the US has been the center piece of attention with economic disappoint after disappointment. Market expectations of economic performance is now so low that it will take gigantic misses going forward to surprise anyone further on the down side. Since we know the market does not like surprises and is forward looking, it will make sense the dollar should rebound as foreigners and investors run for safety in a “relatively” better economic environment. But since our markets are still polluted with toxic assets and credit problems, money is not flowing into higher yielding assets. Instead, its flowing into the liquid Treasury market where investors sacrifice yield for the sake of liquidity and safety. In the near term, expect the technicals to be strong for the Treasury market and these flows to continue where investors move out of commodities and Eur/GBP to go into the mighty Greenback and the Treasury market. Keep an eye on the 200 day moving average on 10yr notes and it should be very bullish if we can convincingly break through it in the next couple of days.

200day MA

2yr 2.38% -5.1 bps

5yr 3.10% -5.2 bps

10yr 3.83% -5.1 bps

30yr 4.46% -5.4 bps