Swap Spreads Signal Rise in Yields--Treasury-Debt Movement
Appears to Be in the Offing; Mortgage Selling May Ensue
By MICHAEL MACKENZIE
DOW JONES NEWSWIRES
October 5, 2005;
The fixed-income market's early warning system, interest-rate swap spreads, are signaling an increase in Treasury yields may be close at hand.
As a link smoothing the trading of Treasurys and mortgage bonds, swap spreads have often flagged big moves in these debt markets since late 2000. The swap spread measures the difference between Treasury yields and swap rates that double as money-market rates traded between banks. When spreads widen in the manner they have over the past week, that is seen as a barometer of impending changes in the balance of fixed-income markets.
In a replay of past periods of percolating pressure, long-term yields appear poised to move higher. Such an outcome would force holders of mortgage bonds to trim their portfolios in case things get ugly, potentially setting in motion waves of selling across mortgage debt, interest-rate swaps and Treasurys.
For much of the summer, the picture for long-term rates has been largely benign, and the predictable trading of the 10-year Treasury-note yield around 4.25% emboldened many investors to increase their exposure to higher-yielding mortgage-backed securities.
That is fine when the market outlook is stable. However, the picture for bond yields has turned bearish the past month. Despite worries over high energy prices' damping economic growth, the bond market has grown more resigned to the Federal Reserve's raising the current 3.75% federal-funds rate to 4.25% by December and possibly 4.50% early in 2006.
This has pushed yields higher across the board, with that on the 10-year note nearing a peak around 4.40% this week from around 4% in early September. The 10-year swap spread is just shy of its widest level this year of 0.475 percentage point, reached in early April when the 10-year Treasury was yielding 4.50%. Such behavior on the part of swap spreads "tells you something is going on," said Jim Caron, fixed-income strategist at Merrill Lynch in New York.
Investors, notably in the mortgage-bond market, use swaps to insure their portfolios against the risk of sharp changes in bond-market yields. When yields rise, the average life of a mortgage extends as the chances of refinancing of home loans fall. That leaves managers of mortgage investments with the choice of either selling some of their holdings or selling Treasurys and/or swaps in order to maintain a balanced benchmarked portfolio.
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Bill Gross's of Pimco's Bullet points from his October missive
Gross eyeballs it as housing peaking 4 to 6 quarters after the central bank raises rates and about 200 basis points of rate increase.
The CB then raise rates another 2 Quarters for a total cyclical increase of 300 basis points.
that's the FED study averages. and We're 5 quarters and 275 basis points into our current adventure. .......So the great housing cool off should be near.
John |
