How bad can it get for shorty when he bets wrong?
Bonds Shaken by Bets on Lower Prices
By Ted Merz
New York, Feb. 4 (Bloomberg) -- Wall Street's biggest bond traders kicked off 2000 with a $67 billion bet against Treasury bonds rising.
So far, the wager has proved costly.
Anticipating the Federal Reserve would continue to raise interest rates to slow the economy, the 30 primary dealers that trade with the Fed had by Jan. 5 sold $67 billion of borrowed bonds, a bet prices would fall and they would be able to buy them back cheaper.
Treasury Under-Secretary Gary Gensler's announcement yesterday that the government would reduce sales of debt, as well as buy back securities due in 10 years or more, prompted a scramble for bonds, producing the biggest two-day rally in bonds since the October 1987 stock market crash.
``People had taken too much pain and they were unwinding whatever positions they were in,' said Martin Mitchell, manager of government trading at Legg Mason Wood Walker in Baltimore.
The surge also set off a rash of speculation that banks or hedge funds unable to buy back bonds they had sold were suffering losses and would need to be rescued. That prompted more buying.
A trader at Goldman Sachs Group Inc. said Deutsche Bank AG had suffered big losses. A trader at Credit Suisse First Boston Inc. claimed Salomon Smith Barney Inc. lost a bundle. A trader at Deutsche said Goldman and Merrill Lynch & Co. were in trouble because of the sudden increase in bond prices. Officials at the firms said they suffered no major losses.
The Fed took the unusual step of calling news organizations to squash talk it was meeting to bail out a hedge fund or a bank. That revived the specter of Long-Term Capital Management, a fund that collapsed in September 1998, triggering a rush into the safety of Treasury bonds and prompting the Fed to organize a bailout.
``Normally the New York Fed does not respond to market rumors, however, we would like to confirm that rumors of a meeting of market participants at the bank are completely unfounded,' said Doug Tillett, a spokesman for the bank.
Bad Bet on Mortgages
The benchmark 30-year bond rose 1 30/32 to a price of 99 26/32, causing its yield to plunge 14 basis points to 6.14 percent. Since the current rally began Jan. 21, the 30-year bond has returned 8.4 percent, including reinvested interest.
``There is a growing realization that we are serious about paying off the debt,' said a senior Treasury official.
While the gain has been spurred by investors snapping up Treasury bonds because they expected them to become scarce, it was accelerated by traders swapping out of unprofitable mortgage securities.
Mortgages were expected to do well this year as the Fed raised rates because higher rates would translate into few bonds sold and slower prepayments, said Jim Shallcross, a portfolio manager at Independence Fixed-income Associates in McLean, Virginia.
``Generally people think that during stable and higher interest rates mortgages will outperform' Treasuries, said Phil Barach, who manages $20 billion in bonds at TCW Group Inc. in Los Angeles.
The primary dealers reported to the Fed that they owned $26 billion of agency and mortgage-backed securities at the beginning of the year. Those fixed-rate mortgage securities have lost 0.67 percent this year, compared with a 0.66 percent gain for Treasuries, according to Lehman Brothers Inc. indexes.
As investors became convinced that the Treasury would reduce the amount of debt outstanding, investors unwound the bets against bonds they'd made, said Joseph Pregiato, co-head of fixed-income sales at Josephthal & Co.
``The only thing you can say for sure is that the movement in the marketplace suggests that people are having some forced liquidation,' said Van R. Hoisington, president of Hoisington Investment Management Co. in Austin, Texas, a fixed-income money manager of about $4 billion.
Bill Gross Weighs In
Michael Hoeh, who manages $5.5 billion in bonds at Dreyfus Corp., said also contributing to the pessimism about mortgages and the optimisim about Treasuries were comments that Bill Gross, head of Pimco Advisors Holdings LP, the world's largest fixed-income manager posted on the firm's Web site.
``Bill Gross put his thoughts on his Web site about fixed- income markets and there were indications he was more bullish on Treasuries and less bullish about spread product such as mortgages,' Hoeh said.
Gross told the L.A. Times that Pimco was ``partly responsible' for the spark that prompted the surge in prices by beginning to by Treasury bonds about a month ago while he was selling mortgage securities and other shorter-term notes.
One indication investors are concerned about losing more money in mortgages is the widening of swap spreads, one measure of the cost of financing purchases of fixed-income securities. Ten- year swap spreads traded as high as 100 today and finished at 90, up from as low as 70 a week ago, traders said. Nicholas Walsh, who helps invest $10 billion in fixed-income asset at J. & W. Seligman & Co., was among the investors who bet on mortgages last year, increasing his holdings of mortgages at the end of last year to 25 percent of his portfolio up from about 20 percent, selling corporate bonds and Treasuries. So far, Walsh isn't selling the mortgage-backed securities, betting on a rebound. ``Once this volatility recedes in the Treasury market, mortgages can rally,' said Walsh. -- Ted Merz in the New York newsroom with reporting by Jonas Bergman, Beth Williams, MaryAnn Busso, Monique Wise, Vernon Silver and Kathy O'Donnell in the New York newsroom (212) 893-3037 and Katherine M. Reynolds in Washington (202) 624-1934/tm/fk Story illustration: To graph the yield on 30-year U.S. bonds: GT30 GY News by category: NI HEDGE Hedge funds NI BON Bonds NI SWAPS Swaps NI SWAPSCOL Swaps Focus columns NI COR Corporate bonds NI MOR Mortgages NI MMC Mortgage market comment NI ABS Asset backed securities NI DRV Derivatives NI NEWBON New bonds NI SCR Securities firms NI RATES Rates of return NI WIN Bloomberg exclusive NI FIN NI BNK NI SCR News by region: NI US U.S. For closing mortgage market stories, type TNI MMC CLM -0- (BN ) Feb/04/2000 11:21
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