Fixed-Income Market Monitor Archive

May 2008

• The broad Treasury market as measured by the Lehman Treasury Index was down 1.72% in April -- the first monthly decline for this index since a modest 0.04% loss in June of 2007. During the month the U.S. Treasury auctioned off a record $30B in two-year notes and reintroduced the 1-year T-Bill after a seven-year hiatus. This is being done to help meet financing needs that have increased at the same time that tax receipts have decreased. On the last day of the month the FOMC concluded a two-day meeting and gave the markets another interest rate reduction, but by only 25 basis points this time around. Chairman Bernanke's Fed has now reduced the Fed Funds rate to 2.00% from 5.25% in just eight months.

  Significant yield swings in short Treasuries continued although this time it was to the downside. The yield on the 2-year note rose 67 basis points in the sell-off to close at 2.25%. The 10-year Treasury closed with a yield of 3.72%, and a price decline of 2.39% for April, shaving its Ytdtotal return to 3.22%. The inflation-linked sector of the Treasury market was not spared either but, like the 10-year, it is still comfortably in the black on a Ytdbasis even after giving up 2.11% during the month.
  
  

• The flight to quality theme of the past few months seems to have found an airport and landed, at least for now. There was a decidedly different tone to the markets in April from pervious months as investors moved away from Treasury bonds en masse. I find it amazing how quickly minds, attitudes and perceptions can change in this business. Just a few weeks ago, the attitude was "if it isn't guaranteed by the Government, I don't want to touch it." But in April, major Wall Street broker/dealers were able to successfully arrange $1B+ derivative product credit deals, as well as moving $139 billon of previously unsold (un-saleable?) high yield / LBO debt off of their books and into the portfolios of institutional investors. This reduced the mountain of unsold debt from $230B to "just" $91B. It appears as though the darkest days were just prior to the Fed/JPM takeover of Bear Stearns. After that trigger event, opinions on the outlook of the market and risk began to change. The danger is that this euphoria is merely a head-fake and that another shoe (or shoes) could drop.

  The speculative-grade high-yield market got into the act in a big way and reversed the
  accumulated losses of the prior three months. The Lehman High Yield Index gained 4.49% -- its best month since a 6.19% return in November 2002. The riskier "Caa" component's return was at bit higher at 4.55%. This transpired in spite of a few defaults in the airline and household products sectors. Inflows into high-yield mutual funds were a healthy $1.5B -- a clear sign that even investors at the retail level were willing to take on a little more risk. No doubt they were attracted to the increased yields that many of these funds were sporting after the first quarter selloff. Spreads to Treasuries had widened out sharply and that helped motivate buyers as well.
  
  

• The muni auction-rate market is starting to thaw, if ever so slowly. We are seeing some items trade in modest sizes and others are being redeemed but not fast enough for us. We'd like to see the pace pick up and return to complete liquidity so we can reassess our exposures. We had representatives in our office from one of the big preferred issuers, and they told us about their efforts to find a solution to the illiquidity problem. They have a plan that will help not only the taxable holders, but the muni preferred holders as well. Of course, it will take time -- perhaps as many as twelve months -- before all is said and done. As we have commented in the past, it will take a while and we don't expect the market to ever return to the way it was. Meanwhile, the size of the muni ARS market continues to contract with another $8B+ being shaved off last week. The cumulative total of redemptions / called bonds is up to $56B since this chaos began. That is about 1/3 of the market's size at its peak.

  Municipal bonds continue to be attractively priced. Without too much effort, investors can find high-quality munis with yield ratios of 100% or more to comparable maturity Treasuries. Historically, this number has been in the low to mid 80% range.

Christopher Keith
Fixed-Income Manager