Ed Yardeni thinks that the volatile duration of mortgage-backed securities is the principal factor behind the extraordinary recent volatility of the ten-year bond:
Posted by DeLong at August 2, 2003 07:00 PM | TrackBackTreasuries as Predictor and, Maybe, Shocker: Edward Yardeni, chief investment strategist at the Prudential Equity Group, took some time last week to chat about the implications of the rise in interest rates for the economy and the stock market.... "Bonds did get dramatically overbought. But much of what has happened in the last few months probably had more to do with derivative transactions related to mortgage-backed securities. As mortgage rates declined, prepayments increased, reducing the duration of mortgage backs. Mortgage portfolio managers with certain duration requirements then had to go out and buy Treasury bonds, which pushed rates lower. They were the most aggressive buyers in May and June. In many ways what happened is similar to what happened in the fall of 1987, when the purchase of portfolio insurance exacerbated the slide in stock prices...
"The announcement from the Treasury that they would need to raise $450 billion over the course of the next year started to reverse the process. With that announcement, the bond market realized they were going to get stuffed with a lot more bonds for the sake of reviving the economy, and more parochially, for the sake of re-electing the president. That started to push interest rates up, and all that derivatives-related activity suddenly went into reverse.
"The Federal Reserve also played a role. Alan Greenspan testified in Congress last month that some research showed that alternative methods of conducting monetary policy, like buying 10-year Treasuries to bring rates down, wasn't a good idea. That didn't help...
http://www.economist.com/finance/displayStory.cfm?story_id=1920907
the economist on mortgage hedge unwinding: "Rising long-term rates led to a vicious circle in the mortgage and Treasury markets. As rates rose, holders of mortgages tried to curb losses by selling Treasuries, which only led to further rises in long-term rates and more losses on their mortgage portfolios."
http://online.wsj.com/barrons/article/0,,SB105977974854313800,00.html
barron's on 1987 all over again: "IT'S CONSIDERED BAD FORM TO UTTER "1987" on an equity-trading floor, the way theater actors are never supposed to mention "Macbeth" by name. So maybe it's no surprise that stock traders felt themselves to be held at knifepoint last week, as the market talk centered on the steepest run-up in Treasury yields since '87."
Posted by: dirk on August 2, 2003 10:31 PMThe party on the secondary bubble is almost over people.
First, there has been very little market run up in constant currency terms, plotting the S&P against the Euro - the "Poor Euro", shows this. You can also do another, more blunt indicator - the S&P in Barrels of Oil.
Both tell the same tale, there was a pop at the end of the war, but most of the rest - is devaluation.
Posted by: Stirling Newberry on August 3, 2003 06:32 AMThe question is will a rise in 10 year treasury rates from 3.11 ro 3.40 between June 13 and Aug 1 slow GDP growth in months to come.
Also, please explain further the "devaluation" effect of the S&P price increase. Does this mean there may be a switch by Euro market investors from American bonds to American stocks as a hedge against devaluation? Stephen Roach believes such an asset switch in shown by Morgan Stanley trading deak patterns.
Posted by: anne on August 3, 2003 07:39 AM