Fixed Income Quarterly Review
Fixed Income Quarterly Review, 09 / 2008
Chart 1: The Treasury Yield Curve
The credit crisis that has been affecting all credit markets since August 2007 accelerated during the third quarter of 2008. One of the results of this intensification was a broad rally in the Treasury market.
The 2-year Treasury yield fell 66 basis points, beginning the quarter yielding 2.62% and ending at 1.96%. The 10-year Treasury yield fell 15 basis points, starting the quarter at 3.97% and ending at 3.82%. The 30-year Treasury yield fell 21 basis points, starting the quarter at 4.52% and ending at 4.31%.
Chart 2: The Shape of the Yield Curve
The rally in the Treasury market that put yields down during the quarter was more pronounced in shorter maturities than in longer ones. Consequently, the 10-year / 2-year yield curve steepened beginning the quarter with a difference of 135 basis points and ending the quarter with a difference of 186 basis points.
The action in the Treasury curve illustrates the market's perception that the Federal Reserve may be put into the position of needing to further lower interest rates.
Chart 3: Corporate Bond Spreads
The yield spread on the Merrill Lynch Corporate Master index rose dramatically during the third quarter. The spread for the index increased 181 basis point, beginning the quarter 274 basis points over Treasuries and ending 455 basis points over.
Bond spreads of finance companies led all spread widening rising 294 basis points, beginning the quarter 322 basis points over Treasuries and ending the quarter 616 basis points over. Financial bonds comprise a large portion, 41% at the end of the third quarter, of the investment grade corporate bond market.
Chart 4: Intermediate Term Bond Market Performance By Sector
Risk taking was largely abandoned during the third quarter as most anything without the explicit, or at least the strongest implicit, guarantee of the U.S. Government was shunned.
U.S. Treasury notes were the best performing sector during the quarter followed by U.S. agency mortgage-backed securities. Corporate bonds had their worst quarter since 1980, lagging badly with the financial sector of the bond market posting a loss of 12.8% for the quarter.
Chart 5: Mortgage Lending Standards - Rising Sharply
The U.S. Government has taken many measures to attack the current crisis in the credit markets. The Emergency Economic Stabilization Act of 2008 is the latest proposal which would allow the government to purchase up to $700 billion in distressed assets from the banking system. This, along with the expansion of other existing programs has dramatically increased the assets and liabilities of the Federal Reserve System.
As much as this balance sheet expansion implies more public debt, it also underscores the length to which the government is willing to go to ease the credit problems currently swirling around the financial markets.
Chart 6: The Price Of Oil Per Barrel - West Texas Intermediate
LIBOR is an issue at the heart of the current credit turmoil. The London Inter-Bank Offering Rate (LIBOR) is a measure of the rate that major banking institutions lend to each other. It is the the lubricant that moves through the financial system allowing money to flow quickly from banks that have an excess amount to those that need extra.
Typically, the LIBOR rate is 20 to 40 basis points above the U.S. Treasury bill rate. Last fall it became quite elevated and it shot up dramatically in the third quarter beginning the quarter at 101 basis points and ending the quarter at 314 basis points. This is indicative of banks unwillingness to lend to each other. The efforts by the Federal Reserve and the U.S. Treasury Department are aimed at reducing this very elevated inter-bank lending rate.
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