Conundrum of the Day
“For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum… Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.”
- Alan Greenspan - Testimony before Congress 2/16/05
Ample warnings have been given by the Fed. The result: 10-year Treasury note yields have declined by about 10 bp since the Chairman’s appearance in Frankfurt last November, when he warned that anyone who is still long fixed income securities and “has not appropriately hedged this position by now obviously is desirous of losing money.”
Subsequent, the Mortgage Finance industry, developed variable-rate products, interest-only loans, and flexible home equity lines of Credit. Wall Street investment bankers engineered a transformation of $100s of billions of variable-rate and subprime mortgage loans into collateralized debt obligations (CDOs), MBS, ABS, and other derivative products. In addition, an enormous amount of interest-rate hedging was put in place.
The market’s reaction to the warnings assured either a downward spiral in bond prices and a spike in rates; or a major margin squeeze and derivative unwind, resulting in a drop in rates.
We saw the margin sqeeze and unwinding when long term rates actually decreased. Now we are seeing the whipsaw effect in the downward spiral of bond prices and long term rates are increasing. So much for the conundrum.
- Alan Greenspan - Testimony before Congress 2/16/05
Ample warnings have been given by the Fed. The result: 10-year Treasury note yields have declined by about 10 bp since the Chairman’s appearance in Frankfurt last November, when he warned that anyone who is still long fixed income securities and “has not appropriately hedged this position by now obviously is desirous of losing money.”
Subsequent, the Mortgage Finance industry, developed variable-rate products, interest-only loans, and flexible home equity lines of Credit. Wall Street investment bankers engineered a transformation of $100s of billions of variable-rate and subprime mortgage loans into collateralized debt obligations (CDOs), MBS, ABS, and other derivative products. In addition, an enormous amount of interest-rate hedging was put in place.
The market’s reaction to the warnings assured either a downward spiral in bond prices and a spike in rates; or a major margin squeeze and derivative unwind, resulting in a drop in rates.
We saw the margin sqeeze and unwinding when long term rates actually decreased. Now we are seeing the whipsaw effect in the downward spiral of bond prices and long term rates are increasing. So much for the conundrum.
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