Credit Markets Seek Bottom

November 26, 2008

(bettertrades) - Flight-to-safety has been the name of the game since the credit and housing meltdowns hit the U.S. in the summer of 2007. Yields have been probing the ocean floor at a frantic pace since well before system risk forced the Treasury to institute the TARP program. With Treasury yields hovering at historically low rates, Wall Street could be watching safe-haven bets at their peak with the ease in which credit market participants have been making money.

Because U.S. government securities are considered risk free, that is, there is little or no chance of default, investors seek these safe-haven instruments when market risk increases.

Tuesday brought a renewed effort by the Fed to bring down long term rates. The 30-year mortgage rate dropped sharply on the Fed's announcement to lend up to $200 billion to security holders of student, auto, and credit card loans, along with its intent to buy $500 billion in GSE MBS's via direct purchase. On top of the Fed's program, the Treasury announced it will provide $20 billion in credit protection for the Fed.

Within the credit market, spreads on Fannie Mae and Freddie Mac's corporate debt plunged to their lowest point since the beginning of October. Mortgage rates for Fannie Mae and Freddie Mac had been downward sticky despite actions by the Treasury and Fed, mostly due to widening spreads resulting from an overarching fear of GSE viability. Credit-default swap spreads dropped across the board on Tuesday, representing a significant thaw in the mostly frozen lending market.

The 30-year bond climbed 3 3/32 to yield 3.621%, the benchmark 10-year note rose 26/32 to yield 3.108%, and the 2-year note gained 6/32 to yield 1.179%. Bond prices move inversely to yields; bond prices fall when yields rise and vice versa. Short-term yields like the 1-month and 3-month bill have seen their yields depressed to nearly 0% as safe haven buyers flood the Treasury market. Could the credit markets be signaling a bottom? A tepid decoupling between the credit and equity markets has made long-term forecasts exceedingly difficult. With that said, economists and traders alike are keeping a watchful eye on the spreads for credit-default swaps and OIS-Libor. Tuesday's thawing in the credit markets offered up the possibility that long-term instability could be nearing a bottom.