Wednesday, March 18, 2009

Fed Announcement Prompts Bond Market Party

If you think that the rally in financials for the past few days has been a spectacle, and I do, it's nothing compared to the radical move in the bond market today.  The Fed announced that it would buy $300 billion in Treasuries and purchase an additional $750 billion of mortgage-backed securities.  The intention is to force down interest rates so that homeowners can refinance into lower monthly payments.  The 10-year note dropped an astonishing 50 basis points, which is one of the largest moves I have ever seen.  

Equities initially staged an impressive rally, after being down for most of the day until after the Fed announcement.  Gains have been tempered a bit as stocks have grown tired of racing uphill for so many days in a row.  Financials, however, have held on to very impressive gains.

The Fed is aiming its spigot in the wrong direction, in my opinion.  Demand for Treasuries isn't really the problem and pushing down the rate on the 10-year note doesn't really help solve the issue of the decline in the fundamental value of many riskier assets that were purchased with borrowed money at the peak of a very frothy market.  The assets won't generate the cash flows to service the debt.  Furthermore, I still don't understand the excitement over the Fed purchasing Treasuries when it has to issue a boatload of them to finance our growing deficit.  Technically it's just selling Treasuries to itself.  But the market is impressed, for now at least.  Whether this move finally filters through the economy and we see some legitimate improvement in economic fundamentals is anybody's guess.  But the fact that this is the largest single-day drop in the 10-year note's yield since October 20, 1987 is eerie, to say the least.




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