Fixed Income Weekly Review & Preview

Transcription

1 Fixed Income Weekly Review & Preview January 24, 2005 Fixed Income Trading Joseph W. Jasper, CFA Director, Fixed Income Strategy & Marketing Private Client Services Fixed Income Investments HIGHLIGHTS Yields fell in parallel last week amid mixed economic reports, including a softer than expected December CPI. Traders who had been betting on stepped-up rate hike trajectory have now scaled back those concerns to reflect the current 25 basis point path. We reiterate our curve flattening outlook. Treasuries Yields fell between eight and nine basis points across the curve last week, led by mixed economic news. The front-end of the curve looks especially over-bought, and we recommend moving out of fixed-rate two and three-year paper into floating-rate product. TIPS TIPS underperformed last week against the softer than expected December CPI. Breakevens narrowed between four and six basis points on the week. We continue to expect breakeven spreads to narrow in the weeks ahead and would refrain from new purchases with an eye toward cheaper entry points. Agencies Agencies finished mixed with the belly underperforming the wings. Mortgages We believe the spike in refi activity to be holiday-related, and continue to recommend premium collateral in 30-year passthroughs. GNMAs are the exception to the rule, where we expect refi activity to remain elevated as borrowers exercise their option to obtain cheaper loans. Corporates Corporates ended mixed, although auto spreads swung wildly during the week. We believe utility bonds are expensive relative to comparably-rated industrials. Municipals We recommend taxable buyers take advantage of the recent cheapening in taxable munis relative to Treasuries, agencies and corporates. This information is a product of the Fixed Income Trading Department and should not be construed as research or a research report. This is for informational purposes only. Fixed Income Weekly Review Page 1 of 8 Piper Jaffray

2 WEEKLY: YIELD, COMMODITY, CURRENCY, AND STOCK MARKET CHANGES LAST WEEK PRIOR WEEK CHANGE (IN BPS)* 3 Month 2.34% 2.36% (2) 2 Year 3.15% 3.23% (8) 3 Year 3.30% 3.39% (9) 5 Year 3.64% 3.71% (8) 10 Year 4.14% 4.23% (9) 30 Year 4.65% 4.73% (8) Curve 2s-10s (0) Curve 2s-30s Year TIPS (0.00) 10 Year TIPS (0.04) 30 Year TIPS (0.05) CRB Crude Oil Gold Yen Euro (0.01) S&P 500 1, , (16.65) Dow Jones Ind. Avg. 10, , (165.01) NASDAQ Comp. 2, , (53.64) *Change column numbers in brackets represent a decline in value relative to the previous week. LAST WEEK S ECONOMIC RELEASES DAY STATISTIC ACTUAL CONSENSUS ESTIMATE Tues. Empire Manufacturing Weds. Consumer Price Index -0.1% 0.0% Less Food & Energy 0.2% 0.2% Housing Starts 2,004,000 1,903,000 Building Permits 2,021,000 1,985,000 Initial Jobless Claims 319, ,000 Continuing Claims 2,694,000 2,675,000 Fed Beige Book Thurs. Leading Indicators 0.2% 0.2% Philadelphia Fed Fri. U. Michigan Sentiment THIS WEEK S ECONOMIC RELEASES DAY TIME STATISTIC CONSENSUS PREVIOUS (CDT) ESTIMATE Tues. 8:45 Consumer Confidence :00 Existing Home Sales 6.80M 6.94M Thurs. 7:30 Durable Goods Orders 0.8% 1.4% 7:30 Less Transportation 1.4% -1.4% 7:30 Initial Claims 333, ,000 7:30 Continuing Claims -- 2,694,000 Fri. 7:30 Q4 GDP Annualized 3.6% 4.0% 7:30 Personal Consumption 4.1% 5.1% Fixed Income Weekly Review Page 2 of 8 Piper Jaffray

3 DAY TIME STATISTIC CONSENSUS PREVIOUS (CDT) ESTIMATE 7:30 GDP Price Deflator 2.2% 1.4% 7:30 Employment Cost Index 0.9% 0.9% Source: Bloomberg ECONOMICS The tone of economic releases last week pointed to a cooling of growth relative to recent months. Manufacturing, inflation, and consumer sentiment all missed their respective forecasts to the low side and prompted some market participants to readjust their expectations for the pace of expansion during Manufacturing activity declined as both the Empire State Manufacturing Survey (Actual vs. Consensus 25.0) and the Philadelphia Fed Survey (Actual 13.2 vs. Consensus 25.0) reported a decline in new orders. Inflation, as measured by the CPI, fell last month led by declines in energy prices. Core CPI (excluding food & energy) rose 0.2% in December, inline with expectations, and is consistent with our view that the rate of inflation will recede in the months to come, leaving the Fed latitude to raise rates at a "measured pace." The University of Michigan Preliminary Sentiment Index abruptly reversed course in January after three months of continued expansion. The expectations sub-index, which is a measurement of optimism for economic conditions over the next one to five years, led the decline on concerns about the pace of job growth. Residential housing continued to accelerate after a brief pause in November. Housing starts rose 11% to slightly over 2 million units fueled by a decline in mortgage rates. Initial jobless claims fell to 319,000, well below the consensus of 345,000. The Labor Department noted this number was heavily affected by seasonal adjustments and likely to be revised. Continuing claims however exceeded forecasts rising to 2,694,000 versus the consensus of 2,675,000. As expected, the Index of Leading Economic Indicators rose 0.2% last month, led by gains consumer confidence, orders for capital goods and stock prices. FIXED INCOME STRATEGY Macro Themes The focus of this week will be the Treasury s auctions (two-year and 20-year TIPS) interspursed with several economic indicators including consumer confidence on Tuesday, durable goods Thursday, and GDP and the Employment Cost Index Friday. The next market moving events will occur in two weeks with the February 2 nd FOMC meeting, and the release of the January payroll report on the 4 th. The market is expecting 25 basis point rate hikes at each of the next three FOMC meetings. However, expectations have been receding for the path of Fed tightenings, and GDP growth after June. We continue to expect the fed to tighten until the 3.75% level based on the tone of economic data released to date. Fixed Income Weekly Review Page 3 of 8 Piper Jaffray

4 GRAPH 1 HISTORICAL TREASURY SLOPE Yield (in %) 3.5 ` 2.5 Off-The-Runs Strips On-The-Runs 2 Swaps Maturity Notes: 1. Off the Runs: Treasury securities other than the most recently issued benchmark securities. 2. On-the-Runs: Most recently issued Treasury benchmark securities. Treasuries The tone of last week s data was supportive to bond prices with most indicators coming up short of expectations. The Treasury will announce a two-year for auction Wednesday, and on Tuesday will auction $8 billion of its existing 20-year TIPS. TIPS The soft December NSA CPI prompted a sell-off in TIPS, narrowing breakeven spreads between two and ten basis points across the curve. Front-end issues bore most of the selling pressure because they respond more responsive to changes in near-term inflation measures relative to longer maturities. As mentioned the Treasury will reopen its existing 20-year this week with an $8 billion auction, bringing the total outstanding to $19 billion. We suggest looking for cheaper valuations before making any additional allocations to TIPS, especially among shorter maturities. Agencies Agencies ended mostly unchanged versus Treasuries in the front end but widened between one and two basis points further out the curve. In new issuance activity, Home Loan priced $4 billion of a two-year issue, and Freddie Mac priced $3 billion of a ten-year. After this spate of supply, there is no more scheduled issuance until mid-february, when Freddie Mac is likely to come in with a front-end issue. Fixed Income Weekly Review Page 4 of 8 Piper Jaffray

5 Fannie Mae debt continues to trade well in spite of relatively frequent headline bombs. Earlier this week, Fannie cut its common dividend, causing a mini-panic in the trading of their equity. Spreads on Fannie Mae benchmark issues have remained largely unchanged however, which we believe is appropriate, considering the immaterial nature of such news on the Company s ability to service its debt. Senator Chuck Hagel (R-NE) said that next week he will reintroduce the GSE reform bill (often referred to as the Shelby Bill) from last year that passed the Senate Banking Committee by one vote but fell flat soon afterward. We expect receivership (the ability of a regulator to sell off assets in case of extreme financial distress) to be the most significant issue addressed in the legislation, and we believe this portion of the bill will be a hotly debated topic. We continue to expect Agency s to outperform Treasuries on a spread basis in light of positive supply technicals and continued strong foreign demand. According to company filings, Fannie Mae s portfolio grew a modest 0.7% for all of The near zero growth rate is a function of the company s capital constraints and continued rich valuation conditions within the mortgage market. These factors support our belief that funding needs at both Fannie Mae and Freddie Mac will continue to be modest over the foreseeable future. Mortgages The sizable jump in last week s MBA refinance index (up 19%) has raised concerns about prepayments among mortgage products. We believe the spike was largely attributable to the holiday reporting period. Activity historically jumps around this time as homeowners rush to close transactions by yearend. Looking forward, we expect prepayments to decline modestly given the range bound interest rate climate. Accordingly, we reiterate our preference for premium 30-year collateral in passthroughs. On a related note, we suggest buying discount GNMA paper. We believe the continued elevated prepayment rates for GNMA bonds relative to FNM and FRE paper is the result of the increasing ability of GNMA borrowers to refinance their traditionally higher cost loans as loan to value ratios drop. These ratios continue to fall as home prices appreciate. Refi Index / Mortgage Applications The Mortgage Bankers Association s index of mortgage applications rose 16.18% to The purchase index increased 13.99% to The refinancing index rose 19.07% to 2, Corporates Investment grade corporate bond spreads finished the week mostly unchanged as investors continue to be hesitant buyers with spreads at five-year lows. Autos were the most volatile, with spreads closing mixed as long GM s tightened 11 basis points while Ford s widened a like amount. Last year, the utility sector was one of our favorites. Looking at current valuations however, suggests the time has come to look elsewhere for incremental yield. Graph 4 highlights the yield advantage of BBB-industrials relative to comparably rated utility bonds. We suggest taking advantage of the spread compression in utilities by swapping into wider industrial names. Fixed Income Weekly Review Page 5 of 8 Piper Jaffray

6 GRAPH 4 SELECTED INVESTMENT GRADE CORPORATE BOND SPREADS 120 Utilities BBB Industrials BBB 100 Spreads (in basis points) year 10 year 30 year Municipals Municipals underperformed Treasury counterparts last week, cheapening their relative valuations. We expect supply to continue to be on the light side for the final week of January, but should pick up in both February and March. Spring is historically a soft period for municipal prices as issuance picks up and investors focus instead on their April tax burdens. We would take advantage of any relative price weakness to add to municipal allocations based on our outlook for a roughly 20% drop in net issuance during There are several taxable deals scheduled to be priced over the next few weeks, providing a perfect opportunity to highlight the increasingly cheap valuations in the sector relative to other taxable sectors. Graph 5 reveals that long taxable munis have cheapened relative to Treasuries, triple-a rated corporates and agency bonds. We expect this phenomenon to be temporary in nature and would take advantage of current cheap valuations by swapping out of more expensive spread product in favor of taxable munis. Fixed Income Weekly Review Page 6 of 8 Piper Jaffray

7 GRAPH 5 TAXABLE MUNICIPAL BOND SPREADS Spread (in basis points) /2/04 2/2/04 3/2/04 4/2/04 5/2/04 6/2/04 7/2/04 8/2/04 9/2/04 10/2/04 11/2/04 12/2/04 1/2/05 Spread over Moody's AAA Index Spread over 30-yr Treasury Spread over 30-yrFNMA MUNICIPAL CONSENSUS YIELD CHANGES FOR THE WEEK MUNICIPAL CHANGE % TO TREASURY YIELD (IN BP) LAST WEEK PREVIOUS WK 5-YEAR AVG. 2 Year % 70.9% 79.0% 5 Year % 76.5% 81.2% 10 Year % 85.4% 86.5% 30 Year 4.66 (2) 100.3% 99.0% 95.5% Source: Municipal Market Advisors CORPORATE MARKET DETAIL CORPORATE RATINGS CHANGES Issuer Ratings Action Rating To From Moody s / S&P Comcast Corp. Watch Positive -- Baa3/BBB Deere & Co. Watch Positive -- A3/A- Foster s Finance Corp. Rev. for Downgrade -- Baa1/BBB+ International Flavors and Fragrances Stable Negative A3/BBB+ Jeffries Group, Inc. Baa1 Baa2 Baa1/BBB Northeast Utilities Rev. for Downgrade -- Baa1/BBB Sara Lee Corp. A A+ A3/A Transocean Inc. Positive Stable Baa2/A- Tyco International Group S.A. Positive Stable Baa3/BBB U.S. Bancorp Aa2 Aa3 Aa2/A+ Westar Energy Rev. for Upgrade -- Ba1/BBB- Source: Piper Jaffray. Ratings Actions by S&P and Moody s. Fixed Income Weekly Review Page 7 of 8 Piper Jaffray

8 CORPORATE NEW ISSUES FROM LAST WEEK Issuer Coupon Maturity Spread Amt. (MM) Rating (in bp) Moody s S&P ALEXION PHARMACEUTICALS /1/2012 NA 125 NA NA ALH FIN LLC/ALH FIN CORP 8.5 1/15/ B3 CCC+ ALLSTATE LIFE GLOB FD TR NA 1/25/2008 NA 225 Aa2 AA ALLSTATE LIFE GLOB FD TR /25/ Aa2 AA ALROSA FINANCE SA /17/ B2 B ANTIGENICS INC /1/2025 NA 50 NA NA APPALACHIAN POWER CO /1/ Baa2 BBB CARRIAGE SERVICES INC /15/ B2 B- CASCADE NATURAL GAS CORP /1/2035 NA 30 Aaa AAA COMMONWEALTH BANK AUST 3.5 1/25/2008 NA 30 NA NA CSN ISLANDS IX CORP 10 1/15/ B1 BB- DEL LABORATORIES INC 8 2/1/ B3 CCC+ FED REPUBLIC OF BRAZIL /3/ B1 BB- FOREST CITY ENTERPRISES 6.5 2/1/ Ba3 BB- JPMORGAN CHASE & CO NA 1/25/2008 NA 2,750 Aa3 A+ LANDWIRTSCH. RENTENBANK /15/ ,000 Aaa AAA LESLIE'S POOLMART /1/ B2 B- RABOBANK NEDERLAND 3.5 1/21/2008 NA 100 NA NA REPUBLIC OF AUSTRIA 4 3/30/ ,000 Aaa AAA ROYAL BANK OF CANADA /26/ Aa2 AA- SWEDISH EXPORT CREDIT 4 6/15/ ,000 Aa1 AA+ TOYOTA FINANCE AUSTRALIA 1.4 1/27/2006 NA 1,000 NA NA VEDANTA RESOURCES PLC /22/ Ba2 BB Source: Bloomberg Disclaimer This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may not be eligible for solicitation in the states in which the client resides. Officers or employees of affiliates of Piper Jaffray & Co., or members of their families, may have a beneficial interest in the Company's securities and may purchase or sell such positions in the open market or otherwise. Past performance is not indicative of future results. Notice to customers in the United Kingdom: This report is a communication made in the United Kingdom by Piper Jaffray & Co. to market counterparties or intermediate customers and is exclusively directed at such persons; it is not directed at private customers and any investment or services to which the communication may relate will not be available to private customers. In the United Kingdom, no persons other than a market counterparty or an intermediate customer should read or rely on any of the information in this communication. Securities products and services offered through Piper Jaffray & Co., member SIPC and NYSE, Inc., a subsidiary of Piper Jaffray Companies. Additional information is available upon request. No part of this report may be reproduced, copied, redistributed or posted without the prior consent of Piper Jaffray & Co Piper Jaffray & Co., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota Fixed Income Weekly Review Page 8 of 8 Piper Jaffray