Re: Bond Trading
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I guess I should be more clear about my "bet" on countrywide. One of the main factors that has hurt this bond (increased the yield) is the assessment of CFC's default probability. I hold a view that the market has overreacted and thus believe I am receiving a higher yield than I should for my assessment of their credit risk.
The yield curve play is more of a "kicker" that will help my trade rather than being a main factor. I believe that IF the market's assessment of countrywide's credit risk comes back to earth, the yield will of course drop, and any fed rate cuts that may be implemented between now and then will also help to decrease the yield.
Summary of my trade, worst case scenario I hold this bond 'til expiration earning the yield (receiving a higher yield than I "should" based on their probability of default, though I think there's very little chance the market lets them default). Best case scenario, their creditworthiness increases, the fed cuts the rate a few times over the next 12-18 months, and I sell the bond for a nice gain.
My next trade, if I were to make one which I won't because I'm taking things slow, would be to bet on the spread between the 10-year and 2-year treasuries tightening as the tension in the market eases. This is most simply done by just longing the 10-year and shorting the 2-year right? Would that fall under your "Steepening" (probably flattening in this case) category?
This stuff to me is much more interesting than plays on equities.
Thanks for the input.
Also, I'm not allowed to trade Fed Funds Futures because I work at the CME and I signed a piece of paper saying "NO FUTURES OR OPTIONS FOR YOU!" [img]/images/graemlins/tongue.gif[/img]
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A couple of thoughts......... I work on a municipal bond trading desk.
There is more at work in Countrywide bonds than the market thinking the company is/isn't going to be able to pay their debts as a going concern. Some other factors:
1.) The market is moving to more historical credit spread levels. For some reason the market did not learn it's lesson from 2000-2002. The credit spreads were ridiculously tight the last couple of years. I had been practically begging people to get rid of their off-rated bonds for app. 6 months. Some of the selling is normal repricing, the results of credit spreads widening. (If you need a more detailed explanation by all means say so)
2.) Baby and Bath water- Obviously you are seeing a "flight to stupidity" in this market. Many area's of the market that should be immune to the subprime mess are selling off (Muni's for example).
Last week Credit default swaps for Financial bonds (Goldman, Bear Stearns, Lehman etc. etc.) were trading as if the bonds were junk levels . Basically C.D.S.'s are swaps/pledges/contracts protecting the bond holder in the event of default. The reason I am mentioning this plays into your Countrywide position. Countrywide provided your analysis is correct will appreciate if/when the market reprices the risk associated to this company and/or the financials firm up in pricing.
Those are just a couple of things........
Also I wanted to say be careful with expecting Fed funds easing to immediately have an effect on your bonds. The fed funds rate or overnight rate has nothing to do with long term benchmark rates. You would expect the rates to go down obviously but in the environment we are in now that may not be the case.
An example: For a longtime we have had a flat to partially inverted yield curve. A Fed easing can certainly steepen the curve and make it more normal. However that would preclude long term rates from moving in concert.
Another example: (I am going from memory here and may be a little off, unlike Dcifr I most certainly do not have a photographic memory).
In June of 04' when the fed started tightening (raising) short term rates were 1.25% till June of 06 when they were 5.25. In that time long term rates changed hardly at all. So the short rates moved 400 basis points and the long term market moved maybe 50 basis points if at all.
Just a few examples of Fed funds rate cycles not really effecting the benchmarks much.
Anyway just food for thought. There is a lot of Jargon in my response sorry for that.
Edit: I just saw that you work on the CME so you probably knew what I posted already....
Further edit: Sorry Dcifr already touched upon CDS, I did not read his post prior to posting mine. Sorry for that.
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