Credit Default Swaps Are Unveiled

Since the waterfall effect created in the stock markets in October of 2008, I have remained wary of the lack of visibility of the credit default swap (CDS) market. This is another 800 pound gorilla in the room, and I am concerned that I cannot see any sign of it. These derivative securities were a major influence in how rapidly stock and bond prices shed value and I cannot forget that. Companies (primarily the foreign and domestic 'too big to fail' entities) that used them for protection suddenly found they were unprotected and suffered large, unexpected losses, repeatedly. Thanks to a swift accounting rule change and federal bailouts to cover realized losses and build up reserves for future losses, their losses were only temporary stock price declines that have almost completely recovered. This may have something to do with their complexity. But their complexity has not prevented Ron Hera from taking on the investigative task and having his article published on Financial Sense. Hera has written what I think is the best review of the CDS world I have found and I want to refer to it in the future. Here is the link to "OTC Derivatives: Failed Banks or Failed Nations?"

10 Yr Treasury Note is Still in Demand

Here is a summary from Bloomberg following today's ten year note auction. For some longer historical perspective, see an earlier post about the 10 yr Note. Briefly, yield has fallen from 3.90% in the April auction when the bid-to-cover ratio was a nine year record high 3.72. This month shows a ratio of 2.96 indicating less enthusiasm for the Note, but still historically strong.

Bidding was aggressive for the month's 10-year note auction, an oversize $24 billion offering where coverage came in at a solid 2.96. Dealers are definitely losing business as direct bidding was very aggressive at 25 percent. Indirect bidding was also firm, at 42 percent, making for a combined 67 percent non-dealer takedown and far above the 52 percent average.

High yield of 3.548 percent was right at the 1:00 bid. A look back at the high yield in last month's auction offers a key yardstick for the sovereign-risk effect. The April yield was more than 35 basis points higher than now, this during a time when U.S. economic data have strengthened! Tomorrow the Treasury auctions $16 billion of 30-year bonds.

Wholesale Inventory and Sales Summary

This from Bloomberg...

Wholesale inventories rose 0.4 percent in March but are far below the 2.4 percent rise in sales, a mismatch that pulled the inventory-to-sales ratio down 3 tenths to a record low of 1.13. This mismatch is not due to price swings but is fundamental and reflects company reluctance to build stocks as the durables ratio fell 2 tenths to 1.50 vs. a 3 tenth slide for non-durables to 0.83.

But the durables side does show solid evidence of accelerating build with inventories up 0.8 percent on top of a 0.6 percent rise in February. Inventories of metals, computers, electrical goods, lumber and autos all rose. Wholesale sales of durables show wide and more significant gains led by lumber, metals, furniture and machinery. The rise in lumber and furniture sales points to improvement in the housing sector while metals and machinery point to improvement in the industrial sector.

Lending and Bank Solvency

This wholesale trade summary posted earlier today tells me that there is weak momentum behind the growth we have in our US economy. Reliant on consumers for nearly 70% of US GDP, there is still too much potential for another housing price collapse due to the number of homeowners who are underwater, the number of homes repossessed and held back from the market in support of prices of houses already listed, and the Fed is no longer providing liquidity. I expect home loans will get more difficult to qualify for than they are now. That seems to be born out in the graph from the St Louis Fed below.

Market Data: Week Ending May 7, 2010

Market Index	2009 Close	5/07   Close	Week Change	YTD Change
Dow Industrials Avg	10428.05	10,380.43	-5.71%	-0.46%
S&P 500	1115.1	1,110.88	-6.39%	-0.38%
Fed Funds Rate	0.25%	0.25%	0%	0%
10 yr T-bond Yld	3.85%	3.43%	-0.22%	-0.42%
5 yr T-note Yld		2.16%	-0.26%
5 yr infl adj Note		0.38%	-0.01%
Implied 5 yr Inflation %		1.78%	-0.25%
2 yr T-note Yld	1.14%	0.81%	-0.15%	-0.33%
2-10 Yr Slope	2.70%	2.62%	-0.07%	-0.08%
90 day T-bill Yld		0.12%	-0.03%
Gold ($/oz)	$1,096.95	$1,210.40	2.45%	10.34%
WTI Oil ($/brl)	$79.36	$75.11	-11.50%	-5.36%
Credit Spread		5/07   Close	Week Change
Inv Grade Credit Idx		4.94%	0.19%
Low Grade Credit Idx		8.86%	0.64%
Markit CDX Inv Grd Idx		92	3.37%
Markit CDX Mid Grd Idx		143	1.42%