Wednesday, May 20, 2009

Bond market green shoots

The folks at Markit have some nifty but relatively arcane indices that track the performance of various asset-backed and mortgage-backed securities. The first chart here shows the price of a representative sampling of home equity-backed securities initially rated AAA, while the second chart shows a sampling of commercial mortgage-backed securities rated AAA. Note how the prices of these securities—issued typically at a price of 100—had absolutely cratered around the same time that the stock market hit its lows in March. In just the past month or so these securities have experienced a significant rally, presumably because the market has sharply revised downwards its expectations of defaults. This is highly significant, and I can't imagine how these price reversals could be attributed to anything other than a) the return of confidence, and b) improving prospects for economic growth and incomes. It's particularly reassuring that, despite all the talk about a developing bust in the commerical real estate market, securities that are directly tied to the health of that same market have experienced significant price gains across the board.

Bears will note that even with the recent price gains, these securities still reflect the expectation that default rates will be much higher than normal in both markets; that things now look very bad whereas before they looked positively dreadful. Optimists will counter that there has been significant improvement on the margin, that the likelihood of the economy falling down a black hole has declined dramatically, and that confidence is returning.


Unknown said...

...and who might have rated these securities? ;) ;)

Donny Baseball said...

Question is "has the Roubini crowd revised their estimates of teh 'capital hole' in the US banking system based on this info and dutifully gone on the record with the new assessment"? Unlikely.

Eccono-monkey said...

Scott, Do you look at the JOC research? Are they really the best at predicting cycle turning points? What other sources are best as leading indicators?

Scott Grannis said...

The Economic Cycle Research Institute does very good work with indices that track the economic growth cycle. I don't follow them as a rule, but I do know that they are pretty good at calling turns. I believe they have already called the end of the recession, and that agrees with what I have seen out there.

They also publish the JOC indices of commodity prices, and I follow those very closely.

My list of leading indicators would include the following: interest rates, inflation, politics, commodity prices, gold prices, the value of the dollar, the shape of the yield curve, the yield on TIPS, weekly unemployment claims, equity prices, etc.

The key thing I look for is prices that are market-determined in real time. Not government stats such as payroll employment which is subject to lags, seasonal adjustments, and time lags.