August 27, 2007

www.hshnfinsec.com/

US Fixed Income
Market snapshot

LIBOR SW/GV SPREAD

current last current last
27-Aug 16-Jul 27-Aug 16-Jul
1M 5.503 5.320 2Y 66.000 49.800
3M 5.506 5.360 5Y 64.500 57.000
6M 4.411 5.387 10Y 65.000 65.800

SWAP RATES ATM CAP VOLS

current last current last
27-Aug 16-Jul 27-Aug 16-Jul
2Y 4.979 5.366 12M 23.090 8.450
5Y 5.057 5.517 2Y 22.250 13.120
10Y 5.263 5.699 5Y 20.150 15.200

Market commentary

Markets around the world have been
experiencing the effects of a liquidity crisis.
In response the central banks intervened by
extending terms of open market operations
and accepting more collateral. The FED
lowered the rate at the discount window by 50
bps and injected liquidity in the form of
overnight/term repurchase agreements.
However, the commercial paper markets,
specifically ABCP markets, are still not trading.
Money market funds that usually invest in
ABCP have reallocated investments towards
treasury bills, short term agency paper and
other safe havens. This is creating a
dislocation in the short end of the curve,
where US treasuries trade 250 to 350 bps
below the federal funds rate (as compared to
the traditional 35bps), cash rates are higher
and the forward curve implies an easing in
monetary policy.
Whereas the ABCP markets have dried up,
there are pools of liquidity available, albeit at
levels which are a slight premium to where we
are accustomed to funding. The next 90 days
with several trillion CPs maturing and waiting
to be rolled will be crucial. If the CP market
does not clear companies might have to draw
on their secondary lines of credit or shrink
their balance sheets.
How is economic growth affected by this
financial turmoil? With equity markets around
the world stabilizing or slightly recovering it is
suggested that global growth is not severely
endangered by an US Subprime crisis. There
are however a couple of factors that might
take a good chunk out of the US GDP:
Sustained rise in risk premia, lengthy
correction in equity markets and further
declining of home prices.
The first two factors can be attributed to a
general deleveraging of the market, slower
M&A activity and pricier leveraged buyouts.
With investors backing up from ABCP
programs it will be more difficult to restructure
and sell credit through structured and complex
securities – those types that were traditionally
put into SIVs. Trends should go to simpler
products.
The last factor – falling home prices – is part
of a slow correction in the residential real
estate market. Experts think that the housing
market will continue to cool down well into
2008. Current inventories are at new 16-year
highs and reached levels of several months of
demand. Foreclosures keep on rising with still
more adjustable rate mortgages having rate
adjustments in Q4 of 2007 and Q1 of 2008.
US Fixed income 8/27/2007 page2

Should there be a material deterioration

markets expect that the FED will intervene by
cutting the benchmark rate. This chance is
currently priced in with expectations for the
next FOMC steps wide spread. They are
centered around a 50 bps ease in the
September meeting, an additional 25 bps in
October and unchanged in December. Volatility
in short maturities is extremely high. With
liquidity rushing into riskless treasury bills with
maturities of 6 months and less short rates
moved at times by more than 80 bps.

Many market participants expect some more

jitters probing financial institutions for
weaknesses. Risk aversion is likely to persist
and markets will be very sensitive to headline
risk.

tino.mehlmann@hshn-finsec.com
+1 212 905 7364

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