Market Insider

Fear Walking Down The Street


You can hear the wings flapping in the Treasury market, as the big flight to safety trade that started yesterday continues. The dollar is skidding to new lows, and a bit of fear has returned to the street.

Buying in Treasurys is creating a fairly sizeable drop in yields. Today, the two-year is yielding 3.906%, off from 3.98% yesterday, and the 10-year yield slipped to 4.497% from 4.55% yesterday.

What's to fear?
Well, part of the blame can be laid squarely on the banks. Big write downs and dismal forecasts from the financial sector this week are hurting sentiment across markets The latest shocker came from Bank of America , once a darling. Its profits fell a much larger-than-expected 32% to $3.7 billionas it put aside $2.03 billion for credit losses and said its non-performing assets doubled to $3.37 billion.

Also, Washington Mutual's CEO late Wednesday said he would not even try to forecast when stabilization in housing would return. WaMu also had a big mortgage related earnings miss.

Plus, the big Wall Street super fund rescue plan needs a rescue operation of its own. Instead of helping confidence, the Treasury initiative to have the major banks setup a fund to hold mortgage debt and other securities from structured investment vehicles (SIVs) has traders suspecting there's still a lot hidden beneath the surface in the credit markets.

The headaches in housing did not materially worsen this week, but there's certainly an increased LACK of optimism about the problem. High profile comments on housing's risks to the economy came from Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke .

Shake, Rattle and Roll
Another factor hurting the markets is geopolitical saber rattling. Tensions between the Turkish government and Kurds in Northern Iraq has cranked up the oil market. (Oil once more inching toward $89 per barrel today) Traders in all markets are watching that big move in oil.

Then, Russian President Vladimir Putin's visit this week to Iran highlighted what appears to be a growing divide between Russia and the U.S. Presidential comments from both sides these days play to the home crowd but also ring with what feels like an eery cold war tone. Although it's worth noting that neither Putin nor President Bush personally criticized the other when it came to Iran.

But Bush did elevate the importance of blocking Iran's nuclear program: "I've told people that if you're interested in avoiding World War III, it seems like you ought to be interested in preventing them from having the knowledge necessary to make a nuclear weapon."

Then Putin, back at home, warns the U.S. that Russia could retaliate if Washington ignores its concerns over plans for a European defense shield. "I can assure you that such steps are being prepared and we will take them," he said.

So, back to the credit markets. This morning, the Fed report on commercial paper showed the amount outstanding increased the for third week in a row. Commercial paper is type of short term note for corporate borrowing. Tony Crescenzi of Miller Tabak follows that report closely and he says in a note today that it shows continued stabilization of that market. Commercial paper outstanding increased by $1.2 billion to $1.866 trillion.

But the asset-backed commercial paper sector, the particularly troubled area of the market, continues to decline. There was a decline of $11 billion , more than last week's $6.8 billion drop off but much better than the $70 billion plus levels of past weeks.

I spoke to James Galluzzo who trades t-bills at RBS Greenwich Capital. T-bills during the worst of the credit crunch became a parking lot for some of the money that would have gone to the commercial paper market.

Galluzzo said there's some nervousness in the short-term market this week after a period of increasing stability. "The bill market is unstable right now, to say the least. Things started to come unglued yesterday when there was a very good bid to the short bills. they've sort of sustained those gains," he said.

"The bill curve is really steepening somewhat systematically," Galluzzo said. "The lack of liquidity is reminiscent of late August, early September. There's been a little bit of that at times. The bottom line is though I think once again the bill market is trading well in anticipation of commercial paper money spilling over into the bill market. I don't think the magnitude of the trade this time will be what it was in early September and August."

What Galluzzo describes is both a symptom and cause of the nervousness that has traders buzzing today. The market feels like it knows something, but what it knows may just be fear.

"Every time the t-bills do something unusual in the last few months, it was an early indicator of more credit ills down the road," said CNBC's Rick Santelli.

"The reason I think the fear trade hit the last couple of days is geopolitics, commodities prices and today we learned in the commercial paper numbers part of the explanation of the markets behavior of the last couple of days," he said.

The SIV rescue plan isn't a good thing, Santelli says. "It doesn't matter how much fresh wall paper you hang if the walls are covered in mold and that's the problem with this giant SIV fund."

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