The ABX.HE CDS index is recovering and ticking back up. The 06 series mark 1 versions reached the 91.63 price point on a rising base: a sign of a recovering and more secure market.

ABX.HE.AAA.06-1: Credit Default Swap Index over AAA tranche ABS securities (2005 vintage).

Some Quick Analysis

So, taking the AAA tranche that were insured by the ABX.HE.AAA.06-1 CDS index, the upfront protection collateral transfer stands at $610k for a $10 million notional exposure (0.728889194 pool factor as of 25th March 2011 fixings) with a $13.12k per annum insurance premium. That is a 27% reduction in upfront collateral payments requirements since October 13th 2010.

Correction To Post
The section entitled “Breakeven Yield”, now removed, included a flawed assumption in its calculation over the underlying Asset Backed Securities and should not have been included in the initial publication. The protection collateral transfers and insurance premium calculations remain valid.

The European Central Bank recently decided to raise its core benchmark rate by 25 basis points presenting a slightly more hawkish view than the United States’ own supportive monetary stance.

The fundamentals across both markets are clearly different and, given the recent inflation pushes in the UK, it is understandable that Trichet is setting the ECB back within its own more restrictive mandate of inflation-control (as opposed to the Fed’s broader outlook on inflation and employment).

But Are Inflation Expectations Really Heading Higher?

Again, it is important to separate the factors affecting the European Monetary Union area with the economic factors covered by the Federal Reserve.

The US Fed’s preferred market metric in describing inflation expectations is the 5 year TIPS to treasuries break-even rate, a graph of which is available below. As the chart shows, there’s been some slight uptick over the course of February and March with resistance at the 3% level.


Data from Bloomberg, FED5YEAR:IND, Federal Reserve Forwad Breakeven Rate

Some debate still surrounds the reliability of the TIPS to treasury yield differential, in part, due to the relative liquidity premium existing between both securities. However, if one considers that the liquidity premia (or lack thereof) may be constant, then one could state that moves across the break even rate still represent shifts in market expectations.

Other Possible Signals to Shifts in Core Inflation

The previous chart depicted one possible market measure over inflation expectations but beyond the issue of expectations is the other substantive problem of actual inflation realisation. I was unable to obtain a raw data set over the FED 5 year break even rate in order to measure it back with actual core CPI measures but did obtain, courtesy of the St. Louis Fed Research branch, some core data over the 5 year Fixed for Floating swap spread.

Historical CPI and Core Measures

The following two charts present a quick ten year historical with CPI measures (percentage change from a year ago) at a broad level and then at the more core base that excludes food and energy prices.


CPI Broad Basket, Monthly Readings 2001 to 2011; source St. Louis Fed.


CPI Excluding Food and Energy, Monthly Readings 2001 to 2011; source St. Louis Fed.

5 Year Fixed For Floating Swap Rate

The following chart, provides data over 5 year fixed for floating swap rates, which, though not necessarily entirely derived from inflation measures, should still price across some level of inflation duration across to their holders.


5 Year Fixed For Floating Swap Rate; Data From St. Louis Fed.

Linear Visualisations

At this point, your eyes should have jumped to some level of affinity between the 5 year swap chart and the core CPI measures. But just to illustrate this a bit further, I’ve provided the following analysis with all data sets matched at a monthly base level.


CPI exc. Food & Energy Vs. 5 years Fixed For Floating Swap Rate

Some Quick Analysis…

The correlation between the core CPI and the 5 years fixed for floating seems to hold visually and does offer a light model between market pricing and core CPI measures.


Correlation Graph Between Core CPI and 5Yrs Fixed to Floating Swap Rate


Linear Regression statistics for 5 Year Swap Rate to Core CPI measures

Clearly, this single factor model still leaves too high a standard error for more stringent applications but it does provide one base over which to view shifts in core CPI separately from shifts in inflation expectations.

Core CPI: Historical Performance And Forecast Figures


CPI excluding Food and Energy VS. Model with March and April 2011 Forecasts

Forecast figures for the above chart were obtained by using averages for March and month-to-date April swap rate data. As the above chart shows, though core inflation is slightly rising, it is still within historical low ranges.

The US CPI figures for March 2011 are due for release this coming Friday, April 15th.

The US economy is progressing on the data front with core economic metrics still pushing to the upside and, in confirmation of past trends (see Plucking article), appears to be doing so at a broad based level.

GDP Revision, check – GO

Q4 2010 GDP figures have been reviewed to the upside with a slight push-up to the 3.1% mark.

Real GDP Above 2007 peak, check – GO

The US Economy is now holding and pushing above its 2007 peak for a reading a tad above $13.38 Trn (chained 2005 dollars).

Total NFP figures firming, check – GO

A further 216k jobs added over the past month. A little bit more per month would assist in matching adult population growth and a still distressed participation rate.


DC, Do We Have Lift-Off?

Again, the performance is good so far but the US front line remains with its unemployed. This is both a worry from a confidence perspective but also a boon from a core-inflation outlook. Labour market spare capacity is, fortunately, not pressuring core wage metrics just yet.

The year is still beginning but, on the bright side, Spring is coming. The odds favour warmer days ahead.

Okay, so the last post was a bit of a whinge over this website’s lack of quantifiable revenue over the near term horizon due to my advertising partner’s sudden about-face decision regarding our partnership. Fine, sudden tail-event encountered – moving on.

Now, as the last paragraph of the previous post succinctly asked: what is one’s word worth these days?

Not sure if there is a firm answer to this but, as in finance, your word is your bond. This logically leads to the following point of argument.

Minimal Coupons and Long Duration

So this website is now going down a long tortuous route of a minimal coupon bond with extreme duration. The real question therefore becomes: will redemption ever come?

Maturity in Perpetuity

You might now see where this may be leading us. There is a form of securities out there, rarely seen these days but still around, their ownership is varied and their usage many: indeed, I am referring to those known as the perpetuals.

The issue is topical at the moment as, with current global debt issues continuing to peek their noses beyond the curtain, many markets are wondering: where to from here? Maybe from here is a never-ending story. One that could range on into perpetuity.

The Rise of the Sovereign CONSOLS?

Investopedia explains Perpetuity
This is not as abstract a concept as you may think; the British issued bonds, called consols, which are a great example of a perpetuity. By purchasing a consol from the British government, the bondholder is entitled to receive annual interest payments forever. Although it may seem a bit illogical, an infinite series of cash flows can have a finite present value.
Source: Investopedia, Perpetuity

And so the question arises, should debt be considered finite and limited in nature or is redemption an unnecessary substitute for the realities of our market.

As most fixed income investors may attest, there is certainly a demand for ongoing future revenue streams and, certainly, this would solve the core issue of how to minimise a cumbersome debt-burden.

This will perhaps best be left for another future post but, who knows, perhaps the reality of perpetual maturity is much sooner than the term may first imply.

Unfortunately, much to my surprise, this site’s online advertising partner closed its services on me for reasons still slightly unclear. This leaves the website bereft of much love, oh wait, I meant money, which is unfortunate really.

It is not that this website is only driven by the good ol’money, but still, there is a point of principle here. No one works productively for free and this blog is not about to make an exception either.

Past Performance…

It really is a shame, actually, as the site’s been a good outlet for some personal research, which, to date, has proven reasonably accurate.

Listed below are a few of the past hits, so far no misses, that were listed on this site. Performance figures were calculated from the published date up until this article’s release date (30/03/11) with the exception of Implied Volatility Squared due to its focus on expiring options. All figures exclude any potential available leverage:

Okay, so this hindsight run is always nice to do from time-to-time. However, its the foresight that matters and again, it goes back to principle, without revenue this blog will have to stay calm and quiet for a while.

So What’s One’s Word Worth These Days?

Now, on more commercial matters, if anybody out there is interested in taking added market exposure, I am more than happy to oblige. Standard CPM/CPC commercial arrangements are available including third-party management through Google DoubleClick’s DFP platform. Please contact me at any time for further information.

If only I received a few dollars for every word I published since August of last year…

The last two weeks witnessed a nice VIX rumble with a brief spike above the 30 mark setting some screens abuzz with flashing lights. The good news is that VIX is now back into safe mode with ongoing economic fundamentals trumping ‘shock’ anxiety.

As a previous post noted (see: Implied Volatility Squared), this was, to a certain extent, priced in to VIX’s own implied volatility curves.

The high implied vol’ mark-up present over the front-month option months (that expired March 16th) needed to be priced through and across the expiry month. Add to that, the ongoing pricing through of previous VIX term-structure related contango, a little earthquake with radioactive aftertastes and fighter-jets buzzing down to North Africa and we were in for a nice little storm in a teacup moment.

VIX’s Contango From Here

Going back on the VIX term structure, we can see that the past market anxiety over VIX, previously discussed in the growing contango over its term structure through the second half of 2010, is now receding.

The VIX term structure appears slightly more subdued compared to start of year pricing as the next two graphs illustrate.

VIX Term Structure Jan 1st 2011

VIX Term Structure Jan 1st 2011 - Note the eager contango of 30.57% across first-quarter prices

VIX Term Structure March 25th 2011

VIX Term Structure March 25th 2011 - As of last Friday: a more subdued VIX front-end with a 17.65% spread over the front-quarter

Where To From Now?

Therein is the money question but it is good to know that the VIX contango, built-up over last year, served its purpose of pricing in some of the risks of this first quarter.

Admittedly, it is quasi-impossible to forecast all the risks that can be (eg. Earthquake/Tsunami/Nuclear Meltdown/Civil War). But maybe, as the VIX curve demonstrated, it is still possible to price their potential impact? Perhaps… Certainly, as this FT article notes, some people are already starting to wrangle over the potential of a slightly too vexatious VIX.

A Defensive Trade

Operation “Odyssey Dawn”, the UN sanctioned (Resolution 1973) No-Fly Zone restriction mission, is now underway over the skies of Libya.

Military assets, already on operational standby in the region, are now activated for ongoing saturation coverage of both Libyan air defense and air force related targets.

On The Market Front

The listed military industrial sector performed remarkably well in 2011 against broad benchmark index volatility due to North African uncertainties, oil price variance, nuclear catastrophes and Tsunami inducing earthquakes.

Explosive Expense Accounts

The charts below present the performance of sector leaders across North-American and European markets. Just as an aside, the Tomahawk® missile, manufactured by the Boeing (BA:US) and Raytheon (RMT:US) companies, come with a $569,000 unit cost (FY99 $). 110 missiles were launched during the opening phase of operations.

US Military Industrials Compared to S&P500


Lockheed Martin (LMT:US), The Raytheon Company (RTN:US), Northrop Grumman Corporation (NOC:US) and The Boeing Company (BA:US) versus YTD S&P500.

European Military Industrials Compared to EuroStoxx50


EADS (EADS:IX) and Dassault Aviation (AM:FP) vs EuroStoxx 50.

Asset Freeze

Also worthy of note is Resolution 1973’s continuation of resolution 1970’s efforts at both freezing and limiting the range of movements for the following economic individuals and entities:


Annex 1 to the United Nations Security Council Resolution 1973

Disclaimer: Material posted on 24-something does not contain (and should not be construed as containing) personal financial or investment advice or other recommendations. The information provided does not take into account your particular investment objectives, financial situation or investment needs. You should assess whether the information provided is appropriate to your particular investment objectives, financial situation and investment needs. You should do this before making an investment decision based on the material above. You can either make this assessment yourself or seek the assistance of an independent financial advisor. 24-Something, associated parties and Tariq Scherer accept no responsibility for any use that may be made of these comments and for any consequences that result.