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Fixed Income Weekly Review & Preview

Highlights

HAWKISH COMMENTS BY FED CHAIRMAN GREENSPAN AND AN UPSIDE SURPRISE IN THE PPI PROMPTED INVESTORS TO DUMP TREASURIES ACROSS THE MATURITY SPECTRUM. THE FIRST SIGNIFICANT SELL OFF OF THE YEAR CAME AFTER GREENSPAN DESCRIBED THE CURRENT LOW LEVEL OF LONG-TERM RATES AS A “CONUNDRUM.” SELLING ACCELERATED AFTER THE JANUARY PPI REPORT SHOWED ACCELERATING INFLATION AT THE CORE LEVEL BEYOND WHAT MANY HAD BEEN EXPECTING. ALL EYES ARE NOW ON THIS WEEK’S CPI RELEASE FOR ADDITIONAL CLUES ON INFLATION AND THE LIKELY IMPACT FOR THE FED’S CURRENT TIGHTENING PATH.

WEEKLY: YIELD, COMMODITY, CURRENCY, AND STOCK MARKET CHANGES

| |LAST WEEK |PRIOR WEEK |CHANGE (IN BPS)* |

|3 MONTH |2.60% |2.55% |6 |

|2 YEAR |3.42% |3.33% |9 |

|3 YEAR |3.60% |3.48% |12 |

|5 YEAR |3.85% |3.69% |17 |

|10 YEAR |4.26% |4.09% |17 |

|30 YEAR |4.65% |4.48% |17 |

|CURVE 2S-10S |84 |76 |8 |

|CURVE 2S-30S |123 |115 |8 |

|5 YEAR TIPS |1.11 |1.03 |0.07 |

|10 YEAR TIPS |1.66 |1.56 |0.10 |

|30 YEAR TIPS |1.76 |1.68 |0.09 |

|CRB |290.66 |286.18 |4.48 |

|CRUDE OIL |48.35 |47.16 |1.19 |

|GOLD |428.40 |422.00 |6.40 |

|YEN |105.65 |105.71 |(0.06) |

|EURO |1.31 |1.29 |0.02 |

|S&P 500 |1,201.59 |1,205.30 |(3.71) |

|DOW JONES IND. AVG. |10,785.22 |10,796.01 |(10.79) |

|NASDAQ COMP. |2,058.62 |2,076.66 |(18.04) |

SOURCE: BLOOMBERG, PIPER JAFFRAY

*Change column numbers in brackets represent a decline in value relative to the previous week.

Last Week’s Economic Releases

|Day |Statistic |Actual |Consensus Estimate |

|Tues. |Empire Manufacturing |19.19 |20.0 |

| |Advanced Retail Sales |-0.3% |-0.4% |

| |Less Autos |0.6% |0.4% |

| |Business Inventories |0.2% |0.3% |

|Weds. |Housing Starts |2,159,000 |1,943,000 |

| |Building Permits |2,105,000 |2,000,000 |

| |Industrial Production |0.0% |0.3% |

| |Capacity Utilization |79.0% |79.3% |

|Thurs. |Import Price Index |0.9% |0.7% |

| |Initial Jobless Claims |302,000 |325,000 |

| |Continuing Claims |2,717,000 |2,710,000 |

| |Leading Indicators |-0.3% |-0.2% |

| |Philadelphia Fed |23.9 |17.8 |

|Fri. |Producer Price Index |0.3% |0.2% |

| |Less Food & Energy |0.8% |0.2% |

| |U. Michigan Sentiment |94.2 |94.8 |

Source: Bloomberg, Piper Jaffray

This Week’s Economic Releases

|Day |Time |Statistic |Consensus Estimate |Previous |

| |(CDT) | | | |

|Tues. |9:00 |Consumer Confidence |103.0 |103.4 |

|Weds. |7:30 |Consumer Price Index |0.2% |-0.1% |

| |7:30 |Less Food & Energy |0.2% |0.2% |

| |1:00 |FOMC Feb. 2 Meetings |-- |-- |

|Thurs. |7:30 |Durable Goods Orders |0.1% |0.6% |

| |7:30 |Less Transportation |0.3% |2.1% |

| |7:30 |Initial Jobless Claims |308,000 |302,000 |

| |7:30 |Continuing Claims |2,710,000 |2,717,000 |

|Fri. |7:30 |GDP Annualized |3.7% |3.1% |

| |7:30 |Personal Consumption |4.6% |4.6% |

| |7:30 |GDP Deflator |2.0% |2.0% |

| |9:00 |Existing Home Sales |6.72M |6.69M |

Source: Bloomberg

Economics

ECONOMIC DATA RELEASED LAST WEEK WAS GENERALLY SUPPORTIVE OF GROWTH, WHILE A MUCH STRONGER THAN EXPECTED PPI REPORT SENT INFLATIONARY SHIVERS THROUGH THE BOND MARKET. WHILE MUCH OF THE FOCUS WAS ON THE CORE NUMBER (0.8% VS. A CONSENSUS 0.2%), WE BELIEVE THE SURGE IN CORE PRICES SHOULD BE DISCOUNTED DUE TO THE SOURCES. ALCOHOLIC DRINK PRICES JUMPED 2.8%, TOBACCO PRICES ROSE 3.1% (THEIR FIRST SIGNIFICANT INCREASE SINCE APRIL 02), AND AUTO MAKERS BUMPED NEW MODEL PRICES AS THEY TRY EVERY YEAR.

WE BELIEVE ALCOHOL AND TOBACCO PRICES SHOULD NOT BE CONSIDERED A STRONG INDICATION OF BROADER PPI PRESSURES. FURTHER, WE BELIEVE THE FALLOUT FROM JANUARY’S WEAK AUTO SALES DATA WILL BE A ROLL BACK OF LAST MONTH’S PRICE INCREASES. WE ACKNOWLEDGE THAT CORE PPI IS TRENDING UP HOWEVER WE CONTINUE TO EXPECT TO SEE MODERATION IN THE YEAR OVER YEAR RATE LATER THIS YEAR.

THE BIGGEST UPSIDE SURPRISES OF THE WEEK WERE SEEN IN JOBLESS CLAIMS AND THE HOUSING MARKET. JOBLESS CLAIMS FELL 2,000 TO A FOUR YEAR LOW, BUT THE NUMBER WAS A FULL 23,000 BELOW THE CONSENSUS ESTIMATE. LIKEWISE, BOTH HOUSING STARTS AND PERMITS SOARED DURING JANUARY, SHOWING AMAZING STAMINA IN WHAT MANY THOUGHT WAS SURELY THE HOUSING MARKET’S 11TH INNING.

• THE EMPIRE MANUFACTURING INDEX EXPANDED AT A SLOWER PACE (ACTUAL 19.19 VS. CONSENSUS 20.0) LED BY DECLINES IN INVENTORY AND NEW ORDERS.

• RETAIL SALES DECLINED AT A MORE MODERATE PACE IN JANUARY, SLOWING -0.3% AFTER INCREASING 1.1% IN DECEMBER. EXCLUDING AUTOS, SALES ROSE 0.6% VERSUS 0.3% DURING THE PREVIOUS MONTH.

• HOUSING CONTINUED TO EXPAND LAST MONTH WITH 2,159,000 NEW HOME STARTS, A 4.7% INCREASE OVER DECEMBER’S FIGURE OF 2,063,000 AND A 21 YEAR HIGH.

• JOBLESS CLAIMS DECLINED TO 302,000, A FOUR-YEAR LOW, AS THE EMPLOYMENT SECTOR SHOWS SIGNS OF STEADY IMPROVEMENT. THE LESS VOLATILE FOUR WEEK MOVING AVERAGE FELL TO 311,750 FROM 315,750.

• THE INDEX OF LEADING ECONOMIC INDICATORS DECLINED FASTER THAN EXPECTED PACE IN JANUARY, FALLING -0.3% VERSUS THE CONSENSUS OF -0.2%. THE DECLINE WAS ATTRIBUTED A DROP IN CONSUMER EXPECTATIONS AND STOCK PRICES.

• THE PHILADELPHIA FEDERAL RESERVE SURVEY OF MANUFACTURING ACTIVITY IN JANUARY ACCELERATED TO 23.9 COMPARED TO CONSENSUS OF 17.8. THE INCREASE WAS LED BY GAINS IN EMPLOYMENT AND NEW ORDERS.

• THE PRODUCER PRICE INDEX, A MEASURE OF WHOLESALE PRICES, ROSE 0.3% AFTER DROPPING 0.3% IN DECEMBER. EXCLUDING FOOD AND ENERGY THE INDEX ROSE 0.8% COMPARED TO CONSENSUS OF 0.2% AND THE FASTEST PACE SINCE DECEMBER 1998.

FIXED INCOME STRATEGY

MACRO THEMES

Putting the events of the week in perspective, the surge in core inflation in last month’s PPI report can be explained away, while the takeaways from Greenspan’s Congressional testimony are clear: expect the Fed to continue raising short term interest rates over the balance of this year. We continue to believe that inflationary pressures and labor growth remain the keys to the pace and duration of the Fed’s current tightening campaign. While inflation data to date has been moderate, the dramatic slowing of productivity is potentially troubling to us. At some point wage pressures will begin to express themselves in the hourly earnings numbers, raising the ire of the Fed. At this point however we do not forecast much stronger data to materialize over the coming months.

Looking ahead, the economic calendar is full, with most investors fixated on the CPI for confirmation of last week’s awful PPI. In addition, minutes from the February FOMC meeting will be released on Wednesday and Friday brings revised Q4 GDP. We expect the CPI to come in as expected (0.2%), which should com e as a relief to many investors who are trying to continue to profit from the curve flattening trend. Our outlook supports this trend, and we continue to suggest a barbelled curve allocation.

Treasuries

Investors dumped Treasuries last week, sending yields higher across the curve after a stronger than expected PPI report, and hawkish comments by FOMC Chairman Greenspan. Yields rose between nine and seventeen basis points with the long-end of the curve experiencing the brunt of the sell-off. Comments by Fed Chairman Greenspan during his semi-annual testimony to Congress were upbeat in assessing current domestic economic conditions. Greenspan also stated that the fed funds rate “remains fairly low,” implying the Fed will not deviate from its current rate hiking campaign in the near future. By Friday’s early close, the curve had steepened eight basis points between 2s and 10s and 2s and 30s. Losses were fairly well contained in shorter maturities, with two and three-year yields up nine and 13 basis points to yield 3.42% and 3.60%, while five, ten and thirty-year yields jumped 17 basis points each to yield 3.85%, 4.26% and 4.65% respectively.

Graph 1 – Historical Treasury Slope

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Source: Bloomberg, Piper Jaffray

Notes:

1. Off the Runs: Treasury securities other than the most recently issued benchmark securities.

2. On-the-Runs: Most recently issued Treasury benchmark securities.

TIPS

TIPS breakeven yields rose last week climbing nine basis points on the back of economic data supportive of future inflationary prospects. Yields pushed higher through the week closing at 2.75%, 2.60% and 2.89% on the five, ten and thirty-year maturities respectively.

Agencies

Agency spreads narrowed across the curve last week despite a sell-off in treasuries as investors took advantage of the yield offered by spread products and light supply. Spreads tightened one and a half to five basis points with short to intermediate maturities experiencing most the gains.

Political commentary on the future regulation and size of GSEs continued last week with comments coming from Fed Chairman Greenspan that mirrored previous concerns expressed by members of Congress. In his testimony to Senate Banking committee Mr. Greenspan referred to the size and growth of the portfolios of the GSEs and the need to slow both. The prospect of a smaller mortgage portfolio means less debt issuance, reducing the supply of agency debt and tightening spreads. In addition, we remain convinced that changes in the regulatory environment will not significantly alter the operating environment of the GSEs. 

Refi Index / Mortgage Applications

The Mortgage Bankers Association’s index of mortgage applications fell 0.49% to 732.3. The purchase index dropped 4.79% to 423.3. The refinancing index rose 4.09% to 2,503.1.

Corporates

Investment grade corporate bond spreads tightened last week on fundamental economic data that offered favorable prospects for extended growth and profits. Spreads narrowed around three basis points supported by strength in employment and manufacturing data. Debt of A/BBB rated financial and utility concerns led the gains narrowing three to six basis points respectively.

Municipal Consensus Yield Changes for the Week

| |MUNICIPAL |CHANGE |% TO TREASURY |

| |YIELD |(IN BP) |LAST WEEK |PREVIOUS WK |5-YEAR AVG. |

|5 YEAR |2.94 |12 |76.3% |76.5% |81.2% |

|10 YEAR |3.62 |13 |85.0% |85.4% |86.5% |

|30 YEAR |4.63 |11 |99.6% |100.9% |95.5% |

SOURCE: MUNICIPAL MARKET ADVISORS

Corporate Ratings Changes

|Issuer |Ratings Action |Rating |

| |To |From |Moody’s / S&P |

|Allied Waste North America, Inc. |Review for Downgrade |-- |Caa1/ B+ |

|Royal & Sun Alliance Group |Review for Upgrade |-- |Ba2/BBB |

|Science Applications International |Watch Negative |-- |A3/A |

|Univision Communications Inc. |Stable |Positive |Baa2/BBB- |

|XL Capital Ltd. |Negative |Stable |A2/A |

|Southern California Edison Co. |BBB+ |BBB |A3/BBB+ |

|Liberty Mutual Group Inc. |Review for Downgrade |-- |Baa3/BBB |

|American Re Corp. |Watch Negative |-- |A3/BBB |

|Northeast Utilities |Baa2 |Baa1 |Baa2/BBB |

|Pacific Gas & Electric |BBB |BBB- |Baa2/BBB |

|Bank of Hawaii Corp. |Positive |Stable |A3/BBB |

|Indianapolis Life Insurance Co. |Negative |Stable |Baa2/A- |

|Oracle Corp. |Review for Downgrade |-- |A3/A- |

|The AES Corp. |B1 |B2 |B1/B- |

|DPL Inc. |Watch Positive |-- |Ba3/B+ |

|General Motors Corp. |Negative |Stable |Baa2/BBB- |

|MCI, Inc. |Watch Positive |-- |B2/B+ |

|Universal Corp. |Baa3 |Baa1 |Baa3/A- |

|Verizon Communications Inc. |Watch Negative |-- |A2/A+ |

|Winn-Dixie Stores, Inc. |Caa3 |B3 |Caa3/CCC |

|XTRA Inc. |AA- |BBB+ |WR/A- |

|International Paper |Negative |Stable |Baa2/BBB |

|May Department Stores |Negative |Stable |Baa2/BBB |

|Progress Capital Holdings, Inc. |Baa1 |A3 |Baa1/BBB- |

|Union Pacific Corp. |Stable |Positive |Baa2/BBB |

Source: Piper Jaffray, Ratings Actions by S&P and Moody’s.

Corporate New Issues from Last Week

|Issuer |Coupon |Maturity |Spread (in bp)|Amt. (MM) |Rating | |

|BEAR CREEK CORP |9 |3/1/2013 |NA |175 |B3 |B- |

|BEAR CREEK CORP |NA |3/1/2012 |NA |70 |B3 |B- |

|AMERICA MOVIL SA de CV |6.375 |3/1/2035 |184 |1,000 |A3 |BBB |

|FIFTH THIRD BANK |4.2 |2/23/2010 |44 |800 |Aa1 |AA- |

|JPMORGAN CHASE & CO |4.75 |3/1/2015 |63 |1,250 |Aa3 |A+ |

|BLACKROCK INC |2.625 |2/15/2035 |NA |250 |NA |NA |

|FPL ENERGY NATL WIND |6.125 |3/25/2019 |212.3 |100 |Ba2 |BB- |

|FPL ENERGY NATL WIND |5.608 |3/10/2024 |145 |365 |Baa3 |BBB- |

|SANMINA-SCI CORP |6.75 |3/1/2013 |270 |400 |B1 |B |

|CPI HOLDCO INC |8.83 |2/1/2015 |NA |80 |Caa1 |B- |

|CHUO MITSUI RUST&BANKIN |5.506 |NA |140 |850 |Baa2 |NA |

|NORDIC INVESTMENT BANK |3.875 |6/15/2010 |18 |1,000 |Aaa |AAA |

|SYBASE INC |1.75 |2/22/2025 |NA |460 |NA |NA |

|ENTERPRISE PRODUCTS |5 |3/1/2015 |98 |250 |Baa3 |BB+ |

|ENTERPRISE PRODUCTS |5.75 |3/1/2035 |136 |250 |Baa3 |BB+ |

|CAPITAL ONE FINANCIAL |5.25 |2/21/2017 |118 |300 |Baa3 |BBB- |

|CAPITAL ONE FINANCIAL |4.8 |2/21/2012 |95 |300 |Baa3 |BBB- |

|PEMEX PROJ FDG MASTER |5.5 |2/24/2025 |205 |1,000 |Baa1 |BBB |

|KIMCO REALTY CORP |4.904 |2/18/2015 |80 |100 |Baa1 |A- |

|CITIGROUP INC |4.125 |2/22/2010 |47 |2,000 |Aa1 |AA- |

|MERCK & CO INC |4.75 |3/1/2015 |78 |1,000 |Aa3 |AA- |

|TELEFONOS DE MEXICO S.A. |5.5 |1/27/2015 |140 |800 |A3 |BBB |

|TELEFONOS DE MEXICO S.A. |4.75 |1/27/2010 |97 |950 |A3 |BBB |

|DOW JONES & CO |3.875 |2/15/2008 |40 |225 |A2 |A- |

|SEMPRA ENERGY |4.621 |5/17/2007 |67 |561 |Baa1 |BBB+ |

|TEMPLE-INLAND |5.003 |5/17/2007 |95 |345 |Baa3 |BBB |

|CAPITAL ONE FINANCIAL |4.738 |5/17/2007 |70 |704 |Baa3 |BBB- |

|ALLTEL CORP |4.656 |5/17/2007 |58 |1,385 |(P)A2 |A |

|SFBC INTERNATIONAL INC |2.25 |8/15/2024 |NA |144 |NA |B- |

|NATIONAL AUSTRALIA BANK |0 |4/8/2008 |NA |300 |Aa3 |AA- |

Source: Bloomberg

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February 22, 2005

Fixed Income Trading

Joseph W. Jasper, CFA

Director, Fixed Income Strategy & Marketing

Private Client Services Fixed Income Investments

612-303-5660

joseph.w.jasper@



Treasuries

• Yields rose between nine and 17 basis points, with the curve steepening on the strong PPI report.

• We expect yields to stabilize near current levels, outside of an upside surprise in the CPI.

TIPS

• Breakeven yields widened between seven to ten basis points last week as the jump in core prices spooked investors.

• We expect the CPI to help counter the run up in TIPS breakeven spreads.

Agencies

• Agencies recorded a stellar performance tightening vs. LIBOR and Treasuries on the week.

• Valuations in belly maturities are back to the LIBOR minus 20 area.

• We believe continued strong investor interest and low net issuance will be supportive to spreads near term.

Corporates

• Corporates tightened versus Treasuries last week as investors took advantage of higher absolute yields.

Municipals

• Municipals outperformed Treasuries, richening valuations across the curve.

• Taxable munis look increasingly attractive versus agencies, given the rich valuations of the latter.

•

Disclaimer

This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may not be eligible for solicitation in the states in which the client resides. Officers or employees of affiliates of Piper Jaffray & Co., or members of their families, may have a beneficial interest in the Company's securities and may purchase or sell such positions in the open market or otherwise. Past performance is not indicative of future results.

Notice to customers in the United Kingdom: This report is a communication made in the United Kingdom by Piper Jaffray & Co. to market counterparties or intermediate customers and is exclusively directed at such persons; it is not directed at private customers and any investment or services to which the communication may relate will not be available to private customers. In the United Kingdom, no persons other than a market counterparty or an intermediate customer should read or rely on any of the information in this communication.

Securities products and services offered through Piper Jaffray & Co., member SIPC and NYSE, Inc., a subsidiary of Piper Jaffray Companies. Additional information is available upon request.

No part of this report may be reproduced, copied, redistributed or posted without the prior consent of Piper Jaffray & Co.

© 2004 Piper Jaffray & Co., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota 55402-7020

This information is a product of the Fixed Income Trading Department and should not be construed as research or a research report. This is for informational purposes only.

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