Building an Appetite
By Benjamin Streed
April 02, 2012
Treasuries finished the first quarter of 2012 down 1.00%, and according to YieldBook data this marks the worst quarterly return for these securities since the last three months of 2010 and is on par with returns from the last quarter of 2009. This corresponds to a yield increase on the 10-yr benchmark Treasury note of nearly 30bp to 2.16% while the 30-yr added nearly 40bp to yield 3.27%. Much of the “risk on” trade can be attributed to a decline in the perceived risk of the European Union’s debt crisis as well as somewhat more upbeat economic news out of the U.S. Despite the overarching positives from each region, there are still concerns over global growth, U.S. joblessness and the possibility of further Greek/E.U. strain on the credit markets.
Current Treasury yields are on par with consensus estimates for the end of Q1 according to a Bloomberg survey which saw the 10-yr at 2.15% and the 30-yr at 3.26%. Looking forward, these surveys indicate only a slight increase in yields for Q2 followed by a more considerable hike coming in Q3 and Q4 where expectations are for the yield on the 10-yr and 30-yr to finish 2012 at 2.55% and 3.58% respectively. Contrasting the negative returns from the Treasury market, corporate bonds continue to show considerable strength and finished up nearly 2.50% year-to-date. The general lackluster returns of Treasuries as a result of the consensus “risk on” trade carried over to higher-quality corporate bonds as evidenced by the return differentials between those companies seen as most credit worthy versus those lower on the credit-ratings scale. AA-rated corporate bonds returned 1.28% for the quarter, while A and BBB-rated corporate bonds produced returns that doubled those of their higher-rated peers with returns of 2.52% and 2.84% respectively. Ignoring credit-quality and examining industry trends, spread compression in the financial sector produced returns of 5.20% for the quarter, handily beating both industrial and utility sectors that saw modest returns of 1.28% and 0.76% respectively. Considering the results of the recent bank “stress tests” released earlier this month, it would seem likely that much of the spread compression in financials came as a result of the passing grades given to the vast majority of the financial institutions. Surprisingly, the returns in the financial sector are attributable to a steady decline in OAS spreads, the option-adjusted difference in yield compared to Treasuries, since the beginning of the year with January producing compression of 70bp, February 33bp and March showing the least narrowing at only 15bp.
Appetite Creates Supply
Spread compression and a decrease in yields encouraged corporate borrowers to enter the market in the first quarter at a blistering pace; according to Bloomberg estimates, nearly $450 billion in new corporate debt was issued in the U.S. market this quarter making it the busiest quarter on record and surpasses the first quarter of 2011 when new issuance of $397 billion hit the market. Included in this record are two newcomers to the U.S. credit markets: Flowers Foods raised $400 million of 10-yr notes at a spread of T+225bp, while Heineken, the global beer company, launched $750 million of 10-yr notes at T+127bp after boosting its plan from an original $500 million. Globally, the issuance number was just north of $1.16 trillion marking an all-time quarterly record beating the pace $1.155 trillion issued Q1 2009.
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The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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