Raymond James Bond Market Update: The Pain in Spain

Raymond James Bond Market CommentaryDire Straits
By Benjamin Streed
July 23, 2012

Last week one was of continuing lows; “safe haven” assets such as U.S. Treasuries, German Bunds and sovereign debt of some peripheral European countries all found themselves sitting at or near record low yields as ongoing concerns in the Eurozone mixed with the threat of a global economic slowdown help push demand for safety. Every time it appears that there is some sort of relief in the Eurozone the markets abruptly reverse course and remind us that the struggles facing some of Europe’s largest economies remain intact. Last week saw a bit of déjà vu for Spanish debt as the country’s 10-yr bond yields rose above the dreaded 7.00% mark, the psychological threshold that saw Greece, Ireland and Portugal seek international bailouts. As of Monday morning, the yield sits at 7.48% marking the highest level on record, and underscores the continuing problems facing not just Spain but the entire European monetary union. Spanish two-year yields jumped at last week’s auction, up nearly 26bp to 5.28% and marked the beginning of a yield spike that saw borrowing costs shoot up more than 90bp to 5.75%. As if the news for Spain couldn’t get any worse, as of Monday morning this very same yield is higher by an additional 80bp and it now costs the embattled nation over 6.55% to borrow for a mere 24-months. Fueling the seemingly unending concerns; over the weekend El Pais, the largest newspaper in Spain by circulation, reported that six of the country’s seventeen regions may ask the federal government for financial aid. The recent wave of hardships follows after Valencia sought a bailout on Friday; Catalonia, Castilla-La-Mancha, Murcia, the Canary Islands and the Balearic Islands are counted among the regions speculated to seek aid from the central government this week. The underlying concerns is that the central government will now need to fund assistance to its struggling regions amidst ongoing rising borrowing costs, continuing to perpetuate the dire straits it finds itself in.

What do you get when you mix the ongoing weak economic data here in the U.S. and around the globe and mix in a few dashes of Eurozone concerns? The answer is a very interesting quote from Federal Reserve Chairman Bernanke. He stated last week that policymakers will continue to provide record stimulus while keeping inflation in check but managed to though in a slightly ironic party reference; “It will be a similar pattern to what we’ve seen in previous episodes where the Fed cut rates, provided support for the recovery, and the recovery reached a point of takeoff where it could support itself on its own, then the Fed pulled back, took away the punch bowl.” During his Congressional testimony, Bernanke made it abundantly clear that he disagreed with lawmakers who insisted that there has been no progress since the “near collapse of the economy in 2008 and 2009”. In his prepared remarks, he admitted that economic growth is slowing and that inflation will probably remain at or below the Fed’Ss 2% objective as energy prices continue to decline. His comments appear reasonable as the markets’ inflation expectations appear to be temperate at best; the five-year, five-year forward breakeven rate, a measure of inflation expectations that the Fed uses to help guide its monetary policies, sits at only 2.41%. This is the nominal 5-yr forward rate minus the yield on a similar maturity Treasury inflation-linked forward contract. The figure stood as high as 2.78% earlier this year and has averaged 2.75% over the last decade.

Ever Lower

In corporate credit, the average yield on investment-grade U.S. corporate debt fell to a record low on Friday of 2.927%, beating the previous record low of just 2.979% set on Tuesday according toYieldBook data. Concurrently, the Citi IG Industrial index jumped to an average yield of only 2.756% yesterday, its respective all-time low, after setting new record lows nearly every day for the last two weeks. With the relatively upbeat earnings reports coming from the banking/finance sector, thanks primarily to lowered expectations, bonds of these issuers have followed their industrial peers to lower yields. The Citi IG Banking index fell to 3.109%, you guessed it, a record low and touched levels not previously seen since October of 2010.

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.

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section ofinvestinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.


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