Bond Market Commentary by Mike PetersenThe Two-Minute Drill
By Zach Berg
February 8, 2010
In honor of the great American tradition known as the Super Bowl, the Bond Market Commentary will attempt to be as effective and efficient as a Peyton Manning or Drew Brees led two-minute drive. The past week saw volatility, fear and even a little capitulation creep back into the markets. The headlines were led by potential heavy governmental regulation of the banking industry, the alarming fiscal state of certain members of the European community, and the all important employment data. We begin across the pond at the epicenter for the uneasiness, Greece. Faced with mounting budget deficits and questions surrounding their debt’s default status, the European Union was forced to intervene proposing a solution that will reduce the country’s debt to GDP ratio. Like a wildfire, the concern over inflated deficits spread from the land of the Gods to other European nations, such as Spain and Portugal. This apprehension over sovereign risk pushed equity markets lower and sent investors fleeing for the safety of treasury debt. The yield on 10-year treasury notes was pushed to its lowest level in six-weeks. With investors fleeing for safety, riskier assets classes, such as corporate bonds, experienced considerable spread widening. When spreads widen, yields rise and prices decline. To illustrate this, the chart below shows the Markit CDX North America Investment Grade Index, which is an index that tracks the credit defaults swaps of 125 investment grade companies. The nearly eight-point widening in the index on this past Thursday (referenced on the chart by the red line) was the largest single day move since October of last year.
With one eye on Europe, the domestic markets were focusing the other eye on the very important release of the Bureau of Labor Statistics January unemployment report. The headline change in nonfarm payrolls number surprised to the downside, -20k versus an estimated +15k, however the unemployment rate did fall from 10% to 9.7%. Within the data were several bright spots, while also some troubling revisions to previous data. On the positive side:
- Temporary agency employment rose 52,000. This figure is considered a leading indicator of future full time employment.
- The average workweek increased slightly to 33.3 from 33.2.
- Manufacturing jobs increased 11,000 versus an estimated loss of 20,000. This was the first positive print in over three years. This figure was on top of other positive manufacturing data released during the week, that showed new orders and employment moved up in the sector.
However, the unemployment figures contained substantial revisions to previous releases. For instance, last year the total job losses increased nearly 600,000 from previous reports. Also of note is the shifting dynamic of employment among men and women in the workforce. In the January figures, adult-male employment (aged 25 years and older) fell 75,000, while adult-female employment (aged 20 and older) gained 529,000 jobs. These figures are a microcosm of the numbers in general, as certain areas such as manufacturing are starting to see some positive growth, while other industries and demographics continue to find the employment situation very challenging.
In Focus – Bank Lending and Consumer Credit
This week we take a look at the hot button subject of bank lending and consumer credit. From Main Street, to Congress, to President Obama, there has been no shortage of outrage expressed at the current lending situation in the US. This past week the Federal Reserve released its January Senior Loan Officer Opinion Survey. The survey participants are made of domestic and foreign banks with US branches and attempts to shine light onto the current lending sentiment among banks. The results of the survey stated that during the 4th quarter no banks had tightened standards for large and medium size companies, and only 2 banks had tightened standards for smaller firms. This is a positive sign; however, the survey went on to state that although the tightening had ceased, participants indicated that they have yet to unwind the tight standards that have been in place during the previous two years. Of note was the commercial real estate market, which continued to see banks stiffen standards. From the supply side, it appears that banks have reduced and perhaps ended the significant constricting of loans to firms, but the standards remain at stringent levels.
When looking at the demand side of the equation, the picture does not get any rosier. The survey indicated that both businesses and households reduced their loan demand during the quarter. In fact, over 40% of banks noted reduced demand for consumer loans. The perception that consumers have been constrained because of a lack of opportunity to credit may be slightly skewed. It appears that while it is challenging to obtain a loan, many borrowers are simply rebalancing their fiscal situations by paying down their existing debt instead of leveraging up. The recent consumer credit analysis from the Fed has supported this concept of fiscal constraint among households. For revolving loans, (credit cards), the amount outstanding during the month of November decreased by nearly $14 billion, a decrease of 18.5% from a year ago. Perhaps the struggle in the current lending situation can best be summed up in a Wall Street Journal article from this past Wednesday (Data Hit Hopeful Notes for Economy). In the article, William Bachman, a board member of the Bremen Bank & Trust states, “We have money we can loan,. It’s finding credit-worthy borrowers that’s the hard part.” He goes on to say, “It’s demand related – they don’t need to borrow, because they’re not expanding.”
Chart of the Week
The chart below depicts the net percentage of banks tightening standards according to the Fed Senior Loan Survey (white line graphed against the right axis) versus total consumer credit outstanding (blue line graphed against the left axis). For the bank lending activity, any number above zero represents a net percentage of banks tightening standards and a point below zero represents a loosening of standards. The graph clearly illustrates the tremendous tightening that occurred in lending standards during this recession, however, it also shows that at least for medium to larger firms the standards are starting to loosen. From the consumer standpoint the deleveraging that has occurred is evident from the move down in credit outstanding. The real questions that remain will be how long does it take banks to reduce standards, and will consumers digress back to their old habits and return to adding credit to their balance sheets or embrace their new fiscal conservatism?
Finally A little Food for Thought...
For many Americans who tune in to catch the Super Bowl, the main attraction is not the action on the gridiron, but the highly anticipated commercials. Companies prepare extensively to have an opportunity to highlight their product or business with an estimated 90 million viewers. According to many reported sources, including NFL fanhouse, the average Super Bowl commercial ad for 2010 will cost approximately between $2.5 and $3 million dollars for a 30 second spot. Now earlier this past week, the White House unveiled its proposed budget for fiscal 2011. The price tag to fuel the American government came in at a whopping $3.8 trillion dollars. Within the proposal were projections to add $8.5 trillion dollars of federal debt through 2020. This additional debt that has been estimated would push the percentage of debt to GDP to approximately 77%. A debt to GDP ratio at such levels could have substantial ramifications not only for the US sovereign debt rating but also the value of the dollar and interest rate levels. To put the $3.8 trillion in perspective, let’s consider that with the average Super Bowl ad costing $3 million for 30 seconds, to pay for the federal budget with just beer and car commercials during the most high profile television event in America, the Super Bowl would have to be played continuously for over 439 days.
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.
Government Policy and the Corporate Bond Market
By Brian Cebuhar
February 1, 2010
The news of this week will continue to focus on how the markets react to all of the information released last week. Not only did the market digest a healthy amount of economic data, the week included several congressional hearings with current and former members of the FOMC and Treasury, as well as President Obama's State of the Union address, which among many other topics, addressed a plan to add an additional 100 billion dollars in stimulus money to the economy. During the busy week, the treasury market saw some volatility. The 10 year benchmark treasury traded with approximately a 12 basis point high to low range on the week, with a 5 basis point rally on Friday. The commerce department released a report that the economy grew at 5.7% in the fourth quarter. Historically, this is the kind of news that would have treasuries selling off and equity markets rallying. However, it appears that concerns over employment and labor are still very prominent factors weighing in on treasury markets.
The impact of last week's news was mixed within the corporate bond market. While financial institutions and bank spreads widened over the week, spreads remained strong in non-finance sectors. The news of the Obama administration wishing to reduce the amount of proprietary trading businesses at large financial institutions, as well as a proposed fee on banks that received government assistance, led to some of the resistance in the finance sector last week. While it is reasonable to assume that these measures might hurt the overall free cash flow of these banks, the relatively modest spread widening in these financials did not indicate a concern to overall credit worthiness of the companies. Likewise, many of President Obama's comments regarding small business loans, increases in impact money, and government initiatives to increase "green utilities" nationwide, have shown some continuing strength in industrial markets.
In current news, Citigroup announced plans to sell or spin off its 10 billion dollar Private Equity Unit and plans to use the proceeds to repay debt. This measure appears to be consistent with President Obama's wishes for large financial institutions to reduce overall risks on their balance sheets. Currently, the U.S government owns slightly more than 27% of the company. In other news, Toyota outlined its plans to create a "recall fix" affecting approximately 2.3 million vehicles in the United States. The corporate issuance calendar remains light this week, with very little being announced in investment grade markets. For the week ahead we have Personal Income, PCE and Manufacturing data released early in the week with some labor and employment data being released later in the week which should have treasury markets responding.
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.
Welcome Back Uncertainty
By Michael Petersen
January 25, 2010
Uncertainties ruled the week and sent investors looking for safety. President Obama’s new plan to cramp down on banks, China’s indication that they may begin to cool economic growth and growing concerns that Bernanke’s second term confirmation may be a tight vote all led investors away from risk assets. The Dow Industrial Average endured its most challenging week since February 2009, losing over 437 points. The S&P 500 three-day, 5.1 percent sell-off for the week was the biggest decline since March 2009. The Equity market weakness led investors into safe-haven assets like Treasuries, which gained on the week. Yields on the benchmark ten-year note fell to 3.60 percent, down 6 basis points. The 3.375 percent treasury security maturing November 2019 gained a half-point (prices move inversely to yields), translating to $5 per $1,000 face amount. The price finished the week at 98 2/32. This capped the third consecutive week of price gains for Treasuries.
That demand for safety will be met this week with ample supply. The Treasury is scheduled to sell $42 billion of five-year notes on Wednesday and $32 billion of seven-year notes Thursday. The last auction for these maturities, right after Christmas, was a record-tying $118 billion. Credit issuance this month has been rather quiet for domestic issuers. As of Jan 21st, according to Informa Global Markets, 72.5% of this month’s $85bln high grade credit issuance has come from overseas entities. Concerns over economic weakness, the recent string of the poor weather’s effect on the housing market, and earnings reports less than analysts expected were a few reasons cited for the lack of domestic issuance. Even with those concerns, the market still appears ripe for issuance as we saw late Thursday with Morgan Stanley pricing a 2 part $4bln issue. Surprisingly, even with the lack of issuance, spreads on existing paper has uncharacteristically widened this week. The Market Investment Grade CDX Index gained nearly 15% or 12 points. This means it collectively costs more to insure the 125 bonds in the index against default. This signifies an increase in skepticism about the economic recovery not only in equities but in credits as well. Since the turn of the year, flows into credit have noticeably picked up, though, as yields and the relative safety still appear attractive given the economic uncertainties that lie ahead. Market Axess reported trade data for the week January 18th – 22nd with average trade volume was up 4.7% and average trade count was up 8.1% from the prior week.
This week we should start to see some clarity to the pressing uncertainties. The FOMC meetings begin Tuesday with their rate decision and statement due out Wednesday at 2:15pm. Also this week is President Obama’s second State of the Union address which may provide additional insight into future policy initiatives aimed at the financial sector and beyond. This week’s economic calendar is rather heavy. First off, on Monday we’ll have existing home sales. With an anticipated two month lag to pending home sales. The poor November number there could rear its head in this month’s data. Weakness beyond what analysts expect could send Treasury yields lower. Tuesday brings S&P/Case-Shiller Index ®, where the markets would like to see signs of housing sector price stability, and Consumer Confidence. Wednesday holds new home sales, but the market mover will likely be the FOMC statement released at 2:15pm. Although forecasters see little chance for a change in the rate, the text of the statement may provide insight into future moves. Many of the liquidity programs brought on line during the credit crisis are due to expire. and It should prove interesting to see how the economy manages as it increasingly is required to stand on its own feet without Central Bank subsidy. Thursday may see reaction from the State of the Union address, as well as durable goods orders, and weekly jobless claims. Friday, 4th quarter GDP numbers are announced. Any weakness may contribute to further gains seen in the Treasury market. Consumer sentiment is also due Friday, but talk of GDP will likely overshadow any fixed income market effects that report may have.
Chart of the Week
The Markit CDX North America Investment Grade Index is composed of 125 investment grade entities, distributed among 6 sub-indices: High Volatility, Consumer, Energy, Financial, Industrial, and Technology, Media & Tele-communications. The composition of Markit CDX Indices is determined by a consortium of 16 member banks. The index is a barometer of credit default risks of the basket of securities, higher price implies the market feels economic risks for the companies are increasing. After touching a low recently we saw a spike upwards in the last week as uncertainty crept back into the markets.
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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