ECONOMIC & BOND MARKET RECAP
Rommel Badilla, CFA – Bondsquawk.com
With the market focused on earnings season and less so of economic data for the time being, stocks rocketed to higher levels while interest rates followed.
Economic Data
The Small Business Optimism Index declined in June according to the National Federation of Independent Businesses. The index came in at a reading of 89.0 in June versus a 92.2 level in the prior month. Analysts were expecting a higher reading for June of 91.2.
As Ben Bernanke stated yesterday that small businesses are the key to a U.S. economic recovery, the signs are less encouraging when looking behind the headline number. Of the small companies reporting, a net 1 percent of responding small businesses plan to add workers in the next three months indicating lackluster job growth (net number equals the number of small businesses offering a positive response less the number of companies providing a negative one). The net number of companies planning to increase inventory declined to -3 percent from +2 percent in May. Also, the net number of companies who think that access to loans is getting easier declined from -12 percent to -13 percent in June.
Of the hundreds of small businesses that responded, the majority still expect lower prices to remain in the months ahead. The net number of firms who expect higher selling prices stands at -13 percent, a slight improvement from -15 percent in May. Despite this, this particular measure is signaling tame inflation expectations and virtually little pricing power as this net number has languished in negative territory since December 2008.
Small Business Optimism Index Net Number for Higher Prices – Historical Chart
Furthermore, the net number of small businesses that expect the economy to improve in the coming months declined to -6 percent, from +8 percent in the prior month. Comparatively, the low for this particular measure reached a low of -23 percent in March 2008 and a high of +51 percent in November 2003.
The Commerce Department reported that the U.S. Trade deficit widened further as imports into the country surpassed goods shipped to overseas markets. The deficit came in at $42.3 billion, an expansion of 4.8 percent from April’s figure of $40.3 billion. Today’s readings disappointed economists as forecasts called for a tightening of the deficit to $39 billion.
With U.S. consumers continuing to do what they do best, which is consume, imports from countries like China and India increased 2.9 percent from the prior period to $194.5 billion. U.S. exports sent abroad managed to advance by only 2.4 percent to $152.3 billion.
Interest Rates
U.S. Treasuries declined again, leading to higher bond yields as concerns of a slowing economy eased for the time being. Longer maturities across the yield curve widened, highlighted by the yield on the 10-Year. The benchmark note increased 6 basis points to a yield of 3.12 percent. Both the 5-Year and Long Bond trailed by widening 5 basis points to close the day at 1.90 and 4.11 percent, respectively. The 2-Year managed to minimize the damage by increasing only 2 basis points to 0.67 percent.
10-Year U.S. Treasury Yield – Intraday Chart
The U.S. Treasury auctioned off $21 billon of 10-Year Notes at a 3.119 percent yield today. The final yield was slightly higher from expectations as dealers forecasted the note to come in at 3.109 percent. Demand was slightly lower from the last auction as the bid-to-cover ratio was at 3.09 versus 3.24. Despite this, the average over the last 12 auctions is at 2.98. Indirect bidders which include foreign central banks was at 41.7 percent versus a prior level of 40.2 percent and a 12-month average of 41.4 percent.
Inflation expectations increased to the higher end of the range as the yield differential between the 10-Year Treasury and 10-Year Treasury Inflation Protected Securities (TIPS) widened 5 basis points to 1.89 percent.
Inflation Expectations aka breakeven yield
Across the pond, government bond yields for the developed economies were higher as equity markets gained on the day. German 5-Year Bunds increased 4 basis points to 1.57 percent while France’s ended at a yield of 1.91 percent, a move higher of 3 basis points. 5-Year U.K. Gilts were wider by 4 basis points to 2.05 percent.
Greece successfully auctioned off 1.625 billion euros of 26-week bills today according to a Bloomberg article. The bills which are due on January 14 were sold at 4.65 percent, well below the five percent level many market participants were expecting. The Public Debt Management Agency reported that the bid-to-cover ratio which is a gauge of the level of demand came in at 3.64.
The spread on Greece Credit Default Swaps, which is the cost associated with protection in the event of a default, declined 30 basis points. The spread stands at 811 basis points. Bonds on the other hand, were less impressed judging by the action in bond yields. The Greek 5-Year government bond yields dropped only 3 basis points to 10.84 percent.
While the Greece auction is a small step in the right direction, the rest of the PIIGS face other headwinds. In particular, Moody’s Investor Service which initiated review in early May announced in a report that Portugal sovereign credit rating has been downgraded two notches from AA2 to A1 with an outlook “Stable”.
The credit ratings agency rationale for the downgrade is that the Portuguese government’s financial strength “will continue to weaken over the medium term, as evidenced by ongoing deterioration in the country’s debt metrics.” The debt to GDP and debt to revenues have increased in recent years due to spending programs such as unemployment benefits that kicked in during the recession. Furthermore, Moody’s stated that “growth prospects are likely to remain relatively weak” unless recent structural reforms which have been added just recently “bear fruit over the medium to longer term.” Hence, the country’s current debt metrics will likely stay elevated for the “foreseeable future.”
As a result of this downgrade, Portuguese debt has fallen. The yield on Portugal’s 5-Year increased 8 basis points to 4.35 percent. The 2-Year has jumped 8 basis points as well to 3.10 percent while the 10-Year closed at 5.45 percent, a 9 basis point spike.
As for the remaining PIIGS in the European pen, Spain’s 5-Year dropped 9 basis points to 3.44 percent. Ireland and Italy’s bond yields increased 4-5 basis points to end the session at 4.34 and 2.89 percent, respectively.
Credit Markets
The credit markets continue its impressive string of outperformance as spreads compressed against comparable maturity Treasuries. The BofA Merrill Lynch High Yield Index tightened 15 basis points to a spread of 670. The U.S. Corporate Bond Index declined 3 basis points to a spread of 200. The U.S. Bank Index tightened 7 basis points to a spread of 254.
There’s not much stopping the outperformance in the mortgage backed securities market. The yield differential between par priced 30-Year Conventional Mortgage Backed Securities and the 10-Year Treasury compressed another 3 basis points to a spread of 65 basis points. Since the end of June, MBS has outperformed comparable Treasuries as the spread has dropped 17 basis points.
Across the Capital Markets
The S&P 500 gained 1.5 percent to 1095.34 while the NASDAQ advanced 2.0 percent to 2242.03. The Interestingly, the market’s fear indicator, the CBOE VIX increased despite the gain. The VIX increased by 0.5 percent to 24.56.
The Dollar Index weakened to 83.522, a drop of 0.8 percent. The Euro jumped 1.0 percent to 1.2724 while the British Pound kept pace and closed at 1.5178.
Gold spot prices traded higher to 1212.35, a gain of 1.3 percent. Crude advanced 3.0 percent to 77.22.
