By Rom Badilla, CFA
July 23, 2012
Concerns over the European Debt Crisis reemerged today as Spanish borrowing costs surged to new highs which led to a flight-to-quality bid for U.S. Treasuries. The yield on Spain’s 10-Year note spiked 23 basis points to 7.49% in early morning trading.
Equally important, yields on the front end of the curve increased even more as the 2-Year yield rocketed to 6.53%, an increase of 77 basis points from Friday’s close. This pushes down the yield differential between the 2-Year and 10-Year yield to just 95 basis points from last week’s close of 152. Comparatively, the yield curve reached its steepest shape in mid March when the yield between the two points hit 296 basis points.
Bond Investing – Spain 2 & 10-Year Yields
As mentioned last week, the flattening of the Spanish yield curve, which if inverted, could signal significant funding and solvency issues. While the curve is currently upward sloping, the fact is that this spread is very volatile and can go inverted fairly quickly. In such an event, this in turn could spell trouble for the markets as Spain, which faces 15 billion of Euros of debt redemptions in regions for the remaining part of 2012, may ultimately seek a bailout.
To add to the turmoil in a move that never quells market fear, Spanish stock market regulators banned short-selling on all securities for a period of three-months, ending on October 23. Furthermore, they added that the ban may be extended beyond that.
As a result, U.S. Treasuries rallied across the curve as yields reached all-time lows before bouncing. According to Trade Monster’s Bond Trading Center, the Long Bond established a new low at 2.475% in intraday trading from Friday’s close of 2.55%. On the day, the 30-Year outperformed the rest of the bonds across the maturity spectrum by gaining 0.9% in dollar price as the yield on the 30-Year maturity ended the session at 2.51%. The 10-Year gained 0.3% in dollar price as the benchmark note finished trading at 1.43%, a fall of 2 basis points from the previous close. The yield on the 5-Year concluded flat on the day at 0.56%, while the 2-Year ended the session at a yield of 0.21%, a fall of a basis point from the previous close.
Bond Investing – 30-Year U.S. Treasury Intraday Chart
With the flight to quality bid and as investors switched back to the “Risk Off” trade, Corporate Bonds declined in value. Yields in both the Finance and Industrial sector of the corporate bond market increased and failed to keep pace with their comparable U.S. Treasury counterparts.
Morgan Stanley continues to take a beating by the chin as yields increased after last week’s volatile performance. This set the tone for the Finance sector as yields on Barclays and Citigroup benchmark notes increased as well.
Among the Industrial sector, bonds were generally wider but there were some gainers on the day. Cisco Systems saw their benchmark note rally as yields declined while Target bonds increased to lower their debt yields. (For More Details, Check out our Corporate Bond Market Snapshot)
On the data release front, U.S. economic activity improved according to the Federal Reserve Bank of Chicago. The Chicago Fed National Index, which combines 85 diverse and already released indicators ranging from housing to employment to new orders, improved from -0.48 in the prior month to -0.15 in June.
This brings the three-month moving average to -0.20 from a reading of -0.38 established in May. According to the Chicago Fed, if the three-month moving average falls below -0.70 after a period of economic expansion, then there is an increasing likelihood that a recession has begun. Conversely, a three-month average greater than 1.00 more than two years into an economic expansion, then there is a substantial likelihood that a period of sustained inflation has begun.
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