Bond Market Commentary
Getting the Call
By Benjamin Streed
May 6, 2013
As the Federal Reserve maintains its “accommodative” monetary policies here in the U.S., many institutions are looking for ways to take advantage of interest rates that continue to sit at, or near, record low levels. Some of these companies are frequent borrowers including many of the nation’s largest banks and financial institutions, while others are initiating themselves into the bond markets for the very first time. A notable initiate into the marketplace last week was Apple Inc. which set records when it issued $17 billion in a single foray into the market. Apple, like many other borrowers over the last few years, chose to schedule a significant portion of the borrowings at maturities of 10 years or more. As a result, Bloomberg data shows that over $610 billion of debt has hit the market so far this year, handily surpassing 2012’s record-setting pace which saw $565 billion come to market by the start of May.
On the flipside, many bank and finance companies are taking a different approach to their borrowing needs. These companies, who often issue preferred stock in addition to traditional debt, are refinancing their outstanding preferred shares. Upcoming and recently completed calls show that payments in the 5.875% to 8.00% range are being redeemed as issuers look to take advantage of lower borrowing costs and comply with new regulatory capital requirements. As a result of the Dodd-Frank regulations, trust preferreds are being phased out as banks seek compliance with the new capital requirements. For example, Citigroup redeemed $3 billion of these securities last month while JPMorgan and Bank of America have announced upcoming calls for a total of $10.5 billion over the next month alone.
A recent article in The Wall Street Journal indicated that U.S. companies have sold $13.6 billion of preferred shares so far this year, marking the fastest pace on record since 2008. This includes such companies as JPMorgan, Citigroup and Goldman Sachs which issued new preferreds with payments just above 5.00%. Banks represent the majority of domestic new issuance at $7.4 billion, while $4.5 billion comes from non-bank financial firms.
According to Bloomberg, the S&P Preferred Index is up 2.85% year-to-date despite the recent yield rally in the Treasury market. This comes after the index rose 10.81% last year.
The “Doves” Win This Round
By Benjamin Streed
April 15, 2013
Last week’s Federal Open Market Committee (FOMC) meeting notes were abruptly released at 9:00am on Wednesday after Fed officials announced that they unintentionally released the notes to a select group late Tuesday afternoon. Despite this hiccup, the notes included some very interesting information on the state of the economy and the group’s willingness to continue with accommodative monetary policy. The meeting notes from the March 19th-20th meeting showed that committee members are still divided when it comes to the bank’s involvement in keeping rates at near-historic lows, thereby swelling the Fed’s already massive $3.2 trillion balance sheet. Although the group voted to continue with its current $85 billion in monthly bond purchases, a number of members felt the risks of continued purchases were beginning to outweigh the benefits. More specifically, the group of dissenters or hawks, those that favor tightening policy, believes that the outlook for the economy is much better than it was late last year and firmly holds that the central bank should withdraw its monetary easing by the end of the year. Unfortunately for the hawks in the group there was a very important economic release on April 5th that firmly contradicted their belief that the economy is “much better” than last year. A week ago last Friday, the nonfarm payrolls report arrived with a dismal +88k on expectations of 190k jobs after the prior reading showed growth of nearly a quarter of a million jobs the previous month.
On the flipside, it could be said that the doves of the group “hit the nail on the head” with regards to job creation; seven of the twelve voting members voiced support for the FOMC’s continued monetary easing until the job market improves “substantially” from its current state. In fact, they noted, “if the outlook for labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end”. In a very interesting twist, voting member Charles Evans of Chicago noted that the so-called “dual mandate” of the Fed, which calls for maintaining low unemployment and low levels of inflation, should be modified to a single mandate given the unique challenges facing the country. He noted over the weekend that the group shouldn’t “obsess” over future inflation since undershooting now could mean more drastic consequences in the future such as deflation. He opined that the U.S. has yet to witness anything even remotely resembling high inflation despite the FOMC’s unprecedented levels of monetary easing in the aftermath of the 2008 recession. Evans is ultimately worried that the U.S. will become like Japan, which has unsuccessfully battled deflation for more than a decade.
So what did the details of the FOMC meeting mean for the markets? The 10-year Treasury auction on Wednesday afternoon was met with relatively tepid demand. Remember, the FOMC notes were released in the early morning instead of the scheduled 2:00pm putting it well before the scheduled 1:00pm 10-yr auction. This gave market participants ample time to dig into the details of the report and identify some of the dissenting comments noted above. The auction arrived with weak demand of 2.79x on the bid-to-cover ratio, an often quoted measure of investor demand at auction. This helped push the auction yield to 1.795% on expectations of 1.78%. The chart below highlights last week’s yield change on the 10-yr note with pre-release movement in red, Wednesday’s “risk on” move in yellow, followed by the late-week reversal in green. Wednesday saw yields fall for a third consecutive day with the 10-yr and 30-yr benchmark securities pushing up in yield by as much as 9bp and 13bp respectively. Friday saw an abrupt reversal of the post-FOMC yield rally thanks to weak retail sales and PPI data.
April Fools and Broken Records
By Benjamin Streed
April 8, 2013
At the turn of 2013 the market appeared ready for a change; many participants around the globe were convinced that the turn of the New Year was certain to bring back stronger global growth, better employment data here in the U.S, and most importantly higher interest rates. In fact, scanning major media sources early this year turned up countless stories on fund managers’ plans to sell Treasuries into the summer with many even intending to sell the securities short. As a reminder, a short seller intends to profit on the decline in the value of a security. It turns out that the first quarter of 2013 isn’t really all that special, and it could be argued that in some ways it is simply copying 2011 and 2012. Relatively speaking, interest rates generally rose or stayed elevated for the first three months in each year but began their decline lower as soon as the month of March concluded. The chart below shows this strange trend as reflected by the 10-year Treasury yield. So what is the cause of this stark reversal each year? This year the catalysts seem to be a broken record of seemingly endless bad news out of Europe mixed with stagnant job creation here at home. Europe continues to struggle with existing (Spain, Italy, Greece) and even new (Cyprus) financial crises amidst startlingly high levels of unemployment. Here in the U.S., Friday’s employment figure was, to put it simply, a disaster, as only 88k jobs were created last month, the lowest reported level in nine months. This pushed the yield on the 10-year Treasury to a 4-month low of 1.69%, the lowest level year-to-date for 2013.
Turning to index returns, Treasuries are showing strong performance thus far with longer-dated maturities leading the way, indicating that bond prices are up as yields move lower. According to YieldBook data, the 10- and 30-year benchmark securities are up 1.13% and 1.87% respectively for the year thanks to strong performances of 1.51% and 5.06% last week alone. Meanwhile, Treasury Inflation Protected Securities (TIPS) continue to struggle as inflation expectations remain tepid; 5-10 year maturities are positive by only 0.98% for the year and maturities of 10+ years are up 1.11%. As we’ve seen in past years, whenever there is a strong “flight to safety” bid TIPS get the benefit of being guaranteed by the U.S. Treasury, despite their return being more directly tied to inflation data than prevailing interest rates. So how do we definitively know that a “safety bid” is the force behind last week’s performance? Looking at corporate bonds, longer-dated issues with maturities of 10+ years only returned 3.33% compared to Treasuries’ 4.10%, proving once again that when it comes to perceived “risk free” assets, there’s really only one game in town. The market will look to confirm, or possibly refute, the recent move in yields as the Treasury Department is scheduled to be very active in auctions this week. We’ll get $32 billion of 3-year notes on Tuesday and $21 billion of 10-year notes (reopening auction) on Wednesday, followed by a smaller $13 billion sale of 30-year “long bonds” on Thursday.
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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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