ECB President’s Pledge Leads to Increase in Treasury Yields

 

By Rom Badilla, CFA

July 26, 2012

After European Central Bank President stated that they would defend the European Union by suggesting that they would intervene in the bond markets, risk assets such as credit bonds and equities rallied as U.S. Treasury yields moved higher.

In a speech in London ECB President Mario Draghi said that “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.”  Furthermore, he added “that the euro is much, much stronger, the euro area is much, much stronger than people acknowledge today. Not only if you look over the last 10 years but also if you look at it now, you see that as far as inflation, employment, productivity, the euro area has done either like or better than US or Japan.”

Draghi added that there are some hurdles to overcome. He stated that “The short-term challenges in our view relate mostly to the financial fragmentation that has taken place in the euro area. Investors retreated within their national boundaries. The interbank market is not functioning. It is only functioning very little within each country by the way, but it is certainly not functioning across countries.”

The ECB President suggested that in order to progress and evolve as a union, he said that strategy is to “to repair this financial fragmentation.” This condition jeopardizes monetary policy transmission mechanism which in turn allows the ECB to intervene since it falls within their policy to address it.

In light of this pledge to defend the Euro which in essence buys policy makers more time to implement economic reforms, risk assets soared as the market reversed its flight-to-quality bid which led to higher U.S. Treasury yields and tighter yields on sovereign bonds.

The yield on the 10-Year U.S. Treasury finished trading at 1.43%, an increase of 4 basis points from the previous close for a dollar price decline of 0.3% according to Trade Monster’s Bond Trading Center. The Long Bond sold off in dollar price as well as the yield on the 30-Year maturity expanded by the same amount to conclude the day at 2.5%. The yield on the 5-Year closed at 0.59%, an increase of 2 basis points from the previous close while the 2-Year closed at a yield of 0.22%, a move higher of a basis point from the previous close.

Bond Investing – U.S. Treasury Yield Curve

Across the pond, bond yields for peripherals dropped dramatically after Draghi’s assurances. The yield on Italy’s 10-Year fell 38 basis points to end the day at 6.01% while Spanish yields on their longer dated benchmark note closed at 6.83%, a drop of 46 basis points.

Equally important, the yield differential between shorter dated bonds and longer ones, jumped and re-steepened the Spanish yield curve. The spread between 2-Year Spanish bonds and 10-Year notes increased almost 30 basis points to 125.

Bond Investing – Spain 2 & 10-Year Yields

As noted before, a flat or inverted yield curve typically signals funding and solvency duress as short-term borrowing costs rise higher relative to yields on the longer end. A curve of this shape coupled with rising overall yields spells trouble for sovereigns (specifically a country that does not issue its own currency) as they have trouble accessing the capital markets for funding.

On the economic data front, today’s data release is a bag of mixed indicators of the direction of the U.S. economy as the headline numbers were positive while the details behind it were not. The Commerce Department reported that Durable Goods Orders which provides the markets a pulse of the health of the economy on the business investment side of growth, jumped in June by 1.6%. In addition, the May number was revised upward from an increase of just 1.1% to 1.6%. June’s data pleasantly surprised the markets since median surveys of economists’ forecast, was at 0.3%.

Despite the better than expected headline number, Durables Ex Transportation aka “Core” which strips out the volatile components of the data, was worse than expected as July’s figure showed a drop of 1.1% versus surveys of an increase of 0.1%.

Even with the better than expected headline number, the underlying data is suggesting little strength ahead for the economy.

Despite the selloff in Treasuries, the Corporate Bond sector performed well today led by Financials as dollar prices gained and yields fell.

Financials as evident by the seven benchmarks bank issuers, on average saw a decline of 6 basis points. After several days of underperforming, Morgan Stanley bonds on the 10-Year part of the curve outperformed massively as the price gained by 1% and as yields declined 14 basis points to 5.44% according to Trade Monster’s Bond Trading Center. Goldman Sachs bonds followed suit by appreciating 0.8% on a dollar price basis as yields ended at 4.64%, a decline of 11 basis points.

Industrials didn’t fare as well as their counterparts in the Financial sector as yields were generally mixed. Anheuser-Busch and Comcast 10-Year benchmark notes gained in price as each saw their yields decline by 2 basis points to 2.29% and 2.61%, respectively.  Conversely, Intel’s 10-Year dropped 0.2% on a dollar price basis to yield 2.14%, an increase of 3 basis points from the prior close. The large retailers each declined in dollar price as 10-Year bonds for Target and Walmart increased 2 basis points to 2.20% and 3 basis points to 1.79%, respectively.

For more information, check out our Corporate Bond Market Snapshot

 

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Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

 
 
 

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