For the most part, the credit markets stood by and watched the equity markets swing back and forth last week. The average spread in the Morningstar Corporate Bond Index ended the week unchanged at +138 and is essentially flat for the year. Year to date, our corporate-bond index has returned 1.27%, putting it on pace to meet our estimated low- to mid-single-digit return for the year.
New Issue Market Standstill as Investors Pore Over Earnings
The new issue market was virtually non-existent last week as most investors spent their time digging into earnings reports. From the syndicate desks we have talked to, this week should also be quiet, as the number of companies reporting earnings will peak this week. As we've seen for the past several quarters, top-line growth has been stagnant, but most companies seem to have been able to meet their earnings targets through tightened cost controls. Commentary on earnings calls suggests that economic activity in Europe continued to slow, while the pace of consumer spending in the United States decelerated last month. Trading volume felt quiet all last week but slowed significantly on Friday as attention was tuned into events in Boston.
Economic Data Sluggish, but Not Recessionary
Economic activity continued to slow globally last week, as China reported that its first-quarter GDP grew at 7.7% year over year. While that growth rate would be the envy of any developed market, it was a reduction from the 7.9% recorded in the fourth quarter and much lower than the 8.0% consensus expectation. Subsequent to this report, most economists reduced their estimate for China's 2013 GDP by 0.4 percentage point to an average 7.8%.
Economic data released in the US last week was also discouraging as far as looking for indications of rising economic growth, but it didn’t augur a recessionary slowdown—just more of the same amount of economic activity plodding along.
Economic data and anecdotal evidence from earnings calls this quarter suggest that the recession in the eurozone may be worsening. GDP estimates for the eurozone are for a 2% decline and some prognosticators are beginning to call for a potentially deep recession in France.
Highlighting the length and severity of the downturn, Fitch downgraded its credit rating on the United Kingdom to AA+ from AAA on Friday, citing slowing prospects for economic growth. We expect many more sovereign downgrades to come before the European economy bottoms out. As a result of weakening activity in Europe and slower growth in the emerging markets, the International Monetary Fund reduced its forecast for global growth to 3.3% from its 3.5% forecast made in January.
Federal Reserve Poised to Keep the Pedal to the Metal
Several members of the Federal Reserve gave speeches last week that indicate the Fed will keep the pedal to the metal for the time being. While Federal Reserve vice chair Janet Yellen (who is a voting member on the Federal Open Market Committee) acknowledged that "Low interest rates may induce investors to take on too much leverage and reach too aggressively for yield," she currently does not see "pervasive evidence of rapid credit growth, a marked build-up in leverage or significant asset bubbles." Minneapolis Federal Reserve Bank president Narayana Kocherlakota also said he does not see any asset bubbles, and in a question-and-answer session after his speech, he reportedly said the Fed wants investors to take on more risk. Based on comments such as these, lacklustre economic indicators in the US and worsening conditions in Europe, we think the Fed will not reduce its asset-purchase programme anytime in the near future.
