What a Difference One Economic Data Point Makes

BOND STRATEGIST: As soon as the employment number was released Friday morning, everyone immediately became a buyer of corporate bonds

Dave Sekera, CFA 11 June, 2013 | 6:58PM

What a difference one economic data point makes. All week long, every investor in the corporate bond market was a seller, but as soon as the us employment number was released Friday morning, everyone immediately became a buyer. With payrolls coming in at 175,000--little higher than consensus--and the unemployment rate weakening slightly to 7.6%, investors could read into the report whatever they were already predisposed to believe. As the prices of long-term Treasury bonds and commodities (especially precious metals) fell, those investors were probably heeding the predictions of the economists who purport that the payroll report supports tapering of the Fed's asset purchase programME this summer. Considering the S&P 500 rose 1.3% on Friday, it appears equity investors are in the camp that the employment report was strong enough to support continued economic growth, but not so strong as to prod the Fed into tapering its quantitative easing program.

Credit spreads widened all week long, as the average spread of the Morningstar Corporate Bond Index rose 10 basis points, reaching +147 at the close Thursday, its widest level thus far this year. However, corporate bond spreads tightened on Friday, sending the index to +145 by the end of the week. Since we changed our view on the corporate bond market to neutral from overweight last fall, the average credit spread has ranged between +130 and +155, averaging +140. We continue to view the corporate bond market as fairly valued, although we acknowledge that the near-term momentum will probably push credit spreads tighter early this summer toward the low end of the aforementioned range.

As investors looked to reduce risk during the week, the yield on the 10-year Treasury bond declined, but never breeched the 2% barrier. After the employment report Friday, the risk-on trade resumed in full force and the yield on the 10-year backed up to 2.16%, essentially the same yield at which it began the week. We have cautioned investors numerous times that once the Fed announces its intention to begin tapering, interest rates will probably rise 100-150 basis points in a relatively short period. Historically, the yield on 10-year Treasury bond averages more than 200 basis points greater than the inflation rate. Even at the currently low rate of inflation of about 1%, the yield on the 10-year Treasury could easily increase another 100 basis points.

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About Author

Dave Sekera, CFA  is a senior securities analyst with Morningstar.

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