The equity markets were on a wild ride last week, but the credit markets only edged out slightly. Through Thursday night (the latest for which we have accurate pricing), the Morningstar Corporate Bond Index widened just 4 basis points to +205. In the equity markets, however, the roller coaster took the market up and down, with the S&P 500 edging 4% lower on the week and the FTSE 100 closing with a 5.3% weekly loss
U.S. Debt Markets
Due to European sovereign debt concerns, fears of a possible global recession, and looming possible settlements from prior mortgage and foreclosure practices, U.S. bank credit spreads have remained volatile and have widened dramatically over the past few weeks. The following chart displays the increase in five-year credit spreads for the six major U.S. banks since Aug. 1. Note the relative increase in spread for Bank of America (BAC) and Goldman Sachs (GS) (rating: A-) compared with Wells Fargo (WFC) (rating: A+), and J.P. Morgan Chase (JPM) (rating: A+). The chart shows that while the bond market is shunning all U.S. banks, banks with recent negative headlines have been hit especially hard. We recently moved Bank of America to unrated as we re-evaluate the bank's legal exposure to mortgage lawsuits in light of American International Group's (AIG) recent filing.
Continued fears about the U.S. economy fuelled the flames of another downturn, reigniting the sentiment that rates will remain low for some time, as we have continued to highlight. This pressured Treasury yields, with the 10-year Treasury ending the week at 2.07%, down 7% from the week before and at its lowest point since late 2008. More significantly, it dipped below 2% on Wednesday.
We expect things to remain relatively quiet this week as the market waits with bated breath for news from Fed chairman Ben Bernanke from Jackson Hole, Wyoming, on Friday. The second round of quantitative easing was announced at last year's meeting, but despite the current turmoil in the markets, it would be hard for the Fed to institute a new stimulus, in our opinion, given inflationary pressures. What exactly the Fed will decide is something we will be closely watching.
European Debt Markets
The European Central Bank's purchase of Italian and Spanish bonds will work for a time, but a permanent fix is needed. Italy's 4.45% notes 2020 rose a mere 1 point to 94.5, resulting in a 5.29% yield, which is +349 basis points over German Bunds. Spain's 4% notes 2020 were flat at 95 and a yield of 4.71% yield, which is +284 basis points over Bunds. While central bank purchases are stemming the rampant rise in these countries' bond yields, they are not addressing the underlying issue that is concerning investors. Investors will need to see the austerity measures enacted in these countries as being effective before jumping back into the market.
