Bond Investors Key In on the Economy

Strong economic data and global stimulus hopes overcame weak corporate earnings in the bond market last week

Dave Sekera 23 October, 2012 | 9:00AM
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The potent brew of stronger economic data in the United States and renewed hope for further central bank stimulus lifted the spirits of the global equity and credit markets last week, only to be dashed on Friday as weak earnings reports weighed on the markets. However, based on the strength earlier in the week, the average credit spread in the Morningstar Corporate Bond Index tightened 10 basis points last week to +133, approaching levels not seen since 2007.

The week brought a slew of positive economic data in the US, which emboldened buyers of risky assets to look past weak third-quarter results from companies such as Intel (INTC), Google (GOOG), Coca-Cola (KO), and IBM (IBM). Offsetting these marginal reports were bank earnings from JP Morgan Chase (JPM) and Wells Fargo (WFC) that showed continued improvement in core businesses.

The Next Round of Central Bank Actions
In addition to the strong economic data in the US, news from China and Spain increased speculation that the next round of central bank monetary stimulus will be launched shortly.

In China, consumer price inflation declined to 1.9% in September from 2.0% in August, and producer prices dropped 3.6% from a year earlier. The closely watched third-quarter GDP data showed growth of only 7.4%. This compares to with 7.6% in the second quarter and is the seventh straight quarter of slower growth. Although other data released last week, such as retail sales, suggest that the decline in the GDP growth rate is abating, the market is taking the view that the relatively weak GDP and inflation data open the door for Chinese policymakers to attempt to boost the economy.

In Europe, Moody's reaffirmed its Baa3 sovereign rating on the Kingdom of Spain but assigned the country a negative outlook. Moody's downgrade comes on the heels of S&P's downgrade to BBB- with a negative outlook. As many market participants believed that Moody's would lower Spain’s rating to junk status, the reaffirmation spurred a rally in Spanish debt, as the 10-year bond rallied to 5.5% after Moody's announcement, the lowest level since April. With the risk of a near-term downgrade to below investment grade removed, European equity and credit markets rallied as the stage is set for the Spanish government to seek support from the European Central Bank.

Moody's expects that Spain will apply for a precautionary line of credit from the European Stability Mechanism, triggering the ECB's Outright Monetary Transactions programme to start purchasing short-term Spanish debt in the open market. The timing of this request is uncertain, but we suspect Spanish Prime Minister Mariano Rajoy will await the results of important regional elections in Spain in order to shield his party's popularity from the potential negative backlash of the support request.

As the structural issues remain in Spain and fundamentals in the country continue to deteriorate, we do not believe the longer-term issues have been solved, but we respect the market's response to potential ECB bond purchases.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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