Thursday, January 27, 2011

A Bump in the Road

Argentina bonds were one of the best performing investments of 2010, returning 38%, so it was inevitable that at some point investors would take profits and that is exactly what they've been doing these past few days. Bonds today were generally down about 1 1/2 points. Venezuela bonds also came under attack, dropping about 3/4 point on top of yesterday's losses which were partially the result of news that Chavez wanted BBVA's Provincial banking unit out of the country. Traders sold Brazil sovereign bonds too, partly due to the turn in Street psychology but also due to the news that Banco Panamericano would need a larger bailout than previously announced. Banco Panamericano bonds fell sharply today, much like they did a month ago when the news first hit that the bank was severely under capitalized due to accounting irregularities, but the rest of the high yield Brazil bank bond sector snapped back. El Salvador 30 year bonds just issued a few days ago that traded as high as $100.85, made their way back to par. Global equities markets were fairly stable today and commodities prices were mixed, so it was a bit unexpected for EM to sell off as it did. Egypt and Lebanon were engulfed in political protests, so after the uprising in Tunisia people were put on alert. Soybean farmers in Argentina took to the Streets in protest and that is country's largest export. US Treasuries sold off at least part of the day and then rallied back slightly after a decent 7 year note auction. After the Federal Reserve communicated yesterday after its 2 day FOMC meeting that it would continue with its quantitative easing measures, people ended up selling Treasuries as they were concerned about inflation creeping up in the US as it has in the UK where quantitative easing measures have also been actively employed. Economic data was a little disappointing, with durable goods and weekly jobless claims missing the mark, but not enough to derail the prevailing sentiment of an economy on the mend. With the economy growing at a measured pace, inflation still at bay, rates locked into a range and people still enamored with the emerging markets, today's sell off is not likely to last long.

Thursday, January 20, 2011

"Don't Worry, Be Happy"

Treasuries sold off hard as the combination of strong existing home sales, falling weekly jobless claims and a poor TIPS (Treasury Inflation Protected Securities) auction drove rates toward recent support close to 3.5%. A poor TIPS auction should be positive in that there's less demand for inflation protection but its hard to argue with the bond vigilantes concerned about improving economic growth. In the end it seemed a case of investors not wanting such low yielding securities, inflation protected or otherwise. That was confirmed by the $15 billion of orders for the $6 billion, 3 tranche bond deal for the Brazilian energy company Petrobras in what was the largest emerging market debt deal on record. With ample spreads of 190 bps over Treasuries for the 5 year tranche and 195 over for the 10 year as well as 220 over for the 30 year, investors clearly expressed their desire for higher yields while lending to a company with a solid business profile and reasonable leverage. The Baa1 (positive outlook)/BBB- rated company priced at a small concession to secondary trading levels with the appeal of the deal for many being the opportunity to buy big blocks of USD denominated bonds with more yield than other comparably rated securities.

Wednesday, January 19, 2011

Profit Taking

The combination of new issue supply, weaker equities and rich valuations led to some spread widening in the credit markets today. Treasuries performed on cue with the dip in stocks, rallying about 4 bps, helped by the Federal Reserve's buyback of $8 billion 3 year notes as part of the ongoing quantitative easing program. Goldman Sachs earnings hit the mark but that was a disappointment as the market had gotten used to the company exceeding estimates by a wide margin. Petrobras, the mammoth Brazilian energy company, wrapped up its benchmark size offering of 5, 10 and 30 year bonds. With a Baa1 rating on positive outlook and a solid business profile, 200 bps over Treasuries looked cheap for 10 year bonds. Overall, the deal reportedly garnered over $10 billion in orders and will price tomorrow. Investment grade sovereign and quasi sovereign Latin American bonds were generally a little weaker to price in the new supply. With further new issues expected over the next week, continued weakness should be expected but its not anything to worry about as the credit market is likely to trade in a range all year long. The former soviet republic Belarus priced a 7 year deal at about 9%, making slightly lower rated Argentina look a little rich at nearly 100 bps tighter in yield. That pattern is likely to emerge numerous times in the first quarter, as rich secondary market valuations get repriced with new issues. Especially vulnerable are Latin American debt issues as compared to new supply from Asia, Eastern Europe and the Middle East.

Tuesday, January 18, 2011

Priced for Perfection

Well maybe not priced for perfection just yet, but getting pretty close. Most fixed income spread product, like mortgage backed securities, corporate bonds and asset backed securities, have performed admirably for the past 2 years. Those who put capital to work at the darkest of times were handsomely rewarded, but what will they do now and what will we do too? If the economy continues to recover along the same path as the past few months, you can still earn a decent return despite the drag from rising interest rates. As a spread to Treasuries, levels in many cases are reminiscent of 2007 before the financial world as we know it nearly came to an end. Across the pond, there is a mounting debt problem amongst European peripheral nations like Portugal, Spain and Italy. Economic growth in those countries has slowed while budget deficits have soared and investors have expressed reluctance to roll the debt. Portuguese debt is trading similar to US 'B' rated high yield bonds and on average Latin American USD bonds are trading well through the sovereign debt of these peripheral countries. Greece debt appears to be priced for a restructuring and Irish debt is following down a similar path. That turmoil overseas has not had a lasting impact on our markets, but merely has shaken them up from time to time as negative headlines surfaced. If a shake up occurs this year, it would provide an opportunity to add to positions. Another opportunity might occur if economic growth disappoints, as it is apt to do occasionally. Credit spreads are destined to go tighter over the course of the year but it is highly likely they widen at some point to provide a better entry point. The primary market for new issues is likely to be heavy and the economic recovery is not likely to continue in a perfectly straight path so look for periods of weakness in equities that may cause people to sell high yield funds as well. Emerging market debt looks pretty healthy as well, though Argentina appears to be overbought since it returned 38% to investors last year. Chile provides some interesting trading opportunities as the government's intervention efforts will have limited success in keeping the Chilean peso cheap to the Dollar. The country has wisely opted to buy $12 billion this year of Pesos in an effort to raise hard currency for a rainy day while pushing against the tendency of off shore investors to drive the Peso to an overvalued position. Venezuelan debt, yielding 15-18%, looks interesting but clearly you get what you pay for as that country's economy is arguably broken. In 2010, the debt of investment grade countries like Brazil and Mexico returned around 11% while junk rated Venezuela returned around 15% so on a risk adjusted basis investors were not paid well. Venezuelan bond supply was heavy last year, as it was in 2009, but we may have arrived at a virtuous period over the next 6 months when the country does not issue and allows its debt to perform like the high beta sovereign that it is, with tightening spreads in a bull market for credit as people grab for the highest yield they can find.

Thursday, January 13, 2011

Latin America today

USD Latam bonds consolidated their recent gains after decent performance these past few weeks. Argentina has been the star lately, much to the surprise of anybody who has actually lived there, with yields now trading well through 8%. The government has successfully managed to re-enter the capital markets with a swap of new debt for old defaulted debt as well as convinced investors that it intends to start reporting its inflation data correctly. Some have said that a ratings upgrade is imminent and that is clearly getting priced in, arguably too much so. Venezuela bonds continue to trade in a range at relatively high yield levels of around 15% as compared to similarly rated US credit due to the country's propensity to issue as many bonds as humanly possible to get Dollars into an economy which seems to be falling apart. Devaluation of the currency seems to have become an annual event and that has contributed to raging inflation rates that are reportedly well north of 30% per annum, electricity shortages have become common, a large portion of private businesses have been nationalized and Dollars have become scarce enough that imports of critical raw materials have not been adequate to maintain production levels. Brazil bonds, the most liquid in the USD sovereign bond market, continue to trade at record tight credit spreads even as some investors have begun to question how long the economic miracle can last. With the change in the Presidential administration this past year, there are some nagging doubts about whether sustainable growth with a manageable inflation rate can be maintained. No one that I know of is predicting a major dislocation in Brazil bonds, but given that they are priced for perfection it doesn't seem like it would take much to cause a correction. Peru bonds have been tracking their Brazilian neighbors. There is an upcoming election there but all of the candidates seem to be sane enough to keep the country on the right track. Colombia still trades a little cheap to Brazil but that is not expected to last long as a credit ratings upgrade from Moody's is imminent, which will allow more people to buy the debt. Mexico bonds have also performed remarkably well this past year and currently trade no more than 10-20 bps wider than Brazil. The Mayor of Oaxaca, Mexico was reportedly shot today and he was the 3rd mayor in Mexico this year (yes, in the past 2 weeks 3 mayors have been shot) to be assassinated. Astonishing is that it has only been two weeks since the start of the year and that the markets have not reacted negatively yet. Colombia originally lost their investment grade ratings when mounting violence severely impacted the country's economy but then the government succeeded in reigning in the drug cartels.Colombia has crawled back to becoming an investment grade country again, at least as far as two out of the three main rating agencies are concerned. Rating agencies stated last year that they were monitoring the situation in Mexico but that violence had not risen to the magnitude yet which would impact ratings. We are waiting to see if this latest serial killing of mayors changes that view. Mexico has typically issued new USD bonds in January yet they have so far been noticeably absent, reportedly due to some staffing changes in the Finance Dept. In this bullish climate for emerging markets it is possible that the latest rash of violence may not have any discernible impact on the debt but we will closely monitor the situation.

Saturday, January 8, 2011

"Fool Me Once, Shame on You. Fool Me Twice, Shame On Me"

The US labor market is still on the operating table, with weak numbers disappointing many, despite the strength suggested by Wednesday's ADP jobs report. Bonds did not like Wednesday's report and it seemed like the 10 year note was poised to blow through 3.5% on confirmation from yesterday's non-farm payroll data. Instead we got another lackluster reminder that structural unemployment is here to stay for a while longer. In fact the unemployment rate dropped but sadly, most of that was from discouraged workers no longer seeking employment and not from more people finding jobs. The whole US Treasury curve rallied about 10 bps, helped by Federal Reserve Chairman Bernanke's comments that while US economic growth in 2011 would improve, it would not be significant enough to stall the previously announced bond buy backs that are part of quantitative easing measures being implemented to accelerate the growth rate to a healthier pace. Economic data these past few months has been robust enough to push the 10 year Treasury north of 3% but a continued anemic labor market should keep it capped inside of 3.5%. That range for interest rates suits a lot of people, including policy makers concerned about higher rates having a dampening effect on the housing market as well as bond investors in spread product such as mortgage backed securities, corporate bonds and emerging market debt. The dazzling returns of bonds from 2009 and 2010 are not likely to be repeated anytime soon, but clipping a nice coupon might end up being preferable to equities that have priced in a lot of good news already.

Wednesday, January 5, 2011

As the Economy Turns

Treasury rates spiked higher today as economic data convinced a few more people that US economic growth might surprise to the upside. If the US Labor Department monthly jobs report due out this Friday materially exceeds expectations, we could be on our way to a 4% 10 year note yield over the next couple of months. The entire Treasury yield curve moved about 13 bps higher today, with the 10 year still inside of recent support at 3.5% but well above the 2.8% from only about a month ago. That support implied a bit of skepticism about the strength of the recovery, with traders willing to buy when rates got to that level, but confirmation of a stronger than expected labor market would be a game changer that would reset the range on interest rates.With the unemployment rate still uncomfortably high at north of 9% and monthly payroll reports from the US Labor Department stubbornly failing to deliver sufficient gains, many traders and investors have been willing to buy Treasuries on dips prior to today. There's a reason why unemployment benefits keep getting extended. Some would say we have a structural employment problem, as the crash of the housing boom and the structured credit bubble left a black hole in our economy with lots of jobs permanently lost.We've all been waiting for the labor market to turn around to provide the income needed to stimulate consumer spending and get the economic cycle going in a favorable direction. The ADP private payroll survey released today, printed at an off the charts +297k today while the Challenger, Gray and Christmas survey reported 29% less layoffs than December a year ago. All of that bodes well for the monthly US Labor Department report this Friday and Treasuries repriced to reflect that risk. Also encouraging was a stronger Service sector report from the ISM (Institute of Supply Management). The housing market is still in a problematic condition and rising rates could slow down the recovery. Also a drag on growth are mounting budget deficits and debt levels for many of our largest States that should lead to layoffs in the public labor sector. Those dampeners should contain growth and inflation enough to keep 10 year yields south of 4% for a while and there is substantial technical support as well. Corporate bonds should outperform, especially high yield and emerging market bonds, as improving corporate profits provide support to balance sheets and commodities markets remain strong, fueled by stronger economic growth. One other concern for investors in higher risk credit products is the European sovereign debt crisis, which has derailed rallies in the past and will likely provide the occasional pothole in the coming year. Investors fear a larger banking crisis overseas but negative headlines will prove to be buying opportunities as they were this past year. As the US economic recovery gains steam that should help European nations as tourism rises and US consumption of their exports increases. Getting from point A to point C has always required going through B first and point B involves major structural changes in the Southern European economies as well as a possible debt restructuring for Greece and asset write downs for banks that hold the debt of other troubled nations that could cause significant but manageable losses for the system as a whole. The bottom line is that certain sectors of the bond market may provide decent returns this year despite rising Treasury rates.