Is it the economy envisioned by the Federal Reserve characterised by deflation, high unemployment, and declining growth in business spending? Or is it the economy distinguished by a whopping 2% increase in durable goods excluding transportation and a 0.3% increase in the Conference Board's Leading Economic Index?
Credit tried its best to widen out last week after the Fed released its statement, but regained any lost ground Friday after the US durable goods report. Once the market digested this news, it took off like a rocket and never looked back.
The Treasury market made significant gains at the beginning of the week as the Federal Reserve's statement was changed to specifically highlight the Fed's concern for potential deflation. We wonder what the Fed is seeing that we aren't, as agricultural commodities (corn, wheat, sugar, and soybeans), base metals (copper and aluminium), and precious metals (gold and silver) have recently all risen to or near 52-week highs. With the 10-year Treasury bond ending the week at 2.60%, we think there is a greater risk for rates to increase than decrease in the near term. We recommend investors favour lower-duration securities unless new evidence surfaces that would indicate a fourth-quarter macroeconomic slowdown.
This week, we caution investors to watch for the ISM index to be released Friday. The August index, released Sept. 1, surprised to the upside by a significant margin. That release began this recent bull market of tightening credit spreads and equity rally. We are concerned that if the September release misses consensus, the market could quickly give up the gains made over the past month.
The European markets struggled with renewed sovereign solvency fears and economic weakening. Ireland and Portugal successfully issued new debt this week, and the media reported that deals were well received by investors. However, investors in those bonds were quickly punished. The new bonds soon traded below issue price as credit spreads for both countries continued their march wider. For the week, Irish credit default swaps widened more than 80 basis points to +475, and Portuguese CDSs widened 50 basis points to more than +400. The widening was specific to these two countries. Credit spreads among the rest of the peripheral eurozone nations were either unchanged or tighter. For example, Greek CDSs tightened 70 basis points to +810 and Spanish CDSs were unchanged for the week at +230.
This is an edited version of an article that first appeared on Morningstar.com, a sister site of Morningstar.co.uk.
