A volatile month has bent bond buyers every which way, but there’s no sign the market is about to break.
November started with the Federal Reserve pledging to buy $600 billion in Treasury securities in a move that, against all odds, sent prices of the targeted bonds tumbling. That selloff, the first sizable one in six months, sent buyers scurrying away from the market for municipal bonds and high-yield corporate debt.
Adding to the anxiety, this week saw a number of junk bond deals pulled in Europe and a light corporate bond issuance schedule in the United States. Worries that the bond market is headed for a crash haven’t exactly been allayed by comments like Pimco manager Bill Gross’ gibe that Treasury buyers are headed for a turkey shoot.
But fears that a big shakeout is at hand appear misplaced. Even after a modest run-up, the yield on the 10-year Treasury note is more than a percentage point below its level at the start of the year. The yield Wednesday afternoon was 2.84%.
And while U.S. investors are surely antsy about what’s going on in Europe, there is no sign as yet that fears about the solvency of European banks have spread across the Atlantic.
Unless that happens, expect investors to regain their appetite for bonds, especially better-quality ones, without a big drop in prices.
“We’re starting to see significant risk aversion in Europe after all that’s happened in Ireland,” said Guy LeBas, a strategist at Janney Capital Markets in Philadelphia. “But it hasn’t quite flowed over to the U.S. yet, and that’s what we’re keeping a close eye on.”
LeBas points to the lack of correlation so far on bank credit spreads on either side of the Atlantic. Thanks to questions about the cost of saving sick Irish banks and the implications for other troubled economies such as Portugal, insuring against a default on debt issued by big European lenders has grown dearer in recent days.
The cost of insuring against a default by Spain’s Santander (STD), the biggest lender in a domestic economy sagging under 20% unemployment, rose 1.5% Wednesday to $234,000 annually for every $10 million of covered debt. That price is in line with the premium that prevailed in May at the time of the last euro debt crisis.
But all the biggest U.S. banks are seeing their spreads tighten Wednesday, meaning the price of insuring against a default is falling – as is the banks’ implicit cost of borrowing. JPMorgan (JPM), to take one example, saw its spreads fall 7% to $86,000 per $10 million of debt insured.
Spreads on other U.S. banks tightened between 2% and 4%, according to CMA Market Data, on a day when the stock market rallied and financial stocks rebounded from a pasting earlier in the week.
That U.S. banks haven’t been hammered by European turmoil is hardly shocking, given both their many problems at home and their lack of exposure to peripheral European economies such as Greece, Ireland, Portugal and Spain.
But the big European banks have no shortage of exposure to weaker European economies. And after 2008, no one doubts that a bank funding problem in Europe could put pressure on U.S. lenders as well, which is why these trends bear watching in coming weeks.
“So far we aren’t seeing much of a link between the U.S. and euro zone markets,” said LeBas. “That’s good news for us over here.”