Fixed Income Market Commentary for the Week of June 4, 2012
The probability for further Fed accommodation rose last week, as a substantial flight to quality drove 5-year, 7-year, 10-year, and 30-year treasury yields to record lows. A much weaker than expected payroll report was the cornerstone of domestic economic news influencing the market. May payrolls grew a disappointing 69K, and March and April were revised downward a net 49K. Private payrolls grew by 82K, whereas 130K was expected, and job losses were led by government and construction sectors. The unemployment rate ticked up to 8.2%, fueled by weak job creation and an increase in the participation rate.
In other domestic news, the ISM manufacturing index in May fell to 53.5 vs. 54.8 in April, and GDP growth in the first quarter was revised down to +1.9% from +2.2%, as expected. The Conference Board's consumer confidence index fell 3.8 points in May to 64.9, the lowest reading of the year, as labor conditions worsened.
Amidst all of the weakness, there were a couple of brighter spots. The S&P/Case-Shiller home price index rose 0.1% in March after a 0.2% rise in February, the first back-to-back gains in two years. The recent improvement was broadly based, with 16 of 20 metro areas demonstrating gains. Chain store sales also came in better than expected, with a 4% increase in May.
The European financial crisis continued to dominate headlines and drive market activity. The EC proposed direct euro-area aid for troubled banks and suggested that the euro’s permanent bailout fund inject cash directly to banks instead of channeling money via national governments. Amidst all of the proposals and discussions, a resolution for recapitalizing Spain’s banks remained unclear. Uncertainty regarding Spain’s banking bailout drove the country’s 10-year yield to new highs and sovereign credit default swaps to record levels. The euro plummeted to a two-year low, as eurozone unemployment reached a record 11%, fueled by worsening labor conditions in Spain, France, and Italy. Global growth fears were also fueled by weaker than expected GDP growth in India and unexpected manufacturing index declines in China and the UK.
For the week, benchmark Treasury yields plummeted another 4 to 30 basis points, and the curve flattened. The 2-year yield fell 4 basis points to 0.25%, 3-year 8 basis points to 0.33%, the 5-year 14 basis points to 0.62%, the 7-year 24 basis points to 0.94%, the 10-year 28 basis points to 1.47%, and the 30-year 30 basis points to 2.54%. Equities erased previous 2012 gains as the S&P 500 fell 3.0%, the Dow dropped 2.8%, and NASDAQ plunged 3.3%. Lower coupon Mortgage-Backed Securities performed very strongly last week, outpacing treasury market gains, as investors now see an increase in Fed buying as likely and supply remains a non-issue. Municipal AAA-consensus yields fell 1 to 9 basis points, with the intermediate part of the curve outperforming. Municipal supply is expected to increase to over $9 billion this week, about double last week’s supply.
No significant supply or purchases are scheduled for the week.