November began with a European shakeup that did little to bolster the confidence of investors. Fear raged as Greece and Italy threatened to roll back efforts made by the ECB and IMF. Two embattled Prime Ministers, George Papandreou of Greece and Silvio Berlusconi of Italy, finally agreed to step down; Papandreou to secure Greek acceptance of the latest aid package while Berlusconi obtained the passage of domestic austerity measures needed to avert a bailout of Italy.

European bond yields were under siege for most of the month. Italian bond yields chopped above and below the 7.00% mark, which many consider key for determining the sustainability of debt levels. Yields for 10-year Spanish debt rose from 5.50% to as high as 6.66%. Much more troubling was the concern traders began to show about higher-tier countries such as France. French 10-year debt yields, which were 2.94% on November 1st, spiked as high as 3.70% before easing to below 3.40% by month end. Moody’s, while not taking any direct rating action, warned that the stable outlook on France’s AAA-rated bonds could be under pressure. This came after nerves were already raw after an erroneous alert from S&P that it had cut the AAA rating for France. Worst of all, on November 23rd, Germany was only able to sell €3.9 billion of a €6 billion 10-year bund offering at auction, placing a seed of doubt about the imperviousness of its safe haven status.

In the US, all eyes were on the “supercommittee”, which was tasked with reducing the deficit by at least $1.2 trillion over the next 10 years. A plan by Thanksgiving was to avert automatic cuts that would be implemented in 2013. Progress from the committee was so ‘non-super’ that the final couple days were spent trying to agree on how best to announce its complete failure. Some politicians immediately began plans to attempt to undo the automatic cuts, which President Obama has vowed to veto. In response, Fitch Ratings affirmed the AAA rating of the US but reduced its outlook from stable to negative, signaling a 50% chance of a downgrade within the next two years.

The end of November brought a coat of gloss to the pessimism that dominated the majority of the month. Despite the gloom, US economic indicators continue to show growth while the FOMC noted that growth had “strengthened somewhat”. Furthermore, Black Friday proved to fuel optimism, as figures show that Black Friday weekend sales were up over 16% versus 2010. The stats also showed that more shoppers are shopping and each is spending more. The final day of November brought a globally coordinated effort from central banks that had instant and significant impact on the markets. The move, by US, Canadian, English, Japanese, Swiss, and European central banks, is designed to keep the liquidity spigot open for households and businesses. More importantly, the action signaled the willingness of global central banks to take action to ensure financial stability.

Despite the lines in the stores, the Grinch still lurks in the markets. So much continues to be unsettled in Europe as governments battle over the depth and breadth of the roles that the IMF, ECB, and EFSF should take in the crisis. While this remains unsettled, yields continue to rise and debt levels become more unsustainable. The month-end action taken by the central banks, while helpful, does not address the fundamental issues affecting European sovereigns. US economic indicators are likely to remain positive, but headway could get undermined by Europe.

Market Summary

Bond Yields

Economic Indicators

Employment

Employment growth for October came in at a moderate, and expected, pace. The ADP report showed that the private sector added 110k jobs, slightly more than expected, while revising the September figures upwards by 25k jobs to 116k. Consistent with previous reports, job growth was concentrated in the service-providing sector and in small and medium-sized employers. The BLS reported that the economy added 80k jobs in October, slightly less than the 95k expected. September figures, however, were revised higher by 55k jobs to 158k. The unemployment rate ticked slightly downwards, from 9.1% to 9.0%.

The way the schedule fell, ADP released its November report on the last day of the month, which surprised to the upside. The report estimated that 206k jobs were added in November, easily outpacing estimates of 130k, while also revising Octobers figure upwards by 20k to 130k. Initial jobless claims figures also showed improvement in November, declining below 400k and remaining there. The four-week moving average also moved below 400k, to 394.3k.

Manufacturing

ISM Manufacturing declined slightly, from 51.6 to 50.8 in October, remaining slightly in expansionary territory. Component questions were mixed, with production and employment both slightly lower while new orders were higher. The price component was significantly lower. The ISM Non-manufacturing report also declined slightly, from 53.0 to 52.9 in October, as employment was higher and production and new orders lower in this report. All three of those components were in expansionary territory (above 50). Factory orders (0.3%) and industrial production (0.7%) also posted solid gains.

Regional manufacturing surveys continue to signal positive economic growth. New York (-8.48 to 0.61) and Richmond (-6 to 0) rose and are no longer negative. Philadelphia moderated (8.7 to 3.6) but remained positive. Dallas (2.3 to 3.2), Chicago (58.4 to 62.6), and Milwaukee (55.5 to 56.7) all rose higher in positive territory.

Prices

Economic indicators showed moderating price pressures, largely led by lower energy prices. Import, producer, and consumer prices all declined in October by 0.6%, 0.3%, and 0.1%, respectively. Prices were even tame with the volatile food and energy components removed from producer and consumer prices, with changes of 0.0% and +0.1%, respectively.

Consumer

Heading into the Christmas holiday, the consumer always takes center stage. Consumer spending has been growing for some time now, and October was no exception. Retail sales grew 0.5% in October, with the core (ex. autos) up 0.6%. Personal income and spending also grew by 0.4% and 0.1%, respectively. In recent months, consumer confidence hasn’t matched spending patterns, but in October confidence measures began to back consumer spending, with the University of Michigan reading rising from 60.9 to 64.2 and the Confidence Board measure spiking higher from 40.9 to 56.0.

Housing

The housing market remains stagnant, with little clear direction. Housing starts were flat in October, although building permits were higher. Both existing and new home sales were slightly higher in October, but they continue to be at historically depressed levels. The Case-Shiller Home Price Index showed weakening home prices in September. 17 of the cities in the 20-city index posted declines during the month, with New York (0.1%), Portland (0.1%), and Washington (1.2%) the only exceptions. The 20-city composite was 0.6% lower in September. The numbers continue to point towards consolidation but currently have little to no momentum higher.

Economic Calendar (December 2011)

US Treasury Market

Treasury yields oscillated in a tighter range throughout November (21-31bp vs. 62-69bp in October) with the 10-yr benchmark note averaging 2.01% and the 30-yr bond averaging 3.02%.  Investors watched the European debt crisis closely which continued to be the main driver of the market, as has been the case for months.  Domestic events that pressured Treasuries included an improving jobs picture, a robust start to holiday spending, and the FOMC minutes which stated that economic growth has strengthened somewhat.

Further attesting to the uncertainty in the markets was the strength of the $32 billion 3-yr note sale earlier in the month.  The bid-to-cover ratio, a gauge of demand for the securities, was 3.41, the most since 1993.  The auction yield of 0.37% was a yield low for the note since September and down from a high for the year of 1.41% on February 14th.  

Congress’s 12-member supercommittee, created in August as a consequence of an increase in the federal debt ceiling, failed to reach an agreement by the November 23rd  deadline to cut at least $1.2 trillion from the federal deficit over the next 10 years.  As a result, automatic cuts will be enacted in 2013, with roughly half coming from defense spending.  Some feel that sequestration was the best result, while others fear the automatic cuts will be blocked by new laws enacted before the cuts will be triggered.  Political issues such as this have increasingly been weighing on global sovereign debt prices.

Fitch affirmed the AAA rating on US debt after the supercommittee failure but downgraded the outlook from stable to negative, citing “declining confidence” that Congress would be timely in getting the country on a sustainable fiscal path. The rating agency noted that the US bond market is the largest and most liquid in the world as a reason for carrying the high rating.  The supercommittee’s failure didn’t change Moody’s or S&P’s ratings or outlooks.  The two agencies confirmed their current negative outlook and ratings, AAA and AA+, respectively.

Treasuries ended the month on a week-long losing streak capped by the Federal Reserve cutting the cost of emergency dollar funding to European banks, along with five other central banks.  The yield for 10-yr Treasury notes closed 9 bps lower on the month while 30-yr yields were lower by 10bps.  Investors will continue to look for signs of a recovery domestically and watch Europe like a hawk as the year comes to an end. 

Corporate Bond Market

Anxiety caused by the ever changing status of the European debt crisis continued to be the focus of the markets in November. November was volatile for investment grade corporate bonds as spreads ranged from a low of 120.6bps on November 3rd to a high of 147.5bps on November 25th according to the Markit Investment Grade Index. The index ended the month at 127.66bps, 6.2 bps wider for the month.

The Barclays Capital U.S. Corporate Index returned -1.96% for the month of November, underperforming similar duration Treasuries by 2.88%. The volatility due to Europe debt angst and the flight-to-quality in the marketplace led to a price return component of -2.37%. The long (10+years) part of the index underperformed the shorter part of the curve returning -3.49% compared to -1.39% for the short end. From the sector perspective, utilities had the least underperformance, -0.33%, followed by industrials returning -1.64% and financials with a return of -3.01%. Higher rated securities performed better than lower rated. AAA rated securities returned -1.05% while BBB securities returned -2.01%.

Financials have had a rough month as they have experienced a high level of volatility due to the debt crisis in Europe. Corporate bonds rallied through October as the picture in Europe began to clear up but most of those gains were given back in November. MF Global’s bankruptcy filing on October 31st set the tone for corporates heading into November which was followed by an expected bankruptcy filing by American Airlines on November 29th to cap a bruising month for corporate bonds.

Standard and Poor’s downgraded 37 of the largest financial institutions and their subsidiaries after applying its revised ratings criteria. Among the banks affected by the downgrade were J.P. Morgan Chase, Citibank, Goldman Sachs, Bank of America and Wells Fargo.

Despite the weak market sentiment and volatile environment in the markets, issuers were able to navigate the unpredictable waters en route to issuing $75 billion in high grade debt in November. Among the issuers that came to market were Amgen, Express Scripts and Walt Disney with $5 billion, $4.1 billion and $1.6 Billion in debt respectively. Future issuance will vary day to day as issuers attempt to time their issuance on days when market sentiment is positive. Since corporate issuance yields are tied to yields on Treasuries, issuers want to come to market when sentiment is positive but not too positive to push investors into higher yielding securities.

Municipal Bond Market

Although trading desks were thinned because of two bond market holidays, muniland was fairly active in November and performed well.  A sizeable amount of new issuance was brought to market and November now holds the record for the largest weekly new issuance total for the year at over $12 billion.   Munis have become more tightly correlated to Treasuries recently, as once was the case prior to the financial crisis.  This partly explains the strong performance in munis last month.  Extremely low absolute yields have kept some investors at bay, yet on a relative basis munis continue to be extremely attractive, reaching levels not seen in years.  The 5- yr muni-to-Treasury ratio reached 130% last month, the 10-yr reached 115% and the 30-year climbed over 130%.

Jefferson County Alabama filed the largest Chapter 9 bankruptcy filing in history on November 9th after years of poor decisions and failed negotiations surrounding sewer debt.  The county’s problems that led to the $4 billion claim were idiosyncratic in nature and the one-off filing event was not a shock to market professionals.  Jefferson County was ordered to make massive repairs and upgrades to its sewer system in 1996 after finding county sewage had polluted rivers, violating the Clean Water Act.  Six years of massive borrowing began in 1997 for the major repairs.  In 2002 and 2003 the debt was refinanced into auction and variable rate debt and risky embedded interest rate swaps.  In 2008 the derivatives market collapsed triggering large penalties and higher interest rates on the swaps and debt.  To make matters worse, the refinancing deal resulted in 20 convictions of corruption related offenses by county officials, contractors and other parties.  Furthermore, an occupational tax which accounted for nearly 25% of the county’s general fund, ended in 2010 after 17 legal challenges over the last several decades.

The market has virtually ignored Jefferson County’s bankruptcy filing and a domino effect between other municipalities is not expected.  The county’s situation had been deteriorating for years and was the result of specific mismanagement.  Municipal bankruptcies are still rare and are expected to remain so.

As we move into the closing month of 2011, activity is expected to pick up in the first two weeks and then trail off as we head into the winter holidays.  December is known to be a large month for principal redemptions and coupon payments and that cash will need to be put back to work.  We could see another month of solid performance in the market if signs of global stabilization are not observed and munis continue to benefit from flight-to-safety trading.

General Investment Disclosures

This publication has been prepared by BondWave LLC.  This publication is provided for informational purposes only.  Neither the information, nor opinion, nor prices in this publication constitute a solicitation to buy or sell any financial instrument.  This publication is not intended to provide personal investment advice.  The securities discussed in this publication may not be suitable for all investors.  Investors should independently evaluate each issuer, security, or instrument discussed in this publication and consult with their investment advisor before making any investment decisions. 

Information contained in this publication has been obtained from sources believed to be reliable, but BondWave Advisors does not represent or warrant that such information is accurate or complete.  The information in this publication is not intended to predict actual results, which may differ substantially from those reflected.  Past performance is not necessarily indicative of future results.  Any opinions in this publication provided by BondWave LLC are as of the date of this publication and are subject to change.  BondWave LLC has no obligation to update its opinions or the information in this publication. 

BondWave disclaims liability arising out of the use of the information and opinions contained herein.

About BondWave Yield Curves

The yields shown in the charts specified as BondWave curves are based on the known and applicable MSRB/TRACE trades for that same date (as reported by MSRB for municipal securities and TRACE for corporate securities, as applicable). Trades must have a minimum par value of $50,000 to be included and the resulting curves are based on the par-weighted values of the yields.  

Please be advised that the yields reflected are only presented to provide an indication of the bond market on the date specified and are not indicative of the expertise of BondWave or any recommendations provided by BondWave.  Because the yields are based only upon the securities that traded over the applicable period, such yields may not be indicative of what is currently available in the marketplace or the yields of other municipal or corporate securities that did not trade on such dates. Municipal and corporate security yields are based in part on certain assumptions and as a result, an investment in such securities may not result in performance comparable to the quoted yields. Past performance is not necessarily indicative of future results.

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