Notes on the Bond Markets — Treasury yields are dropping as investors seek a safe haven. The 10 year T is down to 2.04% after hitting 2.30% exactly two weeks ago. The 10 year swap is actually 3-4 bps below the Treasury, an extremely rare occurrence (recently hovered between 5-10 bps above the Treasury). It is partially due to corporate bond hedging activity and expectations for LIBOR to remain low for an extended period. It will be interesting to see if LIBOR rates rise in step with the anticipated Fed hikes. Speaking of Corporate Bond Issuance – 3 huge bond sales were reduced or pulled from the market this week (Santander, CBL, Westfield Corp) as spreads between Treasuries and Corporates widened. Why? After years of massive corporate bond issuance at tight spreads/low coupons and continued jitters regarding global growth prospects, investors are less confident in basic corporate fundamentals going forward in a rate normalizing environment. The same issues are clouding the prospects of emerging market debt and high yield junk bonds. Huge amounts of debt was issued in the last 5 years and investors are nervous about falling energy prices (bonds are a favored vehicle of financing for sub investment grade energy companies) and the ability of emerging markets to thrive in a rising rate environment. Bond liquidity issues – after Dodd Frank, Bank trading desks can no longer make the market in Treasuries and corporate bonds. Meanwhile, bond funds now own a much larger percentage of a rapidly growing market (bond markets continue to grow faster than equity markets). The issue is that bond funds, algorithm and high speed trading, is changing the way bonds are traded and may cause illiquidity during times of stress, thereby increasing volatility. So as we enter the normalization period with rising rates, it is more uncharted territory with no precedent. CMBS: Even after the recent widening, borrowers are locking in good rates due to the drop in treasuries/swaps. Full leverage 10 year loans are being priced at 240-260 over the swap, so all-in coupons back down to 4.50%…stay tuned… David R. Pascale, Jr.
