by Danielle Robinson
NEW YORK, Aug 8 (IFR) - Investors fled risk assets en masse on Monday and rushed into US Treasuries, the very securities that were downgraded to AA+ late Friday but still remain the largest, most liquid safe-haven.
The 10-year Treasury note rallied 22bp, sending its yield down to 2.33%, on fears the US and the global economy are headed toward a double-dip recession. Gold, the other key safe-haven asset, soared to $1,710 an ounce by mid-afternoon.
News of the downgrade by Standard & Poor's hit all risk markets hard, not because it sparked forced selling, but because of expectations it will exacerbate already weak US consumer confidence. For more on the expected impact of the downgrade, see [ID:nN1E76R1IY].
Equities were already in selloff mode last week after a stream of gloomy economic releases. They continued to plunge on Monday, with the Dow Jones Industrial Average down 311.74 points to 11,132.87 at last check.
The IG16 index, a measure of high grade corporate bond secondary levels, gapped out a staggering 7.75bp to 110.5bp, its widest level since mid-September last year. The HY16 index plunged 2.5 points to 94.438, its lowest level in twelve months.
New issue markets almost ground to a halt, with underwriters pulling about six investment grade deals expected to come today.
"The market is falling apart," said one syndicate head. "Everything is wider in the secondary market. We had as many as four deals ready to go this morning and they all decided to stand down. Bank spreads are out by about 30bp and even the Wal-Marts (WMT.N) and Cokes (KO.N) have widened."
Bankers and credit strategists view the downgrade of the US AAA rating by just one rating agency as the least of the US's problems. The weak economy is still the major concern, along with Europe's ability to deal with its debt crisis without choking off growth. There is also worry that monetary policy and quantitative easing have failed to encourage corporates to expand and create jobs.
"It (the selloff) is a confluence of recent events that has led to an elevated level of volatility and risk aversion," said Edward Marrinan, chief credit strategist at RBS Securities.
"The downgrade of the US government credit rating, disappointing US economic data and fears that central banks have lost their ability to stimulate economic activity have compounded concerns around Europe's sovereign debt crisis , prompting a flight to safe haven assets such as Treasuries and gold."
RBS economists, like many on Wall Street, have revised their outlook for US economic growth downward. RBS is now forecasting a 2.4% growth rate for the second half and into 2012, compared with an earlier forecast of 3.2%.
"The problem of low GDP growth is that there is little cushion to absorb unexpected shocks to the economy; this raises the risk of a double dip recession," said Marrinan.
The highest quality corporate bonds are expected to tighten as investors regain some calm and move back into the best A, AA and AAA names.
But if economic data continues to worsen, investors will have to factor in the possibility that top quality corporates will also be hurt.
Those concerns are behind the widening of yield spreads on top quality bonds today. Coca-Cola's five- and 10-year bonds, issued last week, were barely wider from new issue spread, but had lost all of their after-market gains. The company's 2021s, issued at 72 bp, were trading around 73bp at midday today, from as tight as 65bp last week.
The financial institutions group (FIG) space continued to be the hardest hit. The S&P financial stock index lost 8.3% of its value, and spreads of the biggest US banks widened as much as 30bp.
Even bank debt guaranteed by the government's Temporary Liquidity Guarantee Program widened about 3bp-10bp on news of the downgrade.
Bank of America (BAC.N) was worst hit, after AIG (AIG.N) brought a $10bn lawsuit against the bank, alleging massive fraud on mortgage debt. The bank's 5% of 2021s were trading at 309bp over Treasuries, out from 260bp last Friday and a May new issue spread of 185bp.
"The market is looking ahead and risk of recession has increased, and a recession with a very low 10-year bond yields is very detrimental to the financials," said Frederick Cannon, senior bank analyst at Keefe, Bruyette & Woods.
Even the top quality FIG names like General Electric (GE.N) were hard hit. GE's 5.265% 2021s, rated AA+, were trading at 185bp over Treasuries, from 165bp on Friday.
JP Morgan (JPM.N) bonds were also wider. The A+ rated 4.35% of 2021s, issued on August 3 at a yield spread of 175bp over Treasuries, were trading at 206bp today.
Some strategists are not expecting risk aversion to dissipate until there are solid signs of economic improvement in the US.
With the 10-year Treasury yielding 2.37%, however, credit investors aren't expected to sit in Treasuries for too long.
"I'm still pretty sanguine on the high yield market, " said a senior portfolio manager at one of the biggest asset management firms.
"High yield has cheapened up quite a bit, while the spread rally in Treasuries has out-weighed the spread widening in high grade corporates, meaning overall yield in that market is lower," he said.
"That's resulted in an explosion in the gap between triple-B and double-B yields."
(Reporting by IFR senior reporter Danielle Robinson; Tel: 1-646-223-6141: Editing by Ciara Linnane)
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