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
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
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
Even bank debt guaranteed by the government's Temporary
Liquidity Guarantee Program widened about 3bp-10bp on news of
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
"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)
(firstname.lastname@example.org; Reuters messaging;
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