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  • Dec 27, 2012 | Data Points

    Data Points: 2012 - The Top 10 Observations in the Global Fixed Income Markets

    As the leading builder and operator of global fixed income marketplaces, Tradeweb is in a unique position to observe key themes in finance, policy, politics and investment behavior, all through the eyes of the markets. As always, 2012 was a year full of excitement and intrigue. Below, we outline our Top 10 Observations in the Global Fixed Income Markets for 2012.   

    1. Quantitative Easing 

    Quantitative Easing (QE) remained a key policy tool for several central banks around the world in 2012, as they injected cash in an attempt to stimulate their economies by printing money and buying bonds. Only three months after the Federal Reserve announced QE3, a $40 billion-a-month mortgage-backed securities buying program, it replaced QE3 on December 12 with QE4, an $85 billion-a-month Treasury and mortgage buying program that Fed said will last until unemployment reaches 6.5%. The Fed’s bond buying happened alongside Japan’s own long-running QE program, which was extended in September with QE8 (¥10 trillion-a-month). Meanwhile, in November, the Bank of England halted its QE3 program (£50bn total between July and November).  That’s a lot of QE, but has it worked? The ultimate economic effect of QE will be debated for some time, but bond yields in these three regions did indeed trend lower in 2012.

     

     2012 Top Ten Fig.1- U.S., U.K. and Japan 10-Year Yields 

     

    2. Narrowing and Convergence of Spreads Between Eurozone Peripherals and Germany 

    Going into the first half of 2012, fears and flare-ups in the European debt crisis were keeping spreads between peripheral countries and Germany at high and disparate levels. Throughout the year, markets were supported by the ECB’s Long Term Refinancing Operations (LTRO) program, which was enhanced in Dec. 2011 to accept mortgage securities and commercial paper from banks seeking funding from the Central Bank. The spread narrowing accelerated in late July, when European Central Bank President Mario Draghi vowed to do “whatever it takes” to hold the eurozone together in a powerful speech that showed the central bank’s resolve to contain the crisis. On September 6, the ECB announced that it would buy bonds of struggling countries in Outright Monetary Transactions (OMT) if certain conditions were met. The news led to a significant narrowing and convergence of spreads between the most troubled countries and Germany, and triggered a move toward normalization in peripheral markets. 

     

     2012 Top Ten Fig.1- Eurozone Peripheral 10-Year Spreads vs. Germany 

     

    3. U.S. Mortgages Rally 

    A recovery in the U.S. housing market has long been seen as the key to boosting the broader economy, so it came as no surprise that the Federal Reserve continued to do all it could in 2012 to make mortgages affordable for homebuyers. When the Fed said in September that its QE3 program would buy $40 billion in Agency mortgage-backed securities per month in September, it put the Agency MBS market into overdrive, with spreads between Treasuries and Agencies at their narrowest levels in history, and rates for consumers sinking to all-time lows. The chart below shows price performance of the Fannie Mae 30-Year 3.5% versus the 30-year Treasury, illustrating the significant performance advantage that MBS posted versus the long bond.

     

     2012 Top Ten Fig.2- U.S. 10-Year Treasury and FNMA 3.5% 30-Year (Price) 

     

    4. Record High Yield Bond Issuance 

    U.S. high-yield bond issuance was off the charts in 2012, with $317 billion reported through the end of November, according to S&P. That easily topped the previous record of $287 billion for all of 2010. Investors have been hungry for yield amid low Treasury rates, which made it an opportune time for below-investment grade companies to take advantage of attractive rates and push out the maturity of their debt. Meanwhile, modest growth in the economy and the ability to refinance debt have helped to improve the creditworthiness of high-yield issuers, reflected in a significant rally in CDS indices.

     

     2012 Top Ten Fig. 4- CDX North American High Yield Index 

     

    5. The Federal Reserve’s Operation Twist 

    In June 2012, the Federal Reserve extended “Operation Twist,” a program begun in September 2011 which aimed to push long-term interest rates lower to stimulate borrowing by businesses and consumers. By buying long-term bonds and selling an equal dollar amount of  short-term bonds ($400 billion in the first phase, $267 billion in the second), the Fed intended to “twist” the Treasury yield curve toward a flatter position without creating any new money.  Operation twist had its intended impact on the yield curve in 2011 and continued to torque the yield curve flatter in 2012. The Fed discontinued the program in December 2012 as part of its decision to begin QE4, its fourth round of quantitative easing.

     

     2012 Top Ten Fig. 5- U.S. Treasury 10-Year – 2-Year Spread 

     

    6. Negative Yields in Europe 

    Yields for government bonds in some of the world’s largest economies have been precariously low for some time due to near-zero policy rates and as flare-ups in troubled euro-zone economies spurred demand for safe investments at any cost. Given the uncertain mood in markets, it was understandable when we saw rates on very short-term bills go negative in 2011. In 2012, however, we saw this phenomenon move further out the curve, with investors starting to pay for the privilege of lending money to more creditworthy governments for as much as two years. In July, a primary sale of two-year German bonds came at an average yield of -0.06%, the first time that any government has sold two-year debt at negative yields. Among debt traded in the secondary market, Switzerland saw the most negative yields on two-year notes, which went as low as -0.55% in late July.

     

     2012 Top Ten Fig. 6- 2-Year Yields Hit Negative Territory 

     

    7. LIBOR 

    For many observers, the investigation of improprieties in setting the London Inter Bank Offered Rate (LIBOR) might have initially seemed like it impacted some inconsequential numbers that only financial wonks cared about. But as the furor grew, the public gradually started to realize that there is a little LIBOR in all of us. Mortgages, corporate loans, student loans, derivatives – virtually anything with a floating rate is benchmarked off one form of LIBOR or another. There is no single chart here to illustrate any one isolated market effect of the Libor scandal, but the impact on investor confidence in the bond market and trust in lenders and interest rates will be felt for years. 

      

    8. U.S. Politics: The 2012 Election and The Fiscal Cliff 

    Historically, presidential elections have had the power to drive trends or volatility in the interest rate markets, particularly when the economy was a key focus of the campaigns. But in 2012, the election was notable for its damping effect on market volatility. There had been some speculation that a sweeping Republican victory could prompt a watering down of Dodd-Frank financial reform efforts and lift markets, but the incumbent Democrat Barrack Obama won the election, and the debate turned almost immediately to the Fiscal Cliff, an automatic  program of spending cuts and tax increases set to start in 2013 unless Washington finds a way to avoid it. The cliff might otherwise be good for Treasuries because it could improve the U.S. fiscal situation and spur a flight-to-quality if it pushes the U.S. into recession. However, the situation could turn ugly for Treasuries if the fallout is bad enough to impact the U.S. Credit rating and prompt rates to rise. The election result, the unclear outcome of the Fiscal Cliff debate, and the Fed’s continued buying of Treasury debt all gave investors nowhere to go with Treasury yields, and they traded in ever tighter ranges in the final months of the year.

     

     2012 Top Ten Fig. 8- U.S. 10-Year Note 

     

    9. Greek Yields Fall Back Toward Earth 

    Given the gravity of the Greek economic crisis and the years-long brinksmanship over reforms, bailouts and restructuring, the rally in Greek debt in 2012 probably didn’t touch a wide range of investors since most had long since run away from its bonds.  Still, the move in 10-year bond yields from their high of nearly 40% in early March to below 15% in December is noteworthy, if not incredible. The big move in Greek yields came just after March 9, when the country announced that banks had agreed to write off 75% of the value of their loans. That qualified Greece for a fresh round of bailout money from the IMF, EU and ECB and prompted a drop of more than 20 percentage points in 10-year yields in a matter of days. Greek yields fell further later in 2012, as optimism grew that Greece would help to unlock more emergency loans by buying back more than €30 billion worth of debt. On December 18, Standard & Poor’s raised Greece’s rating to B-minus with a stable outlook from selective default, furthering the rally and bringing yields down near 11%.

     

    2012 Top Ten Fig. 9- Greece 10-Year Yield 

      

    10. The U.S. Municipal Bond Rally 

    Admittedly, Municipal bonds do not typically show up in “Top-10” lists, but 2012 was not a typical year. At a time when taxes were central to the public debate, particularly as part of the presidential campaign and discourse over the Fiscal Cliff, investors flocked to munis, whose income is exempt from federal tax. For many in the market, the results of the presidential election suggested a political status quo that will lead to higher taxes in 2013. According to Morningstar, about $51 billion in new money was put to work in municipal bond mutual fund, making for record inflows and pushing bond prices higher. The J.J. Kenny Long Intermediate Municipal Bond Index, which represents the higher quality end of the muni market at A- and higher, rose about 8%. That significantly outperformed the Barclays U.S. Aggregate Bond Index, which rose about 4% over the same period. Munis also outperformed Treasuries, as seen in the chart below which plots the J.J. Kenny index versus the price of the 10-year Treasury.


    2012 Top Ten Fig. 10- J.J. Kenny Drake Long Intermediate Muncipal Bond Index vs 10-Year Treasury (Price) 

     

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