Bonds Take Control


The oft-predicted pullback that was to occur in U.S. equities is upon us with the Dow Jones Industrial Average plunging below 13,000 and the S&P 500 struggling to stay near 1400. The downturn in equities combined with non-farm payroll numbers released last week have spooked market participants who thought that the good times were here to stay.

And of course, the result has been a flight to U.S. Treasuries, in particular, the 10-year Note which saw yields drop below 2% in mid-day trading Monday. The Federal Reserve, meanwhile, is busy buying long-term debt and selling short-term notes as it begins to wind down its multi-year process of quantitative easing.

This lack of reassurance from the Federal Reserve has also led to the recent sell off in equities as large buyside funds cut their position exposure due to the lack of clarity and support from the Fed. The side effect is that credit markets stand to gain an influx of capital…provided everything goes smoothly.

“The credit picture is pretty good, with default rates projected to remain well below historical average for the next year, barring a sharp deterioration in the economy,” noted one fixed-income strategist on the sellside. “Otherwise, it’s the same story as with other risky assets. The vulnerability is to renewed worries about European sovereign debt, a new crisis in the Middle East…or something that no one is thinking about at all at the moment.”

The ample supply of Treasurys and deep liquidity makes the asset class about the only sovereign debt that’s in high demand. Risks related to Spain and Greece are unnerving to even the most adventurous investors as they shy away from high-yield sovereign debt in favor of sub-investment grade corporate credit.

For equities to continue the bullish melt up that occurred in the first quarter of 2012, positive economic data will be needed. Until then, bonds and fixed-income will remain the darling of the Street.

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