Between Ireland and Greece, the European Union has its hands full trying to stave off potential disaster for the euro and the union itself. Even as Ireland continues to insist that it is not in need of rescue, Englandhas said it is prepared to come to the rescue. Whether the worst or the best happens, bonds will be in flux. What will that mean for fixed income investors?
Chris Shayne (left), CFA and director at BondDesk Group LLC, said in a phone interview, that it’s probably too soon to tell what the outcome will be. However, the markets’ behavior surrounding the Greek bailout earlier in the year can be compared with their behavior in the Irish dilemma, up to a point.
BondDesk, technology firm based in a Mill Valley, Calif., that operates a fixed income trading platform for financial advisors and also provides fixed income market data, doesn’t “do” predictions, but based on the previous crisis with Greece, Shayne said some parallels can be drawn, since some of the same things could possibly happen this time around.
Around the time the crisis started to heat up, Shayne explained, in mid to late April of 2010, “people started buying U.S. Treasury debt with considerable enthusiasm.” That, he said, brought down yield. “From mid-April to mid-May, the [rate on the] 10-year Treasury fell from approximately 3.8 to 3.2 in about a month.” This drop, he said, was primarily a function of global nervousness and a flight to quality. “Any time there’s trouble in the market, there’s a flight to Treasuries; when that happens, yield goes down and the price goes up,” he pointed out. “This was a key phenomenon around the time of the Greek crisis.”
On the corporate side, he went on, “you’d expect to see the yields going up. But two things happened. First, the corporate markets didn’t respond nearly as quickly; there was no change in spreads or yields for a bit longer than with Treasuries, which showed signs of falling yield a couple of weeks in advance of major activity.”
When corporates finally did react at the beginning of May, he continued, the corporate credit spreads went up—an indication of how concerned people were with risk. BondDesk tracks the median corporate spread for the investor, not for the fund manager, and saw that the corporate markets were slower to react. But when they did, it was with a vengeance: “They jumped around 75 basis points in two weeks,” he recalled. “That was right around the time all the different bailout
packages were being announced. Fear had finally spread into the credit markets on the corporate side.” But because it was coincident with falling treasuries, he explained, “you weren’t seeing a big change in corporate yields.” The yields, composed of the credit spread and the treasury rate, saw one factor offsetting the other.
The important factors, he clarified, were that the corporate market in the U.S. was “a little slower to react, and reacted more once the bailout packages were announced. I think,” he added, “that was because there was a lot of uncertainty about whether Germany in particular would step up and throw a lifeline to Greece. If they didn’t, it would create all kinds of problems, but they ended up doing it.” Nervousness, he continued, grew more acute later in the process, and that set off the reaction in the corporate market. Although the corporate markets on the retail side are less sensitive to the European crisis, by the beginning of May “it had permeated far enough that you saw it everywhere.”
The interesting thing, according to Shayne, is that “you would think the same thing would happen, especially with Treasuries” this time, but because of QE2, “the last couple of days nobody’s been going near Treasuries; they’ve been selling, not buying. I’m looking at a Treasury chart for the
last couple of days,” he said, “and the close on the 15th for 10-year Treasuries was higher than on the 16th. So presumably yesterday you saw a little nervousness creep in.”
However, he pointed out, the 10-year Treasury has increased almost every day since Nov. 4. “On Nov. 4, it was around 2.5, and by Nov. 15 it was at 2.9—50 basis points in five trading days, with the Irish crisis already in the news. So most of that would be the hangover of QE2, and people felt that they wanted to get out of Treasuries because of an overcorrection in anticipation of QE2. So they were still selling off their Treasuries.”
His point? “Because that swamped any nervousness in the Treasury market at least for the last week or so, we’re not seeing the same behavior [as we did with Greece]. But if it drags on, I wouldn’t be surprised to see it come back again, because traditionally Treasuries are always the safest haven.”
The last time, he concluded, “it was all very much by the book. Everything that happened, you would expect to happen in a crisis situation. This time, I don’t know if the U.S. isn’t taking it seriously or if there’s some other explanation.” The issue, of course, is the “contagion effect. With Greece on the verge of teetering, people are worried about Portugal and Spain. If one EU country goes down, what happens to the rest of them? We don’t want any of them to default. That would change everything to negative, and spiral out of control.”