Market Reflections 8/31/2009

A 7 percent plunge in the Shanghai stock market, tripped by new concerns that the government will withdraw liquidity from the business sector, reverberated through global markets and the U.S. market where the S&P 500 fell 0.8 percent to just over 1,020. U.S. economic news was upbeat as Chicago purchasers reported no change in business conditions during August, indicating a bottoming in the region's recession and pointing to similar results in this week's ISM reports. Commodities moved with equities with oil closing below $70 at $69.50 and copper falling more than 10 cents to end at $2.84. But gold held firm at $950, firmly underpinned by solid long-term investment demand. The dollar index edged 0.2 percent lower to $78.13.

Weekly market Update August 28, 2009

MARKET LEVELS
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 9,520 9,506 8,776 11,715
S&P 500 1,025 1,026 903 1,301
NASDAQ 2,020 2,021 1,577 2,412
Russell 2000 578 582 499 748
DJ STOXX Europe 600 (€) 238 235 198 287
Nikkei Index (¥) 10,534 10,238 8,860 12,768
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.01% 1.09% 0.77% 2.36%
10-Year Treasury Yield 3.45% 3.57% 2.21% 3.78%
U.S. $ / Euro 1.43 1.43 1.40 1.47
U.S. $ / British Pound 1.63 1.65 1.46 1.83
Yen / U.S. $ 93.59 94.38 90.64 109.50
Gold ($/oz) $955.66 $953.85 $882.05 $834.05
Oil $71.93 $73.29 $44.60 $115.59
*Levels reported as of 10:00 am Pacific Standard Time
MARKET RETURNS
Year-to-date (1/1/09-8/28/09)* Year-to-date (1/1/09-8/27/09)
Dow Jones Indus Avg. 8.47% 90 Day T-Bill 0.16%
S&P 500 13.51% 2-Year Treasury 0.76%
NASDAQ 28.07% 10-Year Treasury -7.89%
Russell 2000 15.67% ML High Yield Index 39.16%
MSCI World Index 17.99% JPM EMBI Global Diversified 21.81%
DJ STOXX Europe 600 19.74% JP Morgan Global Hedged 0.27%
*Returns reported as of 10:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
August 25 Consumer Confidence – The Conference Board’s confidence index rose for the first time in three
months, climbing from 47.4 in June to 54.1 in July. The increase, which beat forecasts, was
largely a result of government programs such as “cash for clunkers” and extended jobless
benefits
S&P/Case-Shiller Home Price Index – The 20-city composite index declined 15.4% from year ago
levels, the smallest drop since April 2008. On a month-over-month basis, the measure rose by
the most in four years.
August 26 Durable Orders – Orders for durables jumped by 4.7% in July, the largest increase in two years. The
core rate, which excludes transportation, posted its third consecutive gain, rising 0.8% during the same
month.
New Home Sales – New home sales climbed to a seasonally adjusted annual pace of 433,000 homes in
July, a 9.6% increase over the prior month and the largest increase since February 2005. On a yearover-
year basis, however, sales were down 13.4%.
August 27 Commerce Department Revisions – Gross domestic product (GDP) fell at a seasonally adjusted 1.0%
annual rate in the second quarter, unrevised from the estimate month ago. Business inventories fell
more than previously reported, with the second quarter cut revised from $141.1 billion to $159.2 billion.
The decline in consumer spending over the April to June period was revised from 1.2% to 1.0%.
August 28 Personal Income and Spending – Consumer spending rose 0.2% in July due to increased durable-goods
spending, likely a product of the “cash for clunkers” program. Personal income was unchanged in July
and fell 1.1% in June, a downward revision from the originally reported 1.3% drop.
OVERVIEW ___________________________________________________
The housing market showed further signs of recovery this week. New home sales increased
for the fourth straight month and 18 of the 20 cities comprising the S&P/Case-Shiller Home
Price Index posted modest price gains. Hard-hit metropolitan areas such as Los Angeles,
Miami, and Phoenix registered slight increases in home prices, underscoring the view that the
real estate market has bottomed. The Federal Housing Finance Agency’s house price index
also rose, climbing 0.5% in June on a month-over-month basis. New home inventories fell to
271,000 in July, a 7.5-month supply at the current sales rate that is significantly lower than the
8.8-month supply in June. Continued declines in inventories may boost future housing starts
as construction firms begin building homes again. Improvement in the real estate market will
likely support overall economic recovery, as banks may be able to stabilize their balance
sheets more quickly.
US MARKETS:
TREASURIES ________________________________________________________________________________
• US Treasuries rallied this week, backed by better-than-expected auctions in 2-year, 5-year,
and 7-year bonds. Five-year on-the-run Treasury yields finished the week 13 basis points
(bps) lower and 30-year yields rallied 17 bps. Trading volumes and liquidity in the Treasury
market was very low this week as most market participants are still on vacation. The market
continues to trade directionless and remains event driven, i.e. dealers position themselves
for Treasury auctions and Treasury buybacks and offer limited liquidity in between.
• US agencies recovered from their temporary sell-off over the last couple of weeks, when
spreads widened 10-15 bps across all maturities. Decreasing supply and the Federal
Reserve increasing their re-purchases helped spreads to recover and tighten back 5-8 bps.
• With Libor continuing to set lower each day, US swap spreads were able to benefit, with
shorter dated spreads tightening 8 bps. Spreads of longer dated swaps tightened up to 4
bps.
LARGE-CAP EQUITIES___________________________________________________________
• The stock market was relatively quiet for the week on mixed economic data and lighter
trading volume. The S&P 500 index finished the week unchanged. The Russell 2000 index,
an index used to gauge small-cap stocks, underperformed large-cap stocks. In terms of
style, large-cap value stocks marginally outperformed large-cap growth stocks. The best
performing sector was financials and the worst performing sector was utilities. In the
headlines this week, the US government ended its highly successful “Cash for Clunkers”
stimulus program on Monday as funds allocated to the program were exhausted. Shares of
Ford Motor Company (Ticker F) fell over 4% on the news. On earnings news, Dollar Tree
reported quarterly earnings of 63 cents per share, which beat analysts’ estimates of 53
cents per share. The company attributed the strong quarter on better operating margins and
an increase in sales. Shares of DLTR rallied over 1% on the news after speculators drove
the stock higher over 4% prior to the announcement.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity was muted, with a few benchmark deals providing those
not taking a late summer vacation a chance to invest some idle cash. The deals priced this
week were well received by investors, as the entire slate of new issuance finished the week
tighter. Consumer products giant Proctor & Gamble brought a two-tranche deal that sold out
as quickly as ice cream cones on a sultry summer afternoon. With next week being the
unofficial final week of summer, expectations are for a light, if not non-existent, new issue
calendar.
• Investment grade corporate spreads were flat to slightly tighter in fairly active trading given
the season. Trading desks were thinly staffed, as many participants were away trying to
wring the last bit of value out of their summer share. The underlying tone was positive, with
a bit of a "stealth-rally" feel to the week. The Barclays Credit Index Option-Adjusted Spread
(OAS) finished the week at +212, tighter by 9 basis points.
MORTGAGE-BACKED SECURITIES _______________________________________________
• It was calm in the mortgage market this week as market participants enjoy the last days of
summer. With Treasuries rallying on air, mortgages underperformed in light trading.
Agency pass-through spreads leaked wider by 3 to 5 basis points as steady supply trumped
demand from Asian central banks, money managers, and the Federal Reserve. Most of the
action, if any, was in the commercial mortgage market as spreads narrowed on a healthy
demand for term-asset backed loan facility (TALF) eligible CMBS bonds. The Treasury’s
release of acceptable collateral of CMBS collateral was warmly received by investors. For
the week, the 30-year current pass-through versus the 10-year Treasury closed at 103 basis
points.
MUNICIPAL BONDS _____________________________________________________________
• Lack of new tax-exempt issuance, led by seasonal calendar effects and Build America
Bonds taxable issuance (which account for about 15% of municipal issuance year-to-date
through July) continues to put downward pressure on longer-maturity municipal bond yields
as investors fight for bonds. Two-year AAA-rated GO bond yields are pinned down at 0.71%
and 30-year AAA-rated GO bonds fell to 4.47%-lower by 7 basis points on the week. Thirtyyear
yields have dropped 25 basis points during August.
• This trend is also having spillover effects on lower-rated credits, where investors have
shifted demand due to pick-up in yield over expensive high grade credits. This difference in
yield though continues to “narrow,” represented by strong demand for tobacco securitization
bonds and gas pre-payment bonds this week. Based on secondary market trades on Friday
morning, this trend is set to continue as we head into September. Next week is already set
up to be very quiet in the primary market. New issuance volume is expected to be in the $1
billion range – 20% of a normal week’s new supply hitting the market. This may mean a
pick-up in secondary market activity (as money managers look to reinvest September 1
maturities) and more downward pressure on yields in the municipal space.
• The biggest deal of the week was the seasonal issuance of the Texas Tax and Revenue
Anticipation Notes (TRANs) as part of the state’s annual cash-flow management. Totaling
$5.5 billion, the notes held the highest short-term rating from all three ratings agencies, and
were traded at yields as low as 0.43% following the competitive deal. Other highlights
included the $77 million Oconee County, South Carolina, Pollution Control Facilities - Duke
Energy Carolinas Project bonds. The A1/A revenue bonds offered 3.60% in the bullet 2017
maturity.
HIGH-YIELD BONDS ____________________________________________________________
• It was another relatively quiet week on the high yield front. Similar to last week, there was no
new issuance in the high yield market and it is likely that we will not see any deals until after
the US Labor Day holiday September 7th. Most market participants are expecting relatively
heavy issuance in September as cash continues to build and there is strong demand for
new well-structured and well-priced deals. After a small outflow last week, high yield mutual
funds this week received inflows of $351 million and this will add to the buying pressure in
September. The Merrill Lynch BB/B high yield index is up just under 1.5% for August, with
much of the price appreciation in the financial sector, in particular the insurance sub-sector.
The insurance high yield sub-sector has rallied as the market outlook on AIG debt and
equity has improved over the past few weeks. In line with the past five months, the riskiest
segment of the high yield market, CCC- and below rated bonds, continued to rally the
strongest, with the CCCs up almost 4% in August and up 70% year-to-date 2009.
INTERNATIONAL MARKETS:
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and
Poland) gained +2.8% this week, while the Russian stock index RTS went up +3.7%.
• Poland, the European Union’s only eastern member to escape a recession since the
credit crisis began, expanded an annual 1.1% in the second quarter of 2009 on the
heels of +0.8% growth in the first quarter of the year. Net exports were the major
driver, as exports declined by only 1% year-over-year, while imports were down -
11.6% versus last year. Investment also surprised on the upside. Since the global
recession started the country’s relatively large internal market, stimulated by cuts in
personal taxes, has helped compensate for a decline in external demand, while a
depreciating zloty early in the year cushioned the fall in exports.
GLOBAL BONDS AND CURRENCIES _______________________________________________
• Major government bond markets ended the week stable to firmer, supported by the good
reception to the week’s heavy US issuance. In the UK, Gilts benefitted from persistent
speculation that the Bank of England will impose negative interest rates on banks’ reserve
holdings to encourage them to lend. However, two-year Bunds outperformed, with yields
closing the week down about 10 basis points as the European Central Bank reiterated its
intention to keep rates low for the foreseeable future. On the data front, news from the UK
was mixed. House prices rose robustly in August and revisions showed that the contraction
in Q2 GDP was less dramatic than initially estimated. However, UK business investment
slumped a staggering 10.4% in Q2. In Europe, the rise in industrial orders exceeded
expectations and the latest round of business and consumer sentiment surveys all
registered further improvement, but Japan’s data was unremittingly disappointing.
Household spending contracted further, unemployment jumped unexpectedly and deflation
worsened. However, Japanese government bonds only managed to finish unchanged ahead
of this weekend’s general election, which is widely predicted to see the ruling Liberal
Democratic Party lose its 60-year grip on power to the opposition Democratic Party of
Japan.
• In currency markets, the focus was on sterling, which extended its recent losses against the
US dollar in response to talk of negative UK rates. The suggestion by the head of the UK
financial markets regulator that the government should impose a tax on financial
transactions to deter short term speculation also undermined confidence in the pound. The
Canadian dollar closed off its highs after an official suggested that the central bank may
intervene to sell the currency, whose recent appreciation is perceived as a drag on growth
and an obstacle to the central bank’s efforts to meet its inflation target. The Australian dollar
edged higher against the greenback on mounting expectations that rates will rise as soon as
October, but the US dollar ended only marginally weaker against the yen and unchanged
against the euro.
EMERGING-MARKET BONDS______________________________________________________
• Emerging market dollar-pay debt spreads were marginally wider this week as liquidity and
trading volumes declined. Economic data continued to surprise on the upside with Q2 GDP
and industrial production better-than-expected in all emerging market regions.
• Israel surprised the markets by being the first country to hike interest rates globally. Bank of
Israel raised rates by 0.25% to 0.75% on the back of increasing inflation expectations and
an improvement in macroeconomic data. Short-date local yields sold off by 25 basis points
as the curve was pricing in no change in interest rates.
• As expected, the Monetary Policy Council (MPC) in Poland left its benchmark interest rate
unchanged at 3.5% citing signs of economic recovery in Poland as well as the global
economy. The MPC’s inflation forecast is lower than its medium-term target of 2.5% (+/-
1%), meaning it maintained an easing bias.
NEXT WEEK'S ECONOMIC RELEASES
Sep 1 ISM Manufacturing Index, Construction Spending, Pending Home Sales
Sep 3 ISM Non-Manufacturing Index, Turkey August Inflation
Sep 4 Unemployment Rate

Market Reflections 8/27/2009

Second-quarter GDP was unrevised at minus 1.0 percent, a bit better than expected but still a fourth straight decline. Initial jobless claims point to no help for the August jobs report, coming in at 570,000 and showing no improvement for the last two months. Company news included a year-end date for the Boeing 787 test flight, now delayed for more than two years. Stocks initially retreated in the session but then rallied with the S&P fractionally higher at just over 1,030. Oil firmed about $1 to end at $72.50 but the gain didn't help natural gas which hit a 7-year low at $2.70 following another rise in inventories and on heavy shorting as the hurricane season has yet to threaten the U.S. Gulf.

Market Reflections 8/26/2009

Wednesday's economic data point very directly to recovery. Durable goods orders bolted higher showing nearly across-the-board strength. New home sales confirm a host of other indicators pointing with certainty that the real estate market is accelerating. Even with the all strength, the jobs market remains weak and indications on consumer spending are not showing the same strength. Atlanta Fed President Dennis Lockhart says he's in the camp calling for a slow recovery and he said it's still early to talk about rate hikes.

The economic news couldn't fire up the market as the S&P was nearly unchanged ending just under 1,030. Oil fell back 50 cents to $71.50 after weekly inventory data showed a small build in crude. Early talk, citing weak demand and limited refinery runs, is calling for a larger build in next week's data. The dollar index firmed 0.4 percent to 78.61.

Market Reflections 8/25/2009

The re-appointment of Fed Chairman Ben Bernanke ends the risk of delays that a new chairman would face in learning the post, specifically how the Fed is going to unwind quantitative easing. Consumer confidence data shows improvement, not striking improvement but an end to two prior months of disappointment. Budget forecasts from the administration and Congress say weak growth and heavy benefit spending will just about double the nation's deficit to nearly $20 trillion over the next 10 years. Stocks showed little reaction with the S&P rising 0.2 percent to 1,028. Commodities were little changed though oil edged back from recent highs ending at $72. The dollar index ended fractionally higher at 78.24.

Market Reflections 8/24/2009

Markets were quiet Monday, reacting to overnight gains in Chinese markets that were reacting to Friday's big report on existing home sales and upbeat comments from Ben Bernanke. But stocks gave up early gains with the S&P ending fractionally lower at 1,025. Most commodities were fractionally higher with oil ending just below $75. The dollar index rose 0.3 percent to 78.25.

Weekly Market Update Week ending August 21, 2009

Friday* Last Week Dec. 31 2008 1 Yr Ago
Dow Jones Ind. Avg. 9,483 9,321 8,776 11,430
S&P 500 1,023 1,004 903 1,278
Nasdaq 100 2,012 1,986 1,577 2,380
The Russell 2000 579 564 499 725
DJ STOXX Europe 235 229 198 278
Nikkei Index 10,238 10,597 8,860 12,752
Fed Funds Target 0-0.25% 0-0.25% 0-0.25% 2.00%
2-Year U.S. Treasury Yield 1.09% 1.05% 0.77% 2.31%
10-Year U.S. Treasury Yield 3.55% 3.57% 2.21% 3.83%
U.S.$ / Euro 1.43 1.42 1.40 1.49
U.S.$ / British Pound 1.65 1.65 1.46 1.87
Yen / U.S.$ 94.54 94.77 90.64 108.45
Gold ($/oz) $954.15 $948.55 $882.05 $837.00
Oil $73.19 $67.51 $44.60 $120.93
*Levels as of 12:40 a.m. PST
Year to Date (1/1/09 -8/21/09)
Dow Jones Industrial Avg 8.05%

S&P 500 13.27%

NASDAQ 27.61%

Russell 2000 15.97%

MSCI World Index 15.53%

DJ STOXX Europe 600 (euro) 18.40%

Year to Date (1/1/00 - 8/20/09)
90 Day T-Bill 0.14%

2-Year Treasury 0.46%

10-Year Treasury -8.29%

ML High Yield Index 38.01%

JP Morgan EMBI Global Diversified 21.24%

JP Morgan Global Hedged 0.10%



August 18

Housing Starts – New-home construction fell for the first time in three months, declining by 1.0% to an annual rate of 581,000 in July from a revised 587,000 in June. The unexpected drop was largely due to steep declines in multifamily units, which include condominium and apartment buildings. Producer Price Index – The Labor Department reported a 0.9% decline in producer prices in July, indicating that inflation will not be a concern for the Federal Reserve in the near future. Core producer prices, which exclude food and energy, fell 0.1% during the month.
August 20
Leading Indicators – The index of US leading economic indicators rose in July for the fourth consecutive month, climbing 0.6% following a revised 0.8% increase in June. The rise signals that the US economy has stopped shrinking and may be headed for an expansion.
August 21
Existing Home Sales – Sales of existing homes rose for the fourth straight month, jumping 7.2% in July to a seasonally adjusted 5.24 million annual rate. This marks both the largest month-over-month percentage increase in more than a decade and the measure’s highest level in nearly two years.
August 14 Consumer Price Index – Headline inflation was unchanged on a monthly basis in July but down 2.1% on a year-over-year basis, the most rapid rate of decline since 1950. Core inflation, which excludes food and energy, rose 0.1%, indicating that inflation will remain subdued for some time. Euro Zone CPI – European consumer prices dropped more than the estimated 0.6%. Prices fell 0.7% from a year earlier after declining 0.1% in June. Core inflation rate, which excludes volatile energy and food costs, eased to 1.3%. Euro Zone GDP – The euro zone GDP contracted by 0.1% in the second quarter—against economists’ forecasts of a decline by 0.5%. Demand for European exports is improving as government rescue packages and lower interest rates support spending. Germany & France GDP – German and French economies grew unexpectedly in the second quarter. GDP rose a seasonally adjusted 0.3% in both countries. June 5 Employment – Nonfarm employment declined by 345,000 in May, the smallest decline in 8 months, beating forecasts of 520,000 job losses. During the same period, the unemployment rate exceeded estimates, rising from 8.9% to 9.4%, the highest unemployment rate since 1983. February 6 Employment Report – The US economy shed 598,000 jobs in January and the unemployment rate rose to 7.6%, which is its highest level since 1992. -->


Though the housing market appears to be stabilizing, there is still a substantial distance to travel before a full recovery. Total housing starts in July were dragged down by severe weakness in multifamily housing construction, which includes condominium and apartment buildings. On the upside, single-family home starts were strong, rising 1.7% in July to 490,000 after climbing 17.8% in June. The dramatic increase in existing home sales, which climbed 5.0% on a year-over-year basis, signals that the three-year housing slump may finally be bottoming. Despite these positive indicators, housing activity remains at historically weak levels, with sales 38% below their peak and distressed sales making up a large share of recent transactions. While economic improvement and affordability may continue to support housing sales in the near future, any sustained recovery will likely be sluggish as high unemployment levels threaten to continue to cause foreclosures.

US Treasuries sold-off this week, due to better-than-expected fundamental data and a strong equity market performance. Two-year on-the-run Treasury yields finished the week 15 basis points (bps) lower, 5-year yields rose 20 bps. The sell-off was more concentrated in shorter dated maturities, which caused the yield curve to flatten six bps for the week.
At the end of the week, the release of better-than-expected US existing home sales data for July accelerated the sell-off. This resulted in unwinding of recent long positions in short and longer dated maturities going into the weekend.
Large-Cap Equities
The stock market continued to trend higher reaching newer highs for the year on strong corporate earnings and better-than-expected economic data. The S&P 500 index rose 1.9% for the week, finishing higher five out of the last six weeks. Large-cap stocks underperformed small-cap stocks. In terms of style, large-cap growth stocks underperformed large-cap value stocks. The best performing sector for the second straight week was health care and the worst performing sector was information technology. In the headlines this week, American International Group Inc. rallied over 21% on news that the company expects to repay their government loans. On corporate earnings this week, Hewlett-Packard reported 91 cents per share, which beat analyst estimates of 90 cents per share. The company attributed the positive quarter to better cost management.
Corporate Bonds
Investment grade primary was somewhat active this week as several small infrequent issuers tapped the market. Watson Pharmaceuticals and Yum Brands both brought small multi-tranche deals across the five- and 10-year part of the curve. Both deals were heavily oversubscribed and performed nicely on the break. The supply calendar is likely to remain light until after Labor Day, which should be constructive on the secondary spreads.
Investment grade corporate spreads widened throughout the week as light trading volumes and a sluggish start in equities contributed to wider spreads. Both thin trading and a skeleton work crew have been conducive to exaggerated spread movement causing spreads to push out. Many investors have been apprehensive that the market has run too far too fast, causing some to sell into this rally and take chips off the table. The Barclays Credit Index Option-Adjusted Spread (OAS) finished the week at +221, wider by 8 basis points. Financials widened by 8 basis points (banks +10, insurance +10); industrials widened by 10 basis points (telecom +15, consumer non-cyclical +5, basic materials +12, capital goods +6, energy +12); and utilities widened by 1 basis point.
Mortgage-Backed Securities
Summer doldrums! Agency mortgages kept pace with Treasuries in a light trading week. Spread movement was benign with no headline story or economic data print to move the market by more than a few basis points. The mortgage market remains in a range as the US Government remedies to heal the financial system comes at a price to future economic growth. Within the mortgage market, Ginnie Maes remain well bid versus conventional mortgages as prepayment differences converge. Premium pass-throughs remain in vogue as money managers stay clear of Federal Reserve buying of production coupons. For the week, the 30-year current coupon mortgage spread versus the 10-year Treasury closed at 96 basis points.
Municipal Bonds
Apparently investors embraced last week’s theme (that shorter maturity bond yields have fallen to unreasonably low levels) and began selling – albeit slowly. From 3 to 5 years, AAA-rated GO bond yields rose 2-4 basis points. Meanwhile, six years and beyond saw bond yields move the opposite direction, finishing the week 5-6 basis points across the curve. In fact, 10-year AAA-rated municipal bond yields as monitored by Thomson Financial, hovered at 2.94% on Thursday, near their lowest level on record stretching back over 20 years. What encouraged the flattening trend? We saw slow secondary market trading activity and plenty of new deal activity this week, but nearly two-thirds of the total municipal bonds issued during the week were in the form of Build America Bonds (BABs), the taxable substitute for tax-free bonds in the longer part of the maturity spectrum. This included $1.2 billion in BABs from the Texas Transportation Commission. The bonds offered a maximum yield of 5.52% in the 30-year maturity, which is 1.2 percentage points above the comparable 30-year Treasury yields.
High-Yield Bonds
The high yield market is taking a well-deserved pause. For the first time in numerous months, there was no new issuance this past week as underwriters and issuers took a break from the torrid pace of new issuance over the past few months. The high yield market tone has subsided from July as investors digest the plethora of market information and economic data, much of it conflicting. For the month of August 2009 to-date, the high yield market total return as represented by the Merrill Lynch BB/B high yield index is up is 0.7%, a significant decline from the return series from the prior five months. It is quite natural for the market to take a “breather” from the neck-breaking speed at which the high yield market was travelling from mid-March 2009 through July 2009. Many investors are awaiting the return of normal trading patterns, when much of the market returns from their summer sojourn post the US Labor Day holiday on September 7.
Eastern European Equities
The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and Poland) gained +4.0% this week, while the Russian stock index RTS went down -0.9%.
Emerging-market equities rose for the last two days with Polish stocks surging the most worldwide after a brokerage advised buying central European shares on prospects for an economic recovery. The WIG20 Index advanced 6.6% over the week. Bank Pekao and PKO Bank Polski contributed to the WIG20’s rally after the brokerage raised its recommendation on Polish, Czech and Hungarian stocks to “overweight.” According to strategists, growth expectations should improve in these three economies, as they benefit from the stronger-than-expected euro zone recovery.
Global Bonds and Currencies
The past week was as quiet one for major non-US sovereign bond markets, with both Bunds and Gilts closing stable to only slightly firmer despite generally stronger-than-expected data. The latest European business sentiment surveys suggested that confidence is improving more swiftly than expected, while in the UK, retail sales surprised on the upside, monthly government borrowing was much heavier than expected in July and the decline in the pace of UK inflation halted. Annual headline CPI was unchanged at 1.8% for the second successive month in July, compared with expectations of a slowing to 1.5%. One recent notable development in the UK Gilt market has been the significant downward pressure on short-term Gilt yields. Two-year Gilt yields ended the week 3 basis points lower at 0.89%, having fallen steadily from 1.3% early this month, on speculation that the Bank of England (BoE) may begin charging banks to hold reserves in a further bid to encourage them to lend. Such a step would mirror actions by Sweden’s Riksbank, which imposed negative rates on banks last month. The week also brought the surprising revelation that BoE Governor King wanted to boost the Bank’s bond purchases by even more than the £50 billion announced after the last Monetary Policy Committee meeting in early August. Along with two other committee members, King voted for £75 billion of purchases, but was overruled by the majority. Meantime, in Japan, the economy joined France and Germany in pulling out of recession in Q2, but this did not deter Japanese government bonds (JGBs) from also making minor gains across the curve on the week, thanks in part to a sharp correction in stock prices on Friday.
In currency markets the US dollar closing the week within its recent ranges against the Euro and Sterling, with both the latter currencies receiving only margin support from the generally stronger-than-expected data. However, the greenback closed down against the Yen, which received support from the positive Q2 GDP figures, weakness in Chinese equity markets and technical factors.
Emerging-Market Bonds
Emerging market dollar-pay debt spreads were unchanged as Friday’s rally reversed the widening during the week. Better-than-expected economic data in the US and Europe led to an equity rally that supported all risk assets.
In Mexico, the Central Bank left its benchmark interest rate unchanged at 4.5% as expected. The bank maintained its view that the economic recovery in Mexico would be gradual and dependent on the United States. Inflation remains contained allowing rates to stay lower in the medium term. Next week, the economic data calendar will lighten up in the United States. Thursday’s report on retail sales will likely garner the most attention as investors and economists seek to gauge the impact of the deterioration in the labor market on consumer spending. In global markets, both the United Kingdom and euro zone will be reporting on retail sales. The UK also has new data on industrial production. Aug 24

Hungary Quarterly Inflation Report
Aug 25

Consumer Confidence, S&P/Case-Shiller Home Price Index
Aug 26

Durable Orders, New Home Sales
Aug 27

Hungary Unemployment Data
Aug 28

Personal Income and Spending
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Market Reflections 8/20/2009

An overnight rally in Chinese stocks gave a boost to U.S. stocks where the S&P gained 1.1 percent to end at 1,007. The market didn't react to the day's batch of mixed economic news: disappointing increases in jobless claims but gains for the index of leading economic indicators and the Philly Fed manufacturing report. The dollar index was little changed at 78.38 as were long rates where the 10-year Treasury yield ended at 3.43 percent. Commodities didn't get much kick out of the gain in stocks with oil ending only slightly higher at $72.50.

Market Reflections 8/19/2009

Equities withstood a 4 percent sell-off in the Chinese market to end slightly higher at 996 on the S&P 500. However frothy the U.S. market may or may not be, with the S&P up 10 percent on the year, the Shanghai composite is up 60 percent on the year. Oil jumped $3 to $72.25 in reaction to stand-out draws in still swollen petroleum stocks. Other commodities showed little movement despite weakness in the dollar which reacted more to the gain in U.S. stocks, a gain that raised demand for risk, than the loss in China. The dollar index fell 0.7 percent to 78.50.

Market Reflections 8/18/2009

Highlights
Cost cutting helped two big retailers, Home Depot and Target, to beat estimates which together with strong economic data out of Germany eased risk premiums, feeding gains in equities and tripping losses for the dollar. The S&P 500 gained 1.0 percent to just under 990 while the dollar index fell 0.4 percent to end at 79.12. The combination of strong equities and the weak dollar gave a boost to commodities which benefit on signs of economic strength and on signs of inflation. Oil jumped about $3 to $69.

Market Reflections 8/17/2009

Traders were at loss to pin point why markets fell so steeply on Monday. Explanations included a delayed reaction to last week's disappointments for retail sales and consumer confidence along with reaction to weekend TV reports that the back-to-school season will be a flop. But Monday's hard economic data were very positive including gains for the Empire State and homebuilder reports and a big jump in the Treasury International Capital headline showing strong foreign demand for U.S. financial assets. Yet markets dropped anyway though in very thin volumes, a factor that often exaggerates swings. The S&P 500 fell 2.4 percent to 979.73 sparking talk of 950 as the next big level. The dollar gained as overnight losses in Asian stock markets tripped a run of risk aversion. The dollar index rose 0.6 percent to 79.29. Dollar strength and talk of economic weakness eased inflation premiums, reflected in commodities where prices fell back. Copper fell 7 cents to $2.74/lb while oil fell 75 cents to $66.75.

August 14, 2009 Weekly Markrt Update

MARKET LEVELS
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 9,251 9,370 8,776 11,616
S&P 500 996 1,010 903 1,293
NASDAQ 1,972 2,000 1,577 2,454
Russell 2000 561 572 499 754
DJ STOXX Europe 600 (€) 229 231 198 286
Nikkei Index (¥) 10,597 10,412 8,860 12,957
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.04% 1.30% 0.77% 2.43%
10-Year Treasury Yield 3.52% 3.85% 2.21% 3.89%
U.S. $ / Euro 1.42 1.42 1.40 1.48
U.S. $ / British Pound 1.65 1.67 1.46 1.87
Yen / U.S. $ 94.65 97.57 90.64 109.74
Gold ($/oz) $946.95 $954.95 $882.05 $806.63
Oil $70.59 $70.93 $44.60 $115.01
*Levels reported as of 9:00 am Pacific Standard Time
MARKET RETURNS
Year-to-date (1/1/09-8/14/09)* Year-to-date (1/1/09-8/13/09)
Dow Jones Indus Avg. 5.41% 90 Day T-Bill 0.15%
S&P 500 10.32% 2-Year Treasury 0.54%
NASDAQ 25.03% 10-Year Treasury -8.88%
Russell 2000 12.27% ML High Yield Index 38.97%
MSCI World Index 16.39% JPM EMBI Global Diversified 20.77%
DJ STOXX Europe 600 15.28% JP Morgan Global Hedged -0.61%
*Returns reported as of 9:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
August 11 Wholesale Inventories – Wholesale inventories fell by 1.7% in June as distributors were able to move out
excess stockpiles. The July drop was almost twice as large as the predicted 0.9% decline and marks
the tenth consecutive month of decreases.
August 12 Trade Balance – The US trade deficit widened by 4.0% to $27.0 billion in June after unexpectedly
narrowing to $26.0 billion in May. Exports and imports increased by 2.0% and 2.3%, respectively,
signaling that the global economic slump may be coming to an end.
FOMC Rate Decision – The Federal Open Market Committee announced that it will maintain the
target range for the federal funds rate at 0.0 to 0.25% and that economic conditions are likely to
warrant exceptionally low levels of the federal funds rate for an extended period. In addition, the
Committee will gradually slow the pace of its purchases of Treasury securities and anticipates
that the full amount will be purchased by the end of October.
August 13 Retail Sales – Despite a boost from the government's cash-for-clunkers subsidy, US seasonally adjusted
retail sales fell 0.1% in July, the first decline in three months. The drop indicates that consumer demand
will likely remain weak even in the face of government stimulus measures.
Business Inventories – Business inventories fell by 1.1% in June, slightly less than the 1.2% drop in
May. This marks the eighth consecutive month of inventory declines larger than 1.0% and indicates that
higher demand may be clearing away unwanted supply.
Import and Export Prices – Import prices fell by 0.7% in July, largely due to price decreases for both
petroleum and nonpetroleum products. Export prices decreased by 0.3% in the same month as a result
of lowered agricultural export prices.
August 14 Consumer Price Index – Headline inflation was unchanged on a monthly basis in July but down 2.1%
on a year-over-year basis, the most rapid rate of decline since 1950. Core inflation, which excludes food
and energy, rose 0.1%, indicating that inflation will remain subdued for some time.
Euro Zone CPI – European consumer prices dropped more than the estimated 0.6%. Prices fell
0.7% from a year earlier after declining 0.1% in June. Core inflation rate, which excludes volatile
energy and food costs, eased to 1.3%.
Euro Zone GDP – The euro zone GDP contracted by 0.1% in the second quarteragainst
economists’ forecasts of a decline by 0.5%. Demand for European exports is improving as
government rescue packages and lower interest rates support spending.
Germany & France GDP – German and French economies grew unexpectedly in the second
quarter. GDP rose a seasonally adjusted 0.3% in both countries.
OVERVIEW ___________________________________________________
The Federal Reserve left its benchmark interest rate unchanged in a range between 0.0% and
0.25% at the conclusion of its August meeting on Wednesday. In its policy statement, the Fed
reiterated that economic conditions were likely to warrant a low federal funds rate for an
“extended period,” despite signs that the US economy is “leveling out.” The central bank also
discussed exiting parts of its credit easing program, suggesting that it may end its Treasury
purchase program in October when it has exhausted the $300 billion allocated for this purpose.
Going forward, the evolution of the economic data will play a key role in driving the Fed’s next
move. The 0.1% July drop in retail sales indicated that consumers are choosing to build savings
and pay down debt rather than increase spending, underscoring our expectation that real GDP
growth will remain at 1-2% for most of 2010. In this environment, we anticipate that the Fed will
leave short-term interest rates on hold until mid-2010 until it begins the process of gradually
raising its overnight rate to 1% by the end of next year.
US MARKETS:
TREASURIES ________________________________________________________________________________
• US Treasuries had a strong performance this week, backed by better-than-expected
auctions in 3-year, 10-year, and 30-year bonds. Two-year on-the-run Treasury yields
finished the week 25 basis points (bps) lower, 10-year yields rallied 35 bps.
• At the end of the week the combination of unchanged consumer prices and lower-thanexpected
consumer confidence, expressed via the University of Michigan survey index,
accelerated this rally. This resulted in unwinding of short positions in longer dated maturities
and the re-emergence of curve flattening trades, with the yield spread between 2-yr notes
and 10-yr bonds tightening by 10 bps over the last five trading days.
LARGE-CAP EQUITIES___________________________________________________________
• The stock market fell for the first time in five weeks due to weaker-than-expected economic
data releases. The S&P 500 index fell about 1.3% for the week. Large-cap stocks
outperformed small-cap stocks. In terms of style, large-cap growth stocks outperformed
large-cap value stocks. The best performing sector was health care and the worst
performing sector was consumer discretionary. Earnings season continues to wind down
with retail companies dominating this week’s announcements. Wal-Mart Stores Inc reported
quarterly earnings of 88 cents per share, which beat analysts’ estimates of 86 cents per
share. The company attributed the positive quarter to cost reductions and better inventory
management. Shares of WMT rose almost 3% on the news.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity continued its torrid pace during the first half of the week.
Money continues to pour into the high grade credit space despite Treasury yields falling
most of the week. For the first time in some time now, several new issues that priced this
week are actually trading wider to where they initially priced. Many investors think that the
widening is temporary as lower Treasury yields dampened interest from absolute yield
buyers. Thin summer trading also contributed to the move wider adding to the notion of
some that the widening was merely a function of the market running too far too fast.
• Investment grade corporate spreads tightened slightly on the week even though it felt like
most of the market was trading sideways on very thin volumes. Range-bound spread levels
should stay at least until post Labor Day weekend. It does feel like we have reached a point
where the buy-everything-you-can-get-your-hands-on mentality has given way to a more
rational approach. The Barclays Credit Index Option-Adjusted Spread (OAS) finished the
week at +213, tighter by 3 basis points. Financials tightened by 9 basis points (banks -7,
insurance -11); industrials widened by 1 basis point (telecom +3, consumer non-cyclical -1,
basic materials +9, capital goods -2, energy +6); and utilities widened by 1 basis point.
MORTGAGE-BACKED SECURITIES _______________________________________________
• Agency mortgages kept pace with Treasuries in the rally back to the middle of the range.
The mortgage market weathered a slew of economic reports and headline events that
offered mixed views on the direction of interest rates. This lack of direction is an ideal
environment for mortgages as rates have oscillated in a narrow 25 basis point range. Thirtyyear
current coupon pass-through spreads closed unchanged versus Treasuries at 94 basis
points. Although the production coupons experienced quiet spread movement, activity
picked up for the higher coupon agency mortgage market. The relatively benign
prepayment report has enticed investors to pay up for premium mortgages opting for an
attractive alternative to short government and corporate products.
MUNICIPAL BONDS _____________________________________________________________
• After closing in on its steepest levels on record, the municipal bond market yield curve
flattened this week. Yields on short maturity bonds edged higher and longer maturity yields
dipped lower. We are hearing – and seeing – investor interest sour for the front end of the
municipal market. An example will help explain why: a 2-year municipal bond yielding just
0.68% did not seem all that appealing as “risk-free” Treasury yields ratcheted up to 1.30% at
the end of last week. As a result, municipal investors held on to cash, shifted their focus
across markets (into taxables) or moved further out along the municipal curve. In addition,
the flood of Build America Bonds (BABs) serves as a substitute for long-term tax-exempt
issuance. Investors continue to anticipate this relative scarcity of longer term municipal
bonds in the markets, bidding up prices and sending yields lower. This helped push the yield
curve flatter. By Thursday, two-year AAA-rated bond yields rested at 0.71% and 30-year
bond yields fell to 4.62%.
• The pace of new supply kicked up a notch on the week as a flurry of deals hit the market.
One highlight was the $775 million Bay Area Toll Authority, San Francisco Bay Area Toll
Bridge Revenue Bonds. The Aa3/AA/AA- credit offered a maximum yield of 5.12% in the
2044 maturity and was met with heavy demand from investors.
HIGH-YIELD BONDS ____________________________________________________________
• The high yield bond market remained firm with bonds generally well-bid in August. The
relatively positive economic data (for example, declining unemployment rate) and the
continuing equity rally has resulted in continuing market momentum for high yield. The
broad Merrill Lynch high yield index is up 1.65% for August to-date and the Merrill Lynch
BB/B index is 1.3% for the month to-date. Similar to the past five months, it is the typically
CCC-rated segment of the market that is up the most as some investors continue to reach
for yield. High yield mutual funds continue to receive significant inflows, as investors
maintain their positive view of the asset class. The inflows this week totaled $713 million.
Surprisingly, given the time of the year, the high yield new issuance remains strong, with
over $5 billion of deals pricing this week. New deals included a $1 billion financing for
Case New Holland, the agricultural and construction equipment company, and a $1.3 billion
bond deal for Sprint Nextel, one of the largest wireless telecommunication companies.
INTERNATIONAL MARKETS:
WESTERN EUROPEAN EQUITIES __________________________________________________
• European stocks went down this week. The sectors with the worst performance were
auto & parts (-3.9%) and food & beverage (-1.1%). Volkswagen (-21.0%) pulled
down the performance of the entire sector as the takeover of Porsche is now
finalized. On the other hand, Porsche gained 11.2% as a result. Chrysler creditors
were granted permission to sue Daimler (-2.2%) over $9 billion in transfers. The food
& beverage sector suffered from high unemployment rates and cost conscious
consumers. The entire sector is suffering under hard price competition, especially
breweries. Heineken (-3.8%), Coca Cola (-3.3%) and Nestle (-3.1%) performed the
worst.
• The best performing sectors were real estate (+5.3%) and utility (+2.8%). A group of
Indian and Gulf investors is considering a take-over of Derwent London leading to an
increase of its stock by +10.2%. British real estate continues to show good growth,
specifically Land Securities (+6.6%) and Brit Land Co (+6.4%). In the utility sector,
Endesa (7.7%) profited from rising energy prices. In Germany, E.ON (+5.6%) and
RWE (+2.6%) benefited from a recovery of the sector overall.
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary,
and Poland) gained +0.6% this week, while the Russian stock index RTS went down
-1.9%.
• The euro zone’s two largest economies, Germany and France, unexpectedly returned to
growth in the second quarter, hauling Europe out of its worst recession since World War II.
This reduced the drop in the 16-nation bloc’s GDP to just 0.1%, helping it outperform the
US and the UK. Global stimulus measures to battle the deepest slump since the Great
Depression have boosted demand for European exports and government packages are
supporting spending at home. Government and household spending were among the main
drivers of second quarter growth in Germany and France. This is also good news for the
economies of Emerging Europe, as trade with Western Europe is an important component
of their growth story.
GLOBAL BONDS AND CURRENCIES _____________________________________________
• The past week was a particularly good one for shorter-dated sovereign bonds in most
markets, supported by equity market jitters early in the week, weaker than expected US
retail sales and jobless data and by indications from the US Fed that rates will remain low
for an ‘extended period’. Two-year Bunds finished the week more than 20 basis points
lower, in line with developments in the US Treasury market, despite unexpected news that
both the French and German economies expanded modestly in Q2 after four successive
quarters of contraction. Short-dated UK Gilts received an extra fillip from the release of the
Bank of England’s (BoE) quarterly Inflation Report. Two-year Gilt yields fell more than 30
basis points on the week after the BoE said that the UK’s recovery will be ‘slow and
protracted’, suggesting that its accommodative policy stance will remain in place for some
time. The buoyant mood filtered up the European and UK yield curves but gains were most
modest in the 10-year zone. The Japanese government bond (JGB) market had a quieter
time than the other sovereign markets, with the short end of the JGB curve closing virtually
unchanged and longer-dated JGBs only a few basis points firmer on scepticism about the
sustainability of the Japanese recovery.
• In currency markets the US dollar was generally weaker against its major crosses
following the Fed’s hint that rates would remain at current low levels. At the same time, the
Euro received a boost from the better-than-expected French and German Q2 GDP data.
The Australian and New Zealand dollars also rose against the greenback due to firmer
commodity prices and mounting speculation that these countries will lead the rise in rates.
Sterling lagged, closing the week lower against the dollar, on disappointment at the BoE’s
cautious comments on the UK’s economic outlook.
EMERGING-MARKET BONDS ____________________________________________________
• Emerging market dollar-pay debt spreads widened this week as risk appetite receded. The
Federal Reserve meeting, however, delivered a statement that was in line with
expectations and reinforced investors' expectations that the global economic recovery is
under way.
• In South Africa, the Central Bank cut its benchmark interest rate by 50 basis points from
7.50% to 7%, a surprise to the market as no change had been expected. The cut was
based on the continued weakness in the South African economy and signs that inflationary
pressures are easing. Local bonds rallied on the news.
NEXT WEEK'S ECONOMIC RELEASES
August 17 Turkey May Jobless Figures
August 18 Producer Price Index, Housing Starts, German ZEW Economic Sentiment
August 19 Crude Inventories
August 20 Leading Indicators, Poland July Inflation
August 21 Existing Home Sales

Market Reflections 8/13/2009

The cash-for-clunkers program packed less of a belt than was expected, making for a grim retail sales report that showed declines across components. But the disappointment was offset by stable jobless claims data and positive GDP readings, not negative readings, out of Germany and France. Strong earnings from Wal-Mart didn't hurt. The S&P 500 rose on day, gaining 0.7 percent to 1,012. The strength in Europe made for losses in the dollar with the dollar down 0.5 percent to 78.43. Copper, driven by Chinese stockpiling, is taking the lead in the commodities group, ending at a 2009 high of $2.88 for a 10 cent gain. Other commodities also held firm. The Treasury, despite its massive debt, wound up another successful quarterly refunding with strong demand for 30-year bonds where the yield fell 12 basis points on the day to 4.42 percent.

Jobless claims A ray of sun or false hope?

Jobless Claims
Released on 8/13/2009 8:30:00 AM For wk8/8, 2009

The rate of layoffs is heavy but steady as first-time jobless claims were little changed in the Aug. 8 week, at 558,000 vs. 554,000 in the prior week. The numbers, in a plus, are a little bit below the four-week average, which is at 565,000. Continuing claims fell steeply, down 141,000 for data in the Aug. 1 week to 6.202 million. But the decline is hard to read, reflecting either new hirings and/or the expiration of benefits. The economy may be in recovery or at least is steady but the outlook for the jobs market, and how far it lags, is a serious concern for the economic outlook and for policy makers.
Market Consensus Before AnnouncementInitial jobless claims fell 38,000 to a much better-than-expected level of 550,000. Businesses appear to have made their major cuts in labor costs in earlier weeks and are now trimming fewer jobs. Continuing claims, however, rose 69,000 for the July 25 week to 6.310 million, indicating that it is still hard to get rehired.
DefinitionNew unemployment claims are compiled weekly to show the number of individuals who filed for unemployment insurance for the first time. An increasing (decreasing) trend suggests a deteriorating (improving) labor market. The four-week moving average of new claims smoothes out weekly volatility. Why Investors Care
Weekly series fluctuate more dramatically than monthly series even when the series are adjusted for seasonal variation. The 4-week moving average gives a better perspective on the underlying trend.

Market Reflections 8/12/2009

Markets showed little reaction to today's FOMC statement which hints at an end to quantitative easing, a minus for assets with risk premiums but offset by the prospect that interest rates will remain low for an extended period. The dollar ebbed back and forth before ending slightly lower with the dollar index at 78.82. Gold, which has a pronounced risk premium against inflation, showed nearly no reaction, ending at $946. Stocks held onto opening gains, gains that follow two days of profit taking, with the S&P ending up 1.2 percent to 1,005. Treasuries ended little changed with the 10-year yield at 3.71 percent.

Market Reflections 8/11/2009

Talk is centered on whether or not there's too much enthusiasm in the stock market. But even the most cautious aren't calling for too big a retracement given that the economy is now stabilizing. Profit taking pushed the S&P 500 down 1.3 percent in quiet trading to 994.35. Selling was concentrated in financials on talk that defaults remain a risk and are a growing risk for commercial real estate. Demand was very strong for the Treasury's 3-year note auction, good news ahead of 10-year and 30-year auctions tomorrow and Thursday. The 3-year yield ended 6 basis points lower at 1.72 percent. The dollar index ended little changed at 79.15.

Market Reflections 8/10/2009

Action was quiet Monday ahead of what promises to be a busy week that includes an FOMC statement, retail sales, consumer prices, and industrial production. Stocks ended little changed with the S&P holding over 1,000. Dollar buying extended into Monday's session after Friday's better-than-expected jobs report continues to raise talk of rising U.S. interest rates. The dollar index rose 0.4 percent to 79.24. There wasn't much action in commodities though copper did hit a 2009 high at $2.82/lb before backing off to $2.75. Many are saying copper, which has nearly doubled this year on strong Chinese buying, is the commodity headliner of the year. Oil ended steady at $71 with gold also steady at $945.

Week ending August 7, 2009 Market Update

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Week ending August 7, 2009

Friday* Last Week Dec. 31 2008 1 Yr Ago
Dow Jones Ind. Avg. 9,389 9,172 8,776 11,431
S&P 500 1,013 987 903 1,266
Nasdaq 100 2,004 1,979 1,577 2,356
The Russell 2000 753 557 499 713
DJ STOXX Europe 231 225 198 287
Nikkei Index 10,412 19,357 8,860 13,125
Fed Funds Target 0-0.25% 0-0.25% 0-0.25% 2.00%
2-Year U.S. Treasury Yield 1.32% 1.12% 0.77% 2.43%
10-Year U.S. Treasury Yield 3.88% 3.48% 2.21% 3.93%
U.S.$ / Euro 1.42 1.43 1.40 1.53
U.S.$ / British Pound 1.67 1.67 1.46 1.94
Yen / U.S.$ 97.55 94.68 90.64 109.44
Gold ($/oz) $957.03 $954.00 $882.05 $873.05
Oil $72.54 $69.45 $44.60 $120.02
*Levels as of 12:40 a.m. PST

Year to Date (1/1/09 -8/7/09)

Dow Jones Industrial Avg 6.98%

S&P 500 12.13%

NASDAQ 27.08%

Russell 2000 14.63%

MSCI World Index 15.11%

DJ STOXX Europe 600 (euro) 16.29%

Year to Date (1/1/00 - 8/6/09)

90 Day T-Bill 0.14%

2-Year Treasury 0.29%

10-Year Treasury -10.10%

ML High Yield Index 38.72%

JP Morgan EMBI Global Diversified 21.06%

JP Morgan Global Hedged -0.85%



August 3

Construction Spending – Construction spending rose unexpectedly in June by 0.3% after dropping 0.8% in May. The increase was mostly due to a record level of spending on public buildings.
ISM Manufacturing – The Institute for Supply Management’s factory index rose to its highest level since August 2008, increasing to 48.9 in July from 44.8 in June. Though readings below 50 signal a contraction, the significant uptick far exceeded expectations and underscores the possibility of a third-quarter recovery in manufacturing.
Auto Sales - Auto sales rose to a seasonally adjusted annualized rate of 11.25 million in July, spurred largely by the government's $2 billion cash for clunkers program. The July figure is the highest this year, but remains significantly lower than the 12.60 million July 2008 level.
Euro Zone PMI – European manufacturing and service industries contracted at the slowest pace in a year in July. The composite index of both industries rose to 47 from 44.6 in June, the highest reading since August 2008 and above estimates of 46.8.

August 4
Personal Income and Spending – Personal income fell 1.3% during the month of June due to the absence of one-time stimulus payments that pushed personal income up by 1.3% in May. Spending rose 0.4%, but fell 0.1% after adjusted for inflation.
Pending Home Sales – The pending home sales index, based on sales contracts on existing homes, rose 3.6% in June after a revised 0.8% gain in May. The index is up 6.7% on a year-over-year basis due to historically low mortgage interest rates, affordable prices, and large selection.

August 6
Germany Factory Orders – German factory orders posted their biggest increase in two years in June. Orders adjusted for seasonal swings and inflation jumped 4.5% from May—the most since June 2007 and the fourth successive monthly gain. Orders are still 25.3% lower than a year earlier.

August 7
Unemployment Rate – The US economy shed 247,000 jobs in July as the unemployment rate fell to 9.4% from 9.5% in June. The drop in the unemployment rate is largely due to a decrease in the civilian labor force participation rate, which declined by 0.2% in July to 65.5%.
June 5 Employment – Nonfarm employment declined by 345,000 in May, the smallest decline in 8 months, beating forecasts of 520,000 job losses. During the same period, the unemployment rate exceeded estimates, rising from 8.9% to 9.4%, the highest unemployment rate since 1983. February 6 Employment Report – The US economy shed 598,000 jobs in January and the unemployment rate rose to 7.6%, which is its highest level since 1992. -->


The US economy shed 247,000 jobs in July 2009, which is less than half the average of 556,000 jobs that were lost each month during the first half of the year. At the same time, the unemployment rate edged down slightly from 9.5% to 9.4% marking the first decline since April 2008. The improvement in the labor market is the latest signal that the US recession is easing. Looking ahead, we expect positive economic growth in the third quarter to translate into a gradual increase in hiring by year end. Given our expectation that real gross domestic product will increase at an annual rate of around 3% in the third quarter, we expect the economy to begin generating an average of 100,000 jobs per month by year end. Unfortunately, this is still below the 150,000 jobs that are necessary to absorb new entrants to the labor force. Therefore, the unemployment rate will continue to rise through the first half of 2010 before peaking somewhere around 10%.

Treasury Bonds
Interest rates moved markedly higher this week, representing a parallel shift across the yield curve of 30 basis points. Driving rates higher was an upside surprise in economic data (GDP and nonfarm payrolls) and a growing sense that the market is trying to move past the prospects of a prolonged dampening of global growth. Agency spreads have continued their march tighter with maturities less than two years offering no incremental yield pick up to Treasuries.
Large-Cap Equities
The stock market rallied for the fourth consecutive week reaching a 10-month high as better-than-expected economic data and strong corporate earnings provided evidence of an improving economy. The S&P 500 index rose about 2.5% for the week. Large-cap stocks modestly underperformed small-cap stocks. In terms of style, large-cap growth stocks underperformed large-cap value stocks. The best performing sector for the second straight week was financials and the worst performing sector was telecommunication services. As earnings season winds down, companies in the S&P 500 index continue to surprise on the upside as 3 out of every 4 companies who have reported have beaten analysts’ estimates. This week, Cisco Systems reported better-than-expected quarterly earnings of 31 cents per share, which beat analysts’ estimates of 29 cents per share. The company attributed the solid quarter to cost reduction and improving order trends.
Corporate Bonds
Investment grade primary activity ignited this week as issuers undertook the task to meet the insatiable demand and the nonstop flow into the high grade credit space. Improving economic data has led to optimistic financial markets causing investors to become more confident. This cycle will continue until we reach the pinnacle of consumer sentiment and start reallocating into other asset classes. The broken record continued this week as almost every new issue was well oversubscribed and performed incredibly in the secondary market. • Investment grade corporate spreads tightened despite a vast amount of issuers tapping the new issue market. Several months ago when a new issue hit the market it would cause secondary issuers in that name/tenor/sector to drift wider due to the new issue concession. These days, however, new issue is pricing appropriately and gapping in on secondary trading because everyone is buying to fill their intended position. The Barclays Credit Index Option-Adjusted Spread (OAS) finished the week at +216, tighter by 15 basis points. Financials tightened by 24 basis points (banks -19, insurance -36); industrials tightened by 15 basis points (telecom -11, consumer non-cyclical -13, basic materials -14, capital Goods -20, energy -13); and utilities tightened by 8 basis points.
Mortgage-Backed Securities
Agency mortgages lagged Treasuries as yields backed up on stronger-than-expected economic reports. The underperformance is not an alarm and a welcomed breather from weeks of favorable market action and spread tightening. For the last six months, agency mortgages have been the product du jour for risk-averse investors that desire an alternative to low yielding Treasuries. As the economy recovers, market participants should start to scale out of their agency mortgage holdings in favor of riskier bond sectors and equities. Some of that trade has already occurred as corporate credit and emerging market have posted very strong absolute and relative returns in 2009. Fortunately, the US Government continues to support the mortgage market by steadily digesting originator supply keeping mortgage spreads in check versus Treasuries. A drop in volatility and a benign rate environment also should help buoy agency pass-throughs. For the week, the 30-year current coupon versus the 10-year Treasury widened by 10 basis points to 100 basis points.
Municipal Bonds
A steep yield curve continues to be one of the most notable features of the current municipal market environment. Two-year AAA-rated bond yields fell 2 basis points to 0.66% while 30-year AAA-rated bond yields fell 1 basis point to 4.66%. That means the difference between a 2-year bond and a 30-year bond is 400 basis points, or 4 percentage points, an unprecedented difference. A large part of the story is driven by municipal bond investors’ worries over liquidity, credit and inflation risks. As a result, investors are hoarding cash in the front part of the yield curve keeping shorter-maturity yields extraordinarily low. However, this trend may come under pressure as Treasury yields back up in the wake of today’s better-than-expected employment report and the relative value of taxable alternatives tempt tax-exempt investors.
New deals this week included the $825 million North Texas Tollway Authority (A2/A-) Build America Bonds (BABs). The bonds featured a 2049 final maturity and priced at +230 basis points, or 2.3 percentage points, above the 30-year Treasury yield. The issuer also issued a $600 million tax-exempt bond deal, which offered a 6.34% yield in the 2039 maturity. The deal was generally well received by the marketplace. One example of this is that for the BABs deal by the end of the week the spread over Treasuries had narrowed to +230 from +210.
High-Yield Bonds
High yield started off the month of August with a very firm tone. The broad index was up 1.5% and was 50 basis points tighter to Treasuries as earnings have generally come in better-than-expected. Triple-C rated bonds continue to lead the way with that portion of the market being up nearly 3% heading into Friday. Despite being in middle of the doldrums of summer, six new deals priced this week for a total of $1.4 billion and liquidity remains robust.
Western European Equities
European stocks went up this week. The sectors with the best performance were real estate (+8.9%) and banks (+6.8%). In the real estate sector, Klepierre (+19.9%) benefitted from strong revenues reinforcing financial flexibility. Segro (+13.6%) announced it will go ahead with the £250 million-share sale to help purchase Brixton after the company’s board agreed on takeover terms. In the banking sector, KBC Group, Belgium’s third largest bank by assets, reported surprising positive earnings. Natixis (+35.4%) performed well due to persistent speculations about withdrawal from the exchange.
The worst performing sectors were healthcare (-0.2%) and retail (+0.1%). Elektra AB (-5.6%), Fresenius (-4.7%) and Elan (-4.5%) lost the most in the healthcare sector this week. As cyclical branches observe big gains, investors draw funds out of this anti-cyclical sector. In the retail sector, Delhaize Group (-6.4%), Metro (-5.0%), and Colruyt (-1.6%) were the worst performers. The sector is still under pressure from the recession and it is lagging other sectors as consumer spending remains at low levels while the general outlook is improving.
Eastern European Equities
The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and Poland) gained +1.7% this week, while the Russian stock index RTS went up 6.2%.
In a reflection of investors’ improving attitudes towards emerging markets, the cost of insuring against developing debt defaults has fallen below industrialized governments. Credit-default swap prices for emerging markets are falling amid signs that their economies are recovering faster than those of developed nations. In addition, Brazil, Russia, India and China now hold $3 trillion in reserves, almost half of the world total. The annual cost of protecting holdings in Turkey’s bonds has fallen by half, sinking below New York City swaps, while 11 years after Russia defaulted; investors demand less to insure its debt than California’s.
Global Bonds and Currencies
The past week was a mixed one for major non-US sovereign bond markets. European government bonds fared worst, with yields rising by almost 30 basis points at the shorter end and by about 15 basis points at the longer end of the curve. These moves came partly in sympathy with losses in the US Treasury market. Some upbeat European business sentiment data also weighed in Bunds. There was no surprise in the European Central Bank’s decision to leave monetary policy unchanged at its Governing Council meeting held in the past week, but Bund market sentiment was damaged by hints from ECB President Trichet that the Bank is about to revise up its economic forecasts to show growth turning positive sooner than previously forecast. UK Gilts had a better week. Two-year Gilt yields rose only slightly and 10-year yields closed the week about 5 basis points lower following the Bank of England’s (BoE) surprise decision to extend its quantitative easing program by £50 billion to £175 billion - market expectations were that the Bank would either make no increase or else increase its bond purchases by a more modest £25 billion. The BoE’s unexpectedly generous move served as a reminder that although there are clear signs that the UK economy is over the worst of the downturn, the recession has been deeper than expected and activity remains weak and in need of encouragement. In Japan, government bonds finished the week little changed as investors await the result of the forthcoming general election scheduled for month end.
In currency markets, the week’s main event was the further weakness in the yen against the dollar. Elsewhere, the greenback was relatively flat against the Euro and the Sterling, after Sterling came off it recent highs following the BoE’s unexpected decision to extend its quantitative easing program. Speculation that the Reserve Bank of Australia will be the first central bank to hike rates provided support for the Australian dollar against the US dollar, especially after Australian employment data came in stronger than expected.
Emerging-Market Bonds
Emerging market dollar-pay debt spreads tightened this week as economic data releases in the US continued to surprise on the up side. Most notably, the better-than-expected employment data in the US gave a renewed boost to risk assets.
Moody’s affirmed Mexico’s Baa1 foreign and local currency sovereign ratings. In a press release following the announcement, the ratings agency stated that they anticipate the corrective fiscal actions to be undertaken by the sovereign to be sufficient to prevent a significant deterioration in government accounts in 2009 and 2010. This was taken positively by market participants, with the currency reacting most favorably.
In Indonesia, the Central Bank cut its benchmark interest rate by 25 basis points from 6.75% to 6.50%, in line with expectations. It is widely expected that this marks the end of their easing cycle, which has brought 300 basis points in rate cuts since last December. Local bonds were a little weaker following the news. Next week, the economic data calendar will lighten up in the United States. Thursday’s report on retail sales will likely garner the most attention as investors and economists seek to gauge the impact of the deterioration in the labor market on consumer spending. In global markets, both the United Kingdom and euro zone will be reporting on retail sales. The UK also has new data on industrial production. -->
Aug 10

Czech Inflation and July jobless rate, Turkey June Industrial Production
Aug 11

Wholesale Inventories
Aug 12

Trade Balance, FOMC Rate Decision, Euro Zone Industrial Production
Aug 13

Retail Sales, Euro Zone GDP
Aug 14

©2009 Payden & Rygel. All rights reserved.
Consumer Price Index, Euro Zone Inflation

Market Reflections 8/7/2009

A better-than-expected July jobs report, showing a slowdown in job losses and a dip in the unemployment rate, gave a lift to the bulls, pulling money off the sidelines and into the stock market where the S&P 500 gained 1.3 percent to 1,010. Gains or not, money managers continue to complain that clients remain tight fisted. While money moved into stocks it moved out of the safety of Treasuries where yields were up 10 basis points across most coupons. The 10-year yield ended at 3.85 percent. Strong signs for the U.S. economy did not make for a movement out of the safety of the dollar which instead rallied on expectations of stronger asset yields. The dollar index jumped 1.2 percent to 78.94. Commodities showed little reaction with oil slightly lower at $71 and gold also slightly lower at $957.

MARKET REVIEW:8/6/09

Investors took a pause from recent buying to digest the latest economic news, including sluggish retail sales in July. A
larger-than-expected drop in new unemployment claims also left investors wondering whether Friday’s jobs report would show
signs of improvement in the employment outlook. The Dow fell 0.27%, the Nasdaq tumbled 1.00%, and the S&P 500 retreated
0.56%. Bond prices were mixed. The yield on the benchmark 10-year Treasury note rose to 3.76%, up from 3.75% late Wednesday.
Energy futures also edged lower. A barrel of light sweet crude fell $0.03 to settle at $71.94 on the Nymex.

Market Reflections 8/5/2009

Failure of the ISM non-manufacturing report to extend improvement, let alone show erosion as it did, is a setback for the economic outlook. The ISM now thinks its manufacturing report, which had been lagging non-manufacturing, will be the first to show month-to-month stability. The ISM sees its manufacturing index, boosted by an easing in inventory draw and/or a slowing in layoffs, hitting 50 either this month or September.But the ISM news isn't scaling back growth predictions from Goldman Sachs which sharply raised its second-half GDP estimate to plus 3.0 percent. The prediction largely offset the ISM results with the S&P 500 showing limited change on the day, down 0.3 percent at 1,002.69. Commodities held strong with base metals posting big gains and oil, despite a heavy build in weekly crude data, ending higher, just short of $72. Treasuries were whipped sawed this way and that, first up by the ISM then down by Goldman. Underlying everything is the certain prospect of heavy supply, punctuated by the day's record $75 billion quarterly refunding announcement. The dollar index ended fractionally lower at 77.61.

Some interesting questions

The trend is your friend. Price is the final arbiter. Market prices are reality. If you fail to respect the information contained in those last three short sentences you usually end up trying to find a source of funds to start another trading account.

But, despite those truths we can’t help asking some why’s:
1) Why is the euro at $1.43 when it’s clear the currency is creating huge pressures within the Eurozone, straight-jacketing countries like Spain with 20% unemployment, and hurting the export machine of Germany thanks to falling currency prices for its two major competitors, US and China?
2) Why do people believe Chinese economic numbers when a whole host of seemingly bright people who have seen China up close and personal tell us said numbers are mostly fabricated?
3) Why does oil surge above $70 per barrel when oil companies who know the market better than anyone tell us there is ample supply and little demand on the horizon?
4) Why is there so little anecdotal evidence among the people in your town suggesting the bottom in the recession is here?
5) Why do some emerging market currencies whose countries are 2-3 clicks away from sovereign bond default surge against the US dollar?
6) Why does the US government continue to eat the seed corn of entrepreneurism when new business and the jobs created therein are the only way to revive the US economy long term?
7) Why does the Japanese yen act as a safe haven while Japan’s debt-GDP towers over other all industrialized countries?
8) Why does everyone love gold even though it has risen only about 10% since it peak in 1980, while the Dow is up about 10-fold since then?
9) Why do we think enormous stimulus will work everywhere else when it hasn’t worked at all in Japan?
10)Why do so many believe the US will lose its currency reserve status when there is no real competitor currency out there to take over that role?
11)Why does the US government confiscate taxpayer money in order to subsidize US citizens who buy Japanese cars?
12)Why is it that former US Presidents now never seem to just fade softly into the night?

All these, and many other things, are a seeming mystery to me. But, as they say, if it were easy we’d all be rich.

Market Reflections 8/4/2009

Markets took a breather on Tuesday with the S&P ending fractionally higher at just over 1,005. A drop in personal income, reflecting one-time stimulus checks paid out in the prior month, didn't the hurt market, and the market didn't get any help from a jump in pending home sales, the latest indication of recovery for the housing sector. Commodities were little changed with oil at $71.50 and gold near $970. The dollar index ended slightly higher at 77.73 while the 10-year Treasury yield ended at 3.68 percent.

Market Reflections 8/3/2009

A big jump in the ISM manufacturing index, together with a surprise rise in construction spending and big gains for vehicle sales, fed a 1.5 percent rise in the S&P which ended over 1,000 at 1,002.63. Gains in the ISM exceeded expectations with new orders and production showing special strength, strength that points to slowing layoffs and an easing need to draw down inventories. Construction spending got a big boost from single-family homes, a gain adding to building evidence that the housing sector has hit bottom and may now be on the rise. And it was cash for clunkers that gave a big boost to auto sales, pointing to strength in next week's retail sales report.
Some of the biggest gains were in commodities where copper was a standout, jumping 8 percent. Grains also showed big gains with corn up 6 percent. Oil rose nearly 4 percent to just under $71.50. Demand for commodities reflects expectations of improved economic demand together with the need to hedge against inflation including dollar-related imported inflation. The dollar index fell 0.7 percent to 77.58. The appetite for risk made for weakness in the Treasury market where the 10-year yield jumped 15 basis points to 3.63 percent.

Weekly Market Update,Week ending July 31, 2009

July 31, 2009
MARKET LEVELS
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 9,164 9,093 8,776 11,378
S&P 500 987 979 903 1,267
NASDAQ 1,987 1,966 1,577 2,326
Russell 2000 559 548 499 715
DJ STOXX Europe 600 (€) 225 220 198 284
Nikkei Index (¥) 10,357 9,945 8,860 13,377
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.12% 1.00% 0.77% 2.51%
10-Year Treasury Yield 3.52% 3.66% 2.21% 3.95%
U.S. $ / Euro 1.42 1.42 1.40 1.56
U.S. $ / British Pound 1.67 1.64 1.46 1.98
Yen / U.S. $ 94.66 94.79 90.64 107.91
Gold ($/oz) $951.25 $951.35 $882.05 $914.07
Oil $67.80 $66.55 $44.60 $124.08
*Levels reported as of 10:00 am Pacific Standard Time
MARKET RETURNS
Year-to-date (1/1/09-7/31/09)* Year-to-date (1/1/09-7/30/09)
Dow Jones Indus Avg. 4.42% 90 Day T-Bill 0.14%
S&P 500 9.28% 2-Year Treasury 0.30%
NASDAQ 25.99% 10-Year Treasury -9.37%
Russell 2000 11.98% ML High Yield Index 35.90%
MSCI World Index 12.88% JPM EMBI Global Diversified 18.93%
DJ STOXX Europe 600 13.39% JP Morgan Global Hedged -0.98%
*Returns reported as of 10:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
July 27 New Home Sales – New homes sales rose 11% to a seasonally adjusted annual rate of 384,000 in June,
surpassing expectations of a 350,000 annualized rate. This increase marks the fourth straight month
that new homes sales have risen, underscoring views that the housing market may be bottoming.
July 28 Consumer Confidence – Confidence among US consumers fell for the second consecutive month
in July, reflecting concerns about the rising unemployment rate. The Conference Board’s
confidence index dropped to 46.6, down from 49.3 in June.
S&P/Case-Shiller Home Price Index – The S&P/Case- Shiller home price index rose 0.5% in May, the
first gain since July 2006. While house prices were still down 17% from a year earlier, the month-tomonth
increase is evidence that the housing downturn may be easing.
July 29 Durables Orders - New factory orders for durables fell 2.5% in June due to a plunge in civilian aircraft
orders. Though the decline was worse than the 0.5% forecasted drop, the core measure of new orders,
which excludes transportation, advanced 1.1% in the month, following a 0.8% rise in May.
Federal Reserve's Beige Book – The Fed reported that though the pace of economic contraction has
moderated and begun to stabilize, aggregate employment is still declining, loan demand remains weak,
and business and consumer spending growth is sluggish.
July 31 Gross Domestic Product (GDP) Second-quarter GDP declined at a 1.0% annual rate, largely due to
weak consumer spending and business investment. The result was above market expectations and
represented a dramatic improvement from the prior two quarters.
Euro Zone Unemployment Rate - The jobless rate in the nations that use the euro currency rose to 9.4%
in June, its highest rate in ten years. The number of unemployed has risen by more than 3 million
workers over the past year.
Euro Zone Consumer Price Index - The flash estimate for annual headline inflation dropped to -
0.6% in July from -0.1% in June. This is the second negative reading since the launch of the
euro.
OVERVIEW ___________________________________________________
The Commerce Department reported that US economy shrank at an annual rate of -1% in the
second quarter of 2009. Real gross domestic product (GDP) has now declined for four
consecutive quarters for the first time since the Commerce Department began keeping records
back in 1947. Still, the second quarter was a dramatic improvement over the prior two quarters
when the economy contracted at annual rates of -5.4% in Q4 2008 and -6.4% in Q1 2009 after
revisions.
Looking forward, there is good reason to believe that real GDP growth will turn positive in the
current quarter as businesses move to rebuild inventories adding to the already positive effects
of a shrinking trade gap and increasing government spending. Beyond that, the question will be
whether a sustainable rebound in private demand will materialize before the impact of the
trillions in fiscal and monetary stimulus fade in late 2010.
US MARKETS:
TREASURIES ________________________________________________________________________________
• US Treasuries were mixed this week, with shorter dated maturities under pressure due to
weak auctions in the 2-year and 5-year part of the yield-curve. Two year on-the-run
Treasury yields finished the week 12 basis-points (bps) higher, 5-year yields ended 5 bps
higher.
• A different scenario turned out in the long end of the US Treasury curve, with 10-year and
30-year Treasuries rallying 15 and 20 bps respectively on the back of a surprisingly strong
7-year auction and a higher-than-expected Q1 2009 GDP downward revision to -6.4%. This
resulted in unwinding of short positions in longer dated maturities and the re-emergence of
curve flattening trades, with the yield spread between 2-year notes and 10-year bonds
tightening by 27 bps over the last five trading days.
LARGE-CAP EQUITIES___________________________________________________________
• The stock market rallied for the third consecutive week and continued to reach new highs for
the year due to strong corporate earnings. The S&P 500 index rose about 1% for the week.
Large-cap stocks underperformed small-cap stocks. In terms of style, large-cap growth
stocks underperformed large-cap value stocks. The best performing sector was financials
and the worst performing sector was energy. So far this earnings season, about 66% of the
S&P 500 companies have reported earnings with approximately 75% of these companies
beating estimates. The most notable companies that surprised on the upside this week
were ConocoPhillips, Amgen and Visa. In the headlines this week, Microsoft and Yahoo
reached a 10-year search agreement. The agreement will require Yahoo to exclusively use
Microsoft’s search engine Bing.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity reverted back to normalcy as earnings continue to
dominate investors’ attention. There were several large infrequent issuers who tapped the
market this week. Macquarie Group LTD, an international investment bank, came to the
market with a $1 billion five-year priced at +475bps over the five-year Treasury. Capital
One also came to the market with a $1 billion 30-year that priced at +586bps over the 30-
year Treasury. Both deals were well oversubscribed confirming there is not enough bond
supply to meet the voracious demand.
• Investment grade corporate spreads tightened once again as light issuance and betterthan-
expected earnings added to the positive sentiment most investors have of the
economic outlook. The imbalance between supply and demand continues to be a major
factor contributing to the tightening we have experienced recently. The Barclays Credit
Index Option-Adjusted Spread (OAS) finished the week at +231, tighter by 16 basis points.
Financials tightened by 16 basis points (banks -14, insurance -28); industrials tightened by
20 basis points (telecom -24, consumer non-cyclical -13, basic materials -24, capital goods
-21, energy -17); and utilities tightened by 15 basis points.
MORTGAGE-BACKED SECURITIES _______________________________________________
• Agency mortgages love a range bound interest rate environment. Mortgage spreads on 30-
year pass-throughs continue to grind tighter as supply was absorbed by steady buying from
the Federal Reserve and Asian central banks. Lower volatility and an improving
prepayment story also helped mortgages outperform Treasuries and agencies. Within the
sector, favorable technicals have lifted Ginnie Mae mortgages over their Fannie Mae and
Freddie Mac conventional cousins. For the week, the 30-year current coupon versus the
10-year Treasury narrowed by 3 basis points to 90 bps.
MUNICIPAL BONDS _____________________________________________________________
• Another month comes to an end and investors in the municipal bond market remain
undeterred from owning high quality, short maturity municipal bonds. Case in point: the twoyear
AAA-rated general obligation (GO) bond yields are just 56% of comparable US
Treasury yields—their lowest level versus Treasuries on record. While part of this is driven
by a rise in Treasury yields, strong demand remains in the front end of the municipal yield
curve. Meanwhile, ten-year AAA-rated GO bond yield held steady this week at around
3.00%.
• The California Legislature resolved its 2009-2010 budget crisis – at least on paper – and the
Governor signed it into law this week. The market responded with elation. Yields on
California GO bonds dropped dramatically compared to high grade GO bonds, with the
difference between CA GO bond yields and AAA-rated GO bond yield narrowing by nearly
50 basis points to 120 bps through Thursday. This spread measure had surged as high as
200 bps at the height of the crisis last month.
• New deals this week included the $250 million Metropolitan Water District of Southern
California, Water Revenue Build America Bonds (BABs). The Aa2/AAA/AA+ credit offered
yields of +220 bps to 10-year US Treasuries for the 2025 maturity and +200 bps to the 30-
year Treasury for the 2039 maturity (which has a par call in 2019). Next week also could be
interesting with the North Texas Toll Authority set to issue $800 million in BABs with a
single, 40-year bullet maturity. Early price talk on this issue is in the +250 bps range to the
30-year Treasury.
HIGH-YIELD BONDS ____________________________________________________________
• After a slow start to the month of July, the high yield bond market has regained
momentum and finished the month in strong form. The Merrill Lynch high yield index is
up 5.3% for the month. The recent rally has been driven, in large part, by the strong
monthly performance of global equity markets, with major US equity indices, such as the
S&P 500, up over 12% since July 10. The recent equity and credit market rally has been
based on generally strong second quarter 2009 earnings from the large US corporations.
Similar to earlier periods, the high yield rally has been concentrated in the more risky
CCC-rated end of the market; CCC and below rated bonds are up 9.5% in July and up
62% year-to-date 2009. It appears that the risk rally of April and May 2009 has resumed
in July. Despite the late stage in the summer cycle, the high yield new issue market
remains relatively active, with over $4 billion in deals pricing just this week. Ford Motor
Credit, the finance arm of Ford Motor and a high yield rated company, issued $1.75 billion
of bonds with a three year maturity. The Ford Motor Credit bonds were priced to yield
10.9% at issue. The high yield market continues to receive significant cash inflows, as
investors are attracted to the asset class. High yield mutual funds received $530 million of
inflows this week, the fifth straight week of inflows.
INTERNATIONAL MARKETS:
WESTERN EUROPEAN EQUITIES __________________________________________________
• Western European stocks went up this week by +2.3%.
• Stocks in Western Europe climbed to their highest point since last-year’s post-Lehman selloff
on expectations of better earnings as the global recession’s grip gets looser. In the
meantime, European consumer prices fell by -0.6% as compared to last year on lower
energy prices, beating analyst expectations of a -0.4% fall, while unemployment rose to
9.4%. The combination of lower prices and continued slack in the economy highlighted that
the risk of deflation in Europe is still on the agenda.
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and
Poland) continued to rally, gaining +5.8% this week, while the Russian stock index
RTS went up +0.5%.
• Bad news continued to come out of the Baltics. Lithuania’s GDP contracted by -22.4% in the
second quarter of the year, significantly worse than first quarter’s revised -13.3% contraction
and consensus expectations. The worst GDP decline for the European Union is a sobering
reversal of fortune for the Baltic country, which, together with Latvia and Estonia, made up
the Union’s fastest-growing “troika” earlier in the decade. The country’s stock market has
significantly lagged its peers so far this year, despite a strong rally in emerging markets
elsewhere.
GLOBAL BONDS AND CURRENCIES _____________________________________________
• Most major non-US sovereign bond markets managed to make gains in the past week, even
as global equity markets hit fresh highs for the year. The bulk of their progress was made
late in the week following the release of the US second quarter GDP data, which showed
unexpectedly persistent weakness in personal consumption. Month-end purchases to rebalance
indexed bond portfolios also helped to push yields lower. The week’s data was
mixed. Unemployment climbed to new cyclical highs and deflationary pressures persisted in
both Japan and Europe. Indeed in Europe, the flash estimate for annual CPI dropped to -
0.6% in July from -0.1% previously, whilst the slowdown in money supply growth continued
apace. However, on the positive side, Japanese industrial production rose for the fourth
consecutive month, the European Commission’s latest economic sentiment surveys all
showed further steady improvement, while UK house prices continue to rise from their lows
and mortgage lending expanded further. By the end of the week, 10-year Bund and Gilt
yields were about 16 basis points lower. Japanese government bonds made more modest
gains, in part due to the outperformance of Japanese stocks over the week and in part
because the Japanese market was closed for the week before the release of the US GDP
data.
• Currency markets spent a relatively subdued week, leaving the dollar slightly weaker against
the euro, the yen and sterling after investors focussed on the disappointing aspects of the
US GDP data. The greenback was also lower against most of the commodity currencies as
commodity prices recovered and the People’s Bank of China provided assurance that it
would maintain its current easy policy stance. The New Zealand dollar proved the exception
however. It underperformed after the central bank warned that rates may fall further.
EMERGING-MARKET BONDS ____________________________________________________
• Emerging market dollar-pay debt spreads widened marginally this week on the back of profit
taking and a lighter new issue calendar.
• The Central Bank of Hungary surprised the market with a larger-than-expected 100 basis
point cut of its benchmark interest rate from 9.5% to 8.5%. Most analysts had been
expecting a cut of 50 basis points. The strengthening of Hungary’s currency, the Forint, over
recent months in line with improved risk appetite has allowed the Central Bank to deliver a
cut of this magnitude in order to address the poor domestic growth scenario.
• In Brazil, the minutes from the Central Bank’s meeting released this week, revealed that
inflation expectations remain below or at the center of the of 4.5% target and indicated that
the Central Bank will be on hold for the foreseeable future. They cited continued idle
capacity in both the industrial sector and the labor market as reasons for the benign inflation
outlook. Local bonds remained stable, while the Real was one of the best performing
currencies of the week.
NEXT WEEK'S ECONOMIC RELEASES
Aug 3 Construction Spending, Auto Sales, July PMI (Hungary, Czech Republic)
Aug 4 Personal Income and Spending, Pending Home Sales
Aug 5 Factory Orders
Aug 7 Nonfarm Payrolls, Unemployment Rate
©2009 Payden & Rygel. All rights reserved