Market Anxiety Heightened by Prospect of Reduced Liquidity
We think last week's focus on the Fed's intentions calls into question just how much of the recent rally has been due to improving underlying fundamentals.
The credit market was generally trendless last week, as volume was muted and we were unable to discern any change in investment themes. Dealers tightened their bid/ask spreads in an attempt to generate trades with the most liquid names such as Apple (AAPL) (AA-, narrow moat) tightening to a 1-basis-point bid/ask spread. The Morningstar Corporate Bond Index ended last week at +138, widening 2 basis points in a holiday-shortened session Friday in sympathy with the decline in the equity market. Those managers with cash were seen waiting for new issues to put money to work, as opposed to chasing bonds in the secondary market. The remaining market participants seemed content to sit on their existing positions, close out early for the week, and head home for the long weekend.
U.S. economic data released last week were generally positive, but completely overshadowed by Fed chairman Ben Bernanke's testimony to the Joint Economic Committee and by several members of the Federal Reserve who gave speeches throughout the week. It's disconcerting to see how much of the market's attention has been focused on the Fed's intentions as to the timing and pace of reducing asset purchases. We think this overreliance on easy-money policy calls into question just how much of the recent rally has been due to improving underlying fundamentals versus the monetary steroids provided by nearly daily asset purchases by the Fed. Considering the yield on 10-year Treasury bonds has historically averaged about 200 basis points over inflation, once the Fed begins to discontinue its purchase program, we think long-term interest rates will quickly increase. Even at the low rate of inflation of 1.1% year over year during March, the 10-year rate needs to increase more than 100 basis points to return to historical averages.
David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.