PIIGs Can Fly
Thus far in 2014, the ten-year T-note has been slow to move, and much of the action in Treasuries has been in the so-called “PIIGS.”
By Steve Van Order, Fixed Income Strategist
This year, if you only watched the ten-year T-note yield you missed the action in Treasuries. As we've written about most weeks, the main trade so far this year has been to sell the short-intermediate maturities and buy the long bond in a reshaping of the yield curve. What yield volatility there was last week was much-related to curve trading. Long maturity yields are near 200-day lows while short-intermediate yields are just below 200-day highs. T-bill yields remain pegged near zero.
Since Treasuries have been kind of boring of late, what has been exciting? There is a reasonable list to choose from. For example, a source of market action this year has been the continued rally of the debt of the peripheral euro area government bonds, the so-called PIIGS (Portugal, Italy, Ireland, Greece, and Spain). Since December, Ireland, Spain, and Portugal left bailouts of various sizes and scope1. Greece is stuck in amber, yet accessed the term debt market in large size this year. The spreads and yields for these government bonds have collapsed.
The lesson here is that it pays to remember what all the major central banks are doing, not just the Fed. The European Central Bank (ECB) is leaning to ease in June, as euro area inflation is slipping and growth is uncertain. Part of its tool kit includes purchases of euro area government bonds—this would be called a Quantitative Easing, in popular terms. With the euro crisis off the market radar now and PIIGS market access back, the ECB will become quite data dependent, like other major central banks. But if, as with the ECB, a central bank may be leaning toward buying something, some investors will try to get in ahead of it.
The global yield chase, stimulated by major central banks with near-zero policy rates, has helped the PIIGS to fly once again. Big bearish bets for U.S. Treasury yields to rise were wrong, not just because the U.S. had a cold and stormy winter, China slowed, the Ukraine boiled, and the Fed did not stumble in its message. It also had to do with global bond spreads. Given the shaky fiscal history of the PIIGS, investors would rely on the ECB to again step in and purchase debt if another debt crisis occurred. Central bank precedent is a powerful thing.
The global investor gives up a lot of yield to move from the U.S. T-note to the ten-year German Bund that yields 1.45% or the ten-year Japanese Government Bond at 0.60%. The wide yield gap between Treasuries and other advanced economy government bonds (the U.K. excepted) helped contain Treasury yields when stronger U.S. data came out. If we get a spring data rebound, paltry yields on other government bonds should help cushion a yield rise in the U.S.
1Portugal's bailout will officially expire on May 17 but the decision was made to not renew any support facilities.
Frequently Used Terms:
The shape of the yield curve summarizes the priorities of all lenders relative to a particular borrower (such as the U.S. Treasury). In general, lenders are concerned about a rising rates of inflation or a potential default, so they offer long-term loans for higher interest rates than they offer for shorter-term loans. When lenders are seeking long-term debt contracts more aggressively than short-term debt contracts, the yield curve inverts, and we see lower interest rates, or yields, for the longer periods of repayment so that lenders can attract long-term borrowing.
What is the "yield spread?"
Simply put, the yield spread is the difference in yield between two bonds. If one bond yields 4% and another bond yields 5%, the "yield spread" is 1%. Yield spread are typically expressed in basis points, where 100 basis points make up 1 percentage point. When the difference between two yields "widens" it increases, and when it "narrows" the difference decreases.
This commentary represents the opinions of the author as of May 9, 2014 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information. Calvert may have acted upon this research prior to or immediately following publication. In addition, accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.