Thursday, 11 February 2010

Fixed income investor risk - not only about the Greek tragedy

Much attention is currently focused on the meeting taking place in Brussels today (Thursday February 11th) of heads of state of the EU countries regarding the "Greek situation". The EU is between a rock and a hard place, and apart from the obvious discomfort being felt by German politicians especially about how to sell a rescue package to the German voters, there are additional strands in the debate that will pose more awkwardness. For example will Gordon Brown acting on behalf of the UK, which is a member of the EU but not of the Eurozone, be asked to contribute to loan guarantees, for example, for distressed states who do share the euro currency? If so, how easy will it be for him to sidestep that?

Also there is a danger that with all of the attention being centered on the plight of the euro two other noteworthy developments are creating ripples which could quickly turn into turbulence for the credit markets. The first relates to Bernanke's written remarks which surfaced yesterday which amount to the first articulation of the Fed's exit strategy. The second relates to the fact, as reported by Ambrose Evans-Pritchard in this article , that Chinese authorities are instructing their asset purchasers to be more diligent in avoiding the riskier sovereign and corporate debt instruments. Both of these developments are starting to have an effect on the bond and fixed income markets as suggested in some of the charts discussed below.

The yield on the US Treasury note of ten year duration along with shorter term maturities are moving forward and as the chart suggests it would be good to monitor follow through from the piercing of the triangular formation as well as a break above the clouds.

One further factor to contemplate is that seeking out assets in the US Treasury complex may still be the preferred safe harbor of choice, but if all debt instruments are becoming subject to a higher risk premium, along with the Fed's intention to begin removing liquidity, even those fleeing to quality may need a higher return to keep funds in these instruments over the longer term.

Investment grade corporate bonds were showing considerable weakness yesterday as the chart for the sector fund LQD reveals. Price has notably dropped below the cloud but may find support at the level indicated but clearly the volume chart is pointing to a gathering exodus from this sector.

Investors also are exiting high yield debt - as represented by the HYG sector fund - which was one of the best performing asset classes in the latter half of 2009.

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