Updated: 08-31-2015

After dealing with concerns that a slowdown in China and other emerging markets could cripple the global economy, economic sentiment quickly reversed course. Accordingly, equities and commodities posted big rallies at the end of the week.

There was nothing in the U.S. or European economic data that warranted the sudden fear of a global recession. At the same time, there was nothing in the economic data last week either that would lead one to believe that economic growth trends were suddenly accelerating.

Instead, the shift in demand for risk assets seemed predicated on outside exogenous circumstances. For one, a rally in Chinese equities seemed to be caused by Chinese government interference instead of an improvement in the economic numbers. A statement by New York Fed President Dudley that tacitly acknowledged that a September rate hike was becoming more unlikely also had a positive impact.

8/28/2015 8/21/2015 Change
Fed Fund Futures Rate Prediction Dec. 2015 (55.9%) Dec. 2015 (59.9%) ---
10yr Treasury - 2yr Treasury 147 bps 141 bps 6 bps
High Yield - 10yr Treasury 543 bps 564 bps -21 bps
Corp A - 10 yr Treasury 136 bps 138 bps -2 bps
10 yr Bund - 10 yr Treasury -149 bps -148 bps -1 bps
5yr, 5yr Forward Inflation Breakeven 1.99% 1.92% 7 bps

Treasury yields ripped back and forth over the past couple of weeks as buyers quickly rushed into -- and then rushed out of -- safety. The 10-year Treasury yield closed the week up 14 basis points (bps) to 2.19%. While that is still below its trading range from mid-July - when the market started pricing in the idea that a rate hike could occur as early as September - it represents more normalcy in the Treasury market.

The reality is that U.S. growth trends have not changed over the past several weeks, and the economy remains on an upbeat path.

The 2/10-year yield spread steepened by six basis points to 147 bps.

Spot crude prices jumped 11.8% over the last week and closed at $45.22 per barrel. That was the highest closing price since the first week of August. The increase in energy prices drove down the risk-premium on high yield debt by 21 bps.

The spread on investment-grade assets was more or less unchanged despite the general increase in demand for risk assets. Without changes in the underlying economic data, the market failed to price in any changes to the risk premium.

 

German and U.S. official government bonds yields both jumped as risk-on assets found a rebound footing. The 10-year German bund yield increased 13 bps to 0.70%, and the spread-to-Treasuries fell by a very modest one basis point.

After reaching its lowest point since May 2009, the five-year, five-year forward inflation breakeven increased 7 bps. Inflation expectations are at the low end of the December-July trading range.


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