Fixed-Income Market Commentary Archive

Key Points:
• Greece's borrowing costs rise to a prohibitive level
• Goldman Execs Go to Washington
• Our index review box shows positive returns across the board

"Great is the country that controls the sea" is the motto of the Hellenic (Greek) Navy. That may be the case, but currently Greece finds its financial sea and future being controlled by the mercy of others who are willing (or not) to lend it some cold hard cash. For weeks there has been speculation over the size of an aid package that would be needed to save the country from its failed fiscal policies, and now it has come in at ~ $146B. The European Union and the International Monetary Fund will essentially bail out the nation with loans. Greece needs this support because yield levels on its debt have risen to such levels that it makes it next to impossible to finance its needs even if they could raise new money in the capital markets and buyers could be found.

The rout began in the bond market where the yield on Greece's sovereign debt maturing in about two years reached almost 19% intra-day on April 28^th before closing the month at 12.6% (for anyone with access to a Bloomberg terminal, this can be found by typing GGB 4.30 12 govt giy<go>). To put this yield level into perspective, consider that back in September 2009, the yield on this bond was ~ 2.07%. Bond market vigilantes are out in full force and in the end, it is their opinions that matter most – like it or not.

The reason for the “improvement” from 19% down to 12% was news that the German government, recognizing the threat of contagion as borrowing costs for other Mediterranean rim and EU countries soared, became willing to lend its support. As of the time this report was written, Germany, the region's biggest economy, was on board and conditionally behind an aid package.

This sovereign debt crisis began long before Standard &Poor's recent downgrade (BB+) of Greece's debt rating to below investment grade status. As far as I can tell this Greek tragedy has many of its roots seeded in an overly generous pension system that is becoming divisive as Greece is totally dependent upon the charity of its EU neighbors that have more responsible pension plans. The unpleasant alternative is default, which still remains a possibility down the road.

As part of the aid package agreement Greece will be forced to make some big changes to the way it runs its financial affairs. Part of that includes raising the sales tax to 23% as well as the restructuring of its pension system. There is internal strife as Greek citizens come to grips with austerity measures and economic contraction that will result, but this is what eventually happens when government spending gets too big and out of balance. Investors become focused on the increasing size of deficits and the ability to repay debt.

This is not a diatribe against Greece, it just happens to be the country in the spotlight today. I hope that other developed economies around the globe are paying close attention – especially in the United States where our government spending and deficits are rising quickly.

As far as market impact is concerned, the result from Greece's problems can be seen in lower bond yields for US Treasuries as the flight-to-quality phenomenon plays out. Investors waiting for higher US bond yields could be in for a longer wait than they had anticipated. When it comes to Greece's EU neighbors, their borrowing costs are rising. Spain, whose debt rating was recently lowered to “AA” by S&P, as well as Portugal, are now seeing investor concern about the size of their deficits. The market is worried about who the next “Greece” will be.

The other big story of the month extends far beyond the bond market, but the bond market is where the roots of the story developed. Goldman Sachs finds itself on the hot seat and executives of the firm traveled to Washington for public hearings. They discussed, among other items, a trade the firm brokered involving a complex and high dollar value specialized product that is far beyond the reach of individual investors. This was a transaction among sophisticated institutional investors that have teams of individuals working on their behalf to review, measure and understand the risks involved. Anyone who thinks otherwise probably does not have all the facts or does not have an understanding of the way the trades work.

I am not saying that Goldman can do no wrong or that the firm has done no wrong, but I do not see the political circus that occurred at the end of the month as anything other than grandstanding by elected officials eager to get on TV. This may sound cynical, but I believe that once any serious matter gets to the level of televised public hearings before Senate or Congressional committees, then a level of sincerity has been lost or sacrificed in the name of politics. The charges were serious enough as civil charges and are now even more serious as a criminal investigation begins. Goldman should defend their actions in the right forum, rather than being chided by Washington for their success.

I stated in the past that our financial markets should be braced for an intensified level of government regulation after the credit crisis of 2008. The events in Washington with Goldman have taken us a step closer in my opinion. The stage is being set.

Market review: The Treasury market performed well in April and both nominal and inflation linked treasuries benefited. 10-year TIPS break-evens are now at 2.40% - above the longer- term historical average of 2.05%, indicating that they are more fully valued at these levels. Once again, the High Yield market continues to put up good numbers in both the primary index and in the higher risk component of that market. The low volatility cycle for this asset class continues and our favorable outlook remains intact. The Municipal Bond market performed well as new issue supply was low in April at ~ $26B. By way of comparison, I saw a statistic that suggests that redemptions (bonds maturing or being called) in the month of May will approach $50B.

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