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Bond markets reacted to the Argentina and Portugal debt crises

Phalguni Soni

Overview: US Treasuries saw pendulum shifts after the Fed’s FOMC (Part 2 of 10)

(Continued from Part 1)

Bond markets react to debt crises

On Thursday, July 31, Argentina failed to make sovereign debt payments and was officially in default. Portugal’s second-largest lender, Banco Espirito Santo (or BES), faced increasing uncertainty last week. Markets were concerned that BES would become entangled in the debt woes of a parent company, after a group company had missed a debt payment a few weeks ago.

U.S. investment-grade debt (AGG), including U.S. Treasuries (TBT) are considered some of the safest assets in the world. An increase in overseas geopolitical tensions and market risks, usually results in increasing their demand, raising prices, and lowering yields.

Last week, besides the Argentina and Portugal debt crises, there were geopolitical events that caused an investor flight to safe-haven Treasuries towards the end of the week. These included Middle East tensions in Gaza and Iraq, and the fallout from the MH17 plane crash in Ukraine, which resulted in international sanctions on Russia.

Impact of Friday’s releases 

The non-farm payrolls report, although revealing healthy growth in payrolls, saw the unemployment rate move unexpectedly higher to 6.2% in July from 6.1% in June. This was primarily due to more persons entering the labor force. Labor market slack in the economy, represented by an artificially low participation rate, is a fact that the Fed has repeatedly underlined .

This would also justify the Fed’s stance on keeping monetary policy accommodative—low interest rates—for an extended period. U.S. auto sales for July, U.S. construction spending, and the Fed’s favored measure of inflation or the Change in Personal Consumption Expenditure (or PCE) were released on Friday. Although they were disappointing, these indicators implied that the economic recovery may not be as robust as many investors believed.

Due to geopolitical risks and weak economic data, Treasury yields fell in the latter half of the week. Three-year Treasuries (CSJ) and five-year Treasuries fell the most over the period Wednesday to Friday, by ten basis points to end the week at 0.94% and 1.67%, respectively. Ten-year Treasuries and 30-year Treasuries (TLT) declined by five basis points and two basis points to end the week at 2.52% and 3.29%, respectively.

Geopolitical and market risk factors were also reflected in stock markets like the Dow Jones Industrial Average (DIA) which fell by 2.29% between Wednesday and Friday. This could also partly be attributed to a long-due market correction as U.S. stock markets have breached record after record in 2014. However, geopolitical and credit risk factors were also key in weighing down market sentiment.

Primary market activity

The U.S. Treasury held auctions for ~$199 billion worth of both coupon-paying and non-coupon paying debt securities in the primary market last week. These included Treasury bills, at $91 billion, as well as Treasury notes, at $108 billion. In the next section, you’ll find details of the five-year Treasury notes auction. Please continue reading the next section in this series.

Continue to Part 3

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