With two weeks left in August, the global bond market has already delivered its biggest monthly loss since 2010 as reports from unemployment to consumer purchases suggest the worldwide economy is stronger than investors anticipated.
From government to corporate to mortgage securities, fixed-income assets have declined 0.64 percent this month, the worst performance since a 1.09 percent loss in November 2010, according to the Bank of America Merrill Lynch Global Broad Market Index. At the same time, global stocks returned 2.9 percent, including reinvested dividends.
Bonds are losing value after retail sales and jobs gained more than forecast, and Germany and France slowed less than economists estimated. Goldman Sachs Group Inc. says the Federal Reserve will now likely wait until late this year or early 2013 rather than September to add more stimulus by purchasing bonds in a policy known as quantitative easing, or QE.
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"It's just much less likely that the Fed can justify doing QE," Hans Mikkelsen, a high-grade credit strategist at Bank of America Corp. in New York, said in a telephone interview. An improving economy is giving investors less cause to seek a haven in bonds, he said.
While junk bonds have returned 0.84 percent this month, government and investment-grade debt both have declined about 0.7 percent, separate Bank of America Merrill Lynch indexes show.
"The market was looking for the end of the world, looking for the Fed to extend QE," said Thomas Roth, a senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. "The better numbers, and no bad news out of Europe, has put that story on hold. People are being forced out of positions that they may have put on at not-so-great levels," he said.
The global economy is still facing headwinds. Morgan Stanley lowered its 2012 global growth forecast this week as scheduled spending cuts in the U.S., Europe's sovereign-debt crisis and "accumulating evidence for the breakdown of the traditional growth models" of emerging markets threaten to curb expansion.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. fell to the lowest level in more than three months. Rio Tinto Group sold $3 billion of bonds in its second offering this year. The market for corporate borrowing through commercial paper rose for the fifth time in six weeks.
Rate Swaps
The U.S. two-year interest-rate swap spread, a guage of debt market stress, was little changed at 20.5 basis points. The measure narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, declined 2 basis points to a mid-price of 101.2 basis points, according to prices compiled by Bloomberg. That's the biggest drop since Aug. 3 and the lowest level since May 8.
The cost of insuring corporate and sovereign bonds in Asia against non-payment declined, with the Market ITraxx Asia index falling 2 basis points to 149. The index touched 147 basis points on Aug. 9, its lowest since March 19, according to data provider CMA.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 0.5 at 144.5 at 10:13 a.m. in London.
Both indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds of Rio Tinto were the most actively traded dollar- denominated corporate securities by dealers, with 141 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The offering by the world's third-largest mining company was split between $1.25 billion of 1.625 percent, five-year notes that yield 93 basis points more than similar-maturity Treasuries, $1 billion of 2.875 percent, 10-year debt at a spread of 120 basis points and $750 million of 4.125 percent, 30-year bonds at 135 basis points, according to data compiled by Bloomberg.
Rio Tinto last sold debt in March with a $2.5 billion, four-part offering, including $1 billion of 3.5 percent, 10-year debentures at a relative yield of 120 basis points, Bloomberg data show.
Commercial Paper
The seasonally adjusted amount of U.S. commercial paper outstanding climbed $6.7 billion to $1.02 trillion in the week ended Aug. 15, the Fed said on its website. Issuance increased after dropping $20.8 billion in the prior period, according to Fed data compiled by Bloomberg. The market has climbed from this year's low of $925.6 billion as of March 7.
Corporations sell commercial paper, typically maturing in 270 days or less, to fund everyday activities such as rent and salaries.
The Standard & Poor's/LSTA U.S. Leveraged Loan 100 index rose for the ninth time in 10 days, increasing 0.06 cent to 94.82 cents on the dollar, the highest since June 7, 2011. The measure, which tracks the 100 largest dollar-denominated first- lien leveraged loans, has climbed from 91.8 on June 5, the lowest since Jan. 6.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody's Investors Service and lower than BBB- by S&P.
In emerging markets, relative yields narrowed 3 basis points to 310 basis points, or 3.1 percentage points, according to JPMorgan Chase & Co.'s EMBI Global index. The measure has averaged 371.2 basis points this year.
Losses in bonds this month have trimmed gains this year to 3.51 percent, following 2011 returns of 5.9 percent, according to the Bank of America Merrill Lynch Global Broad Market index, which tracks about 20,000 securities with a market value of almost $44 trillion.
The declines are led by German bunds, which have lost 1.79 percent, U.K. government securities, off 1.55 percent, and Treasuries, down 1.58 percent, Bank of America Merrill Lynch index data show. In contrast, the MSCI All Country World Index has returned 2.9 percent and in the U.S., the S&P 500 stock index gained 2.4 percent.
Jobs Report
The selloff in bonds was triggered by a jobs report in the U.S. on Aug. 3, showing employers added more workers than forecast in July, easing concern the three-year expansion is faltering.
Employment increased by 163,000 last month, helped by a pickup at automakers and health-care providers, after a revised 64,000 June advance, Labor Department data showed. The median estimate of 89 economists surveyed by Bloomberg called for a rise of 100,000.
The jobless rate, based on a separate survey of households, climbed to 8.3 percent.
Retail sales by auto dealers to department stores rose 0.8 more in July, the biggest since February and first gain in four months, according to Commerce Department figures released on Aug. 14.
"The likelihood of a significant September QE3 measure has clearly dissipated," David Rolley, vice president of the global fixed-income group at Loomis Sayles & Co., who co-manages $32 billion, said in a telephone interview.
That's helped to increase interest rates as investors abandon bets that the Fed would act in the near term to boost an economy that expanded at a 1.5 percent pace last quarter, according to Martin Fridson, global credit strategist at BNP Paribas Investment Partners in New York.
"There was quite a bit of QE3 expectation built in," Fridson, based in New York, said in a telephone interview. "A lot of speculators really were counting on that, and now they've headed for the hills."
The central bank didn't announce further action to boost the economy at its Aug. 1 meeting after saying growth will "remain moderate" for an economy that's had an unemployment rate of more than 8 percent for 42 months.
"While QE3 at the Sept. 12-13 Federal Open Market Committee meeting remains possible, our best estimate is that it will take until late 2012, early 2013 before Fed officials return to balance-sheet expansion," Jan Hatzius, chief economist at Goldman Sachs in New York, wrote in an Aug. 14 report. "Our own view remains that there is a very solid case for additional accommodation under the Fed's dual mandate of maximum employment and 2 percent inflation."
'Twilight Zone'
The U.S. is confronting a contraction in spending of about 5 percent of gross domestic product if policy makers don't resolve scheduled tax increases and government spending cuts, Morgan Stanley economists led by Joachim Fels wrote in an Aug. 15 report.
"The global economy has sunk deeper into the twilight zone that divides sustainable recovery from renewed recession," Fels wrote in the report, which cut the New York-based bank's 2012 global growth forecast to 3.2 percent from 3.7 percent.
European Central Bank President Mario Draghi's pledge in July "to do whatever it takes to preserve the euro" has buoyed investor confidence, said Mark Cernicky, a managing director of fixed-income at Des Moines, Iowa-based Principal Global Investors, which oversees $72.2 billion.
"Even though we didn't see anything definitive a couple weeks ago, the mere fact that the ECB is willing to commit additional resources has been a positive," Cernicky said in a telephone interview.
The German and French economies, the two-largest in the euro region, slowed less than forecast in the second quarter. Germany's expansion was driven by consumption and trade with exports rising more than imports. In France, company and government spending helped the economy avoid contraction.
With yields still at almost record lows, a 12.5 basis-point increase is prompting bigger losses with duration, a measure of securities' price sensitivity to yield changes, reaching a record high this month. Bonds worldwide lost 0.5 percent in December 2010 as yields rose 18 basis points.
Average modified duration on the Bank of America Merrill Lynch Global Broad Market Index reached an unprecedented 5.9 years on Aug. 2. The measure was 5.5 a year ago.
"Investors are starting to have this bubble feeling," Rajeev Sharma, a money manager who helps oversee $1.5 billion of high-grade debt at First Investors Management Co. in New York, said in a telephone interview. "It just takes a move, like we've seen in August, to hurt some of these long-duration funds out there."
Bloomberg News
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