After a phenomenal trading week for U.S. equity markets last week, the Dow, Nasdaq, and S&P 500 have traded in negative territory each of the last two days with yesterday’s action being particularly sloppy. As we have stated for a long time, markets don’t move in a straight line as investors lightened positions ahead of Fed Chairman Ben Bernanke’s Congressional testimony later today. Specifically, investors are waiting to hear Mr. Bernanke’s thoughts on the economy, with a particular emphasis on the outlook for monetary policy. Recall that Mr. Bernanke spooked markets last week with the decision to raise the discount rate. While everyone knew this was going to happen, not many expected it to happen so quickly. With the quantitative easing program (Fed’s mbs purchase program) set to expire in March, market participants seek clarity on the potential timing of further tightening and implementation of the Fed’s exit strategy. I would suspect that Mr. Bernanke will go out of his way to assure the markets that the decision to raise the discount rate in no way alters the outlook for monetary policy in the short-term. Specifically, I believe he will reiterate the outlook for easy monetary policy for an “extended period” as multiple headwinds remain embedded in the dubious outlook for a sustained economic recovery, despite the marked improvements already experienced.
Circling back to the sloppiness in equity markets, there could be another reason explaining its behavior over the past few days. Now that the snow has melted in D.C. and the politicians in Washington are back to “work,” if that is what they call it, political headwinds are resurfacing. It seems as though the markets like it much better when Washington is on hiatus so they can’t mess things up, which is why; perhaps, another winter storm is bearing down on the Mid-Atlantic and Northeast. It is remarkable that despite the clear message the American people have sent and are continuing to send, that the administration still wishes to pass healthcare legislation, even threatening reconciliation, otherwise known as the nuclear option, to ram it down our throats. Clearly healthcare reform, at some level, is necessary given skyrocketing costs, etc. However, forcing legislation that the majority of Americans don’t want questions everything that is good about our government and our country. As it relates to the markets, it seems to me that our government, on both sides of the aisle, must be cognizant of the issues surrounding Greece and the other debt laden countries in Europe. Continuing on our path to spend and spend and spend, it is only a matter of time before we are the next Greece.
On the treasury front, we mentioned Monday that the U.S. Treasury was set to auction a record amount of $126 billion in U.S. debt this week in order to support the spend happy policies in Washington. Yesterday, the $44 billion 2-year auction went extremely well with a bid to cover ratio of 3.33, higher than the average bid to cover ratio over the previous ten auctions. Despite the new issue treasury supply glut, global appetite remains insatiable as the U.S. continues to be the prettiest sow at an empty trough. Post auction yesterday, treasury yields move significantly lower across the curve. Keep an eye on today’s $42 billion five-year auction as well as Thursday’s $32 billion seven-year auction to see how well they go.
On the fixed income front, shorter corporates in the two to four year range are starting to look relatively attractive once again for shorter duration alternatives, as well as fairly priced cushion callables with one time calls. In addition, we continue to like taxable Build America Bonds across the curve on a selective basis.