Fixed Income Weekly Review & Preview

Transcription

1 Fixed Income Weekly Review & Preview May 17, 2004 Fixed Income Research Joseph W. Jasper, CFA Director, Fixed Income Strategy & Marketing Private Client Research We believe the recent run up in rates and aggressive tightening built into futures and forward contracts has left the market oversold. With quarterly refunding supply behind us and no significant economic data points being released until month-end, we believe rates may trend lower temporarily. HIGHLIGHTS Treasuries The market appeared to run out of sellers last week in spite of upside surprises in both the PPI and CPI. Yields ended the week seven basis points lower in the front-end, and nearly unchanged in the long-end. TIPS We have been a month or so early in calling a top in TIPS outperformance. As we mentioned last week, we believe yield spreads will continue to expand on growing inflation fears and a lack of response from the Fed. Mortgages Mortgages saw heavy buying last week, helping to tighten spreads. Valuations are attractive on a number of measures. We continue to like the performance characteristics of mortgages in general, and higher coupon paper specifically. Corporates Spreads widened for a second straight week, following swap spreads. We reiterate our preference for economically sensitive credits. Municipals We believe the back up in mortgage rates will have positive implications for the municipal housing bond market. We discuss the attractive opportunities in both the single-family and multifamily sectors. Note: The next Fixed Income Weekly will be published on Tuesday, June 1 Piper Jaffray does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information, including an attestation under Regulation Analyst Certification, found on the back pages of this report or at the following site: Fixed Income Weekly Review Page 1 of 9 Piper Jaffray

2 YIELD, COMMODITY PRICE, CURRENCY, AND STOCK MARKET CHANGES FOR THE WEEK LAST WEEK PRIOR WEEK CHANGE (BP) 3 Month 0.99% 1.06% (7) 2 Year 2.54% 2.62% (8) 5 Year 3.91% 3.95% (4) 10 Year 4.78% 4.78% 0 30 Year 5.50% 5.47% 3 Curve 2s-10s Curve 2s-30s CRB (4.34) Crude Oil Gold (2.0) Yen Euro Wilshire ,794 10,794 0 Dow Jones Ind. Avg. 10,013 10,117 (104) NASDAQ Comp. 1,904 1,918 (14) Source: Bloomberg ECONOMIC HIGHLIGHTS Business inventories rose 0.7% in March, but more importantly sales surged 2.9% month over month suggesting that greater than expected demand is making it difficult for firms trying to rebuild inventories. The inventory/shipments ratio fell to 1.30, a record low. This is a big positive with broader macro implications including increased production and hiring as firms scramble to meet demand. Industrial production jumped 0.8% during April, the third consecutive monthly increase. Gains were broad-based across industry sectors, including manufacturing, up 0.7%. University of Michigan Consumer Sentiment was unchanged in May versus April. Consumers became equally more optimistic about the current state of the economy but more skeptical about the future. Initial jobless claims rose last week above consensus, to 331,000, though the four-week average dipped to another 3 ½ year low. Continuing claims rose 53,000 to million, but remain below the key 3 million mark. Producer prices rose 0.7% in April, higher than expected due to higher energy and food prices. Core prices rose 0.2% as expected. Meanwhile, inflation at early stages of production showed continued acceleration as prices for intermediate goods rose by 1.1%. Consumer prices rose 0.2% during April, and are up 2.3% year over year. Less food and energy, the core CPI rose by 0.3%, 0.1% higher than consensus expectations. Year over year, the core rate is now up 1.8% versus the 1.1% low seen in November. Fixed Income Weekly Review Page 2 of 9 Piper Jaffray

3 Retail sales fell 0.5% in April, but excluding autos, sales were down just 0.1%. LAST WEEK S ECONOMIC RELEASES DAY STATISTIC ACTUAL CONSENSUS ESTIMATE Wednesday Trade Balance -$42.7B -$46.0B Import Price Index 0.4% 0.2% Monthly Budget $40.0B $17.6B Thursday Producer Price Index 0.2% 0.7% Less: Food & Energy 0.6% 0.2% Advance Retail Sales 0.0% -0.5% Less: Autos 0.0% -0.1% Initial Jobless Claims 325, ,000 Continuing Claims 2,900,000 2,974,000 Friday Consumer Price Index 0.3% 0.2% Less: Food & Energy 0.2% 0.3% Business Inventories 0.5% 0.7% Industrial Production 0.5% 0.8% Capacity Utilization % U. Of Michigan Sentiment Source: Bloomberg THIS WEEK S ECONOMIC RELEASES DAY TIME STATISTIC CONSENSUS PREVIOUS (CDT) ESTIMATE Monday 7:30 Empire Manufacturing Tuesday 7:30 Building Permits 1,950,000 1,946,000 Thursday 7:30 Initial Jobless Claims 325, ,000 7:30 Continuing Claims -- 2,974,000 9:00 Leading Indicators 0.2% 0.3% 11:00 Philadelphia Fed Source: Bloomberg FIXED INCOME STRATEGY Macro Themes With rates at their highest levels since August 2003 and the Fed still on the sidelines, we believe the rate markets have gotten ahead of themselves in pricing in downside risk. Supply pressures from the Treasury s quarterly refunding are now behind us. There is little in the way of significant economic data out until the last week of May. Against this backdrop, we believe the market may be entering a short-term period of consolidation. The recent month-long back-up in rates has been impressive, with ten-year yields up over one point. Futures trading and forward rates across the curve are also pricing in an aggressive Fed tightening campaign. Trading in Fed Funds imply a 25 basis point tightening at each of the FOMC meetings over the balance of the year. In addition, Fixed Income Weekly Review Page 3 of 9 Piper Jaffray

4 five-year forward rates are trading around 6.50%, fully 2% north of current spot levels. Trading in the Treasury market last week is supportive of our notion that investors are starting to take note of the new, cheaper valuations. Selling seemed to reach a near-term capitulation on Friday despite higher-than-expected prints for both PPI and CPI. Rates ended the week only marginally higher than what prevailed after last Friday s payroll report. Be advised, however, that any near-term correction or bargain hunting is likely to give way to additional selling pressure as the Fed commences its tightening campaign. We continue to expect the first rate hike to be administered at the conclusion of the Fed s June FOMC meeting. With this in mind, we would use periods of price strength to continue to reposition portfolios to more defensive postures. GRAPH 1 HISTORICAL TREASURY SLOPE Off-the-runs On-the-runs 1.0 Swap Yields 0.5 STRIPS Source: Bloomberg, Piper Jaffray Treasuries The Treasury completed its quarterly refunding, issuing a total of $54 billion in coupon securities ($24 billion three-year notes, $15 billion five-year notes, and $15 billion 10s). On balance, the auctions had solid demand, with each note being awarded at below-market yields. Participation from indirect bidders (read foreign central banks) also held up, easing concerns that foreign demand would evaporate. TIPS TIPS had an impressive week, rallying as nominals sold off, and sending breakevens 11 basis points wider, to all-time highs across the real curve. We acknowledge that Fixed Income Weekly Review Page 4 of 9 Piper Jaffray

5 we have been a month or so early in calling a top in TIPS valuations. As we mentioned last week, breakevens have additional room to expand as long as inflation fears mount and the Fed remains sidelined. With the Fed not likely to move until its June meeting at the earliest, TIPS could continue to be a source of outperformance relative to nominals. One factor continuing to support TIPS is the spike in oil prices. Oil continued its rally last week, as crude futures closed at $40.77/bbl, the highest close since futures began trading in GRAPH 2 10-YEAR TIPS BREAKEVEN YIELD VS. SPOT CRUDE PRICE Spot Oil (in $) Yr TIPS BE Yields /2/99 2/2/00 12/2/00 10/2/01 8/2/02 6/2/03 4/2/04 Crude Oil Generic 10-Yr TIPs Source: Bloomberg, Piper Jaffray Mortgages Spreads tightened last week amid heavy buying. Mortgages had cheapened considerably over the past month, and now appear reasonably attractive on a number of valuation measures. We continue to like the up in coupon trade, given slowing prepayments and the more defensive characteristics of higher coupon passthroughs. Refi Index / Mortgage Applications The Mortgage Bankers Association s index of mortgage applications fell 5.0% to The purchase index increased 2.4% to The refinancing index fell 13.2% to Corporates Corporate spreads continue to trade directionally with Treasuries, widening on backups and tightening during rallies. On the week, spreads moved out several basis points. Over the near term, we expect declining rate volatility to provide a supportive tone for credit spreads. We continue to recommend overweights in industrial cyclicals. Fixed Income Weekly Review Page 5 of 9 Piper Jaffray

6 AMG reported that investors withdrew $2.1 billion from high yield mutual funds last week, the second largest outflow over the past ten years. In tobacco news, Moody's affirmed the ratings and maintained the outlooks of companies with tobacco subsidiaries operating in the U.S., following Wednesday's decision by the Florida Supreme Court to hear the Engle class action suit later this year. The ratings action affirmed Altria (Baa2/P-3), RJR (B2), Loews (Baa1), and BAT (Baa1). GRAPH 3 MOODY S BAA CORPORATE BOND SPREADS 'Baa' Rated 'A' Rated 'AAA' Rated 0 Jan- 99 Sep- 99 May- 00 Jan- 01 Sep- 01 May- 02 Jan- 03 Sep- 03 May- 04 Source: Bloomberg, Piper Jaffray Municipals The back up in rates and continued improvement in economic fundamentals is creating a perfect environment for municipal housing bond outperformance. Single family municipal housing bonds (SFMHB), for example, are benefiting from the dramatic decline in prepayment activity. In general, housing bonds outperform in flat and rising interest rate environments given their above average yields. However we suggest that the current environment presents a decent opportunity to position premium SFMHBs due to the lengthening of premium amortizations. We may still see one final period of elevated prepays, because semiannual redemption periods produce a significant lag in response to interest rate movements. Going forward, we believe prepays should approach historical norms. Also bear in mind that SFMHBs have prepayment characteristics akin to GNMAs, which are consistently slower than conventionals. While we believe SFMHBs are appropriately valued, multi-family municipal housing bonds (MFMHB) continue to trade at cheap levels. We believe MFMHBs will also benefit indirectly from the back up in mortgage rates. As mortgage rates have risen over the past several weeks, the increased interest burden makes home ownership less affordable. This in turn should help to stabilize apartment occupancy rates which have been hit hard over the past two years. Ultimately increased occupancy will improve the credit profiles of issuers projects. Fixed Income Weekly Review Page 6 of 9 Piper Jaffray

7 A final source of the current cheap valuations is the narrowing of the traditional investor base for AMT bonds, of which many housing bonds are generally subject. The growing number of American tax payers subject to AMT has led to a bifurcation in spreads in this sector, where AMT bonds have continued to cheapen relative to non-amt bonds. Again we believe this creates a decent opportunity for investors not subject to the tax to capture incremental yield in the neighborhood of basis points. MUNICIPAL CONSENSUS YIELD CHANGES FOR THE WEEK MUNICIPAL CHANGE % TO TREASURY YIELD (BP) LAST WEEK PREVIOUS WK 5-YEAR AVG. 2 Year % 76.3% 77.1% 5 Year % 79.5% 80.4% 10 Year % 87.0% 85.4% 30 Year % 94.0% 94.3% Source: Municipal Market Advisors CORPORATE MARKET DETAIL CORPORATE RATINGS CHANGES ISSUER RATINGS ACTION RATING TO FROM MOODY S / S&P Baxter International Inc. Baa1 A3 Baa1/A- Delta Air Lines Inc. Negative Stable B2/B- GATX Financial Corp Stable Negative Baa3/BBB- Halliburton Company Stable Positive Baa2/BBB J.B Hunt Transport Services Inc. BBB+ BBB Baa3/BBB+ Juniper Generation, LLC Ba3 B1 Ba3/BBB- MasTec Inc. CCC+ B B2/CCC+ Monsanto Co. A- A Baa1/A- Nat l Commerce Financial Corp Watch Positive -- A2/A Nextel Partners Inc. B- CCC+ Caa1/B- Northern Trust Corp. Stable Negative Aa3/AA- Pactiv Corporation Positive Stable Baa2/BBB Principal Life Insurance Co. Rev. for Upgrd -- Aa3/AA Safeway Inc. Negative Stable Baa2/BBB Seacor Holdings Inc. Stable Positive Baa3/BBB Tesoro Petroleum Corp Positive Stable Ba3/BB Trico Marine Services Inc. C CCC- Ca/C UnumProvident Corporation Ba1 Baa3 Ba1/BB+ *: CreditWatch Developing *-: Review for Downgrade/CreditWatch Negative *+: Review for Upgrade/CreditWatch Positive SELECTED NEW ISSUES FROM LAST WEEK Fixed Income Weekly Review Page 7 of 9 Piper Jaffray

8 ISSUER COUPON MATURITY SPREAD AMT. RATING (BP) (MM) MOODY S S&P ALPHA NATURAL RESOURCES 10 6/1/ B3 CCC+ ASSURED GUARANTY LTD 7 6/1/ NA NA BAYVIEW RES CTR FIN TRST /15/ NA AAA MONUMENTAL GLOBAL FDG /19/2006 NA 300 Aa3 AA GEO SUB CORP 11 5/15/ Caa1 B- DA-LITE SCREEN CO INC 9.5 5/15/2011 NA 160 B2 B- UNION ELECTRIC CO 5.5 5/15/ A1 A- PIXELWORKS INC /15/2024 NA 125 NA NA CV THERAPEUTICS /16/2012 NA 125 NA NA ELECTRONIC DATA SYSTEMS /17/ Baa3 BBB- THOMSON CORPORATION /28/ A3 A- MILACRON ESCROW CORP /15/ Caa1 CCC+ LAZYDAYS RV CENTER INC /15/ B3 B- AINSWORTH LUMBER /15/ B1 B+ BUFFETS INC 0 12/15/ NA NA PPL CAPITAL FUNDING INC 0 5/18/2006 NA 99 Baa3 BBB- BRINKER INTERNATIONAL /1/ Baa2 BBB CNSLDTED CONTAINDER CO 0 6/15/ B3 CCC ENCANA HLDINGS FIN CORP 5.8 5/1/ Baa1 A- DUQUESNE LIGHT CO 5.7 5/15/ Baa1 BBB+ CENDANT CORP /17/ Baa1 BBB Source: Bloomberg New Preferred Issues ISSUER COUPON MATURITY AMT. (MM) RATINGS MOODY S S&P REALTY INCOME CORP NA 400 Baa3 BBB- CONSECO INC 5.5 5/15/ NA NA CAPITAL CROSSING PFD CAP 8.5 NA 150 NA NA ALBERTSON'S INC /16/ Baa2 BBB Fixed Income Weekly Review Page 8 of 9 Piper Jaffray

9 Analyst Certification Joseph W. Jasper, CFA The views expressed in this report, including the Key Points and Risk sections in particular, accurately reflect my personal views about the subject Company and the subject security. In addition, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report. Research Disclosures The following disclosures apply to stocks mentioned in this report if and as indicated: (#) Piper Jaffray was making a market in the Company s securities at the time this research report was published. Piper Jaffray will buy and sell the Company s securities on a principal basis. (^) A Piper Jaffray analyst who follows this Company or a member of the analyst s household has a financial interest (a long equity position) in the Company s securities. (@) Within the past 12 months, Piper Jaffray was a managing underwriter of an offering of, or dealer manager of a tender offer for, the Company s securities or the securities of an affiliate. (>) Piper Jaffray has either received compensation for investment banking services from the Company within the past 12 months or expects to receive or intends to seek compensation within the next three months for investment banking services. (~) A Piper Jaffray analyst who follows this Company, a member of the analyst s household, a Piper Jaffray officer, director, or other Piper Jaffray employee is a director and/or officer of the Company. (+) Piper Jaffray and its affiliates, in aggregate, beneficially own 1% or more of a class of common equity securities of the subject Company. Disclaimer Piper Jaffray research analysts receive compensation that is, in part, based on revenues of Piper Jaffray Equities & Investment Banking which include overall investment banking revenues. Piper Jaffray research analysts who follow this Company report to the Head of Investment Research who, in turn, reports directly to the Chief Executive Officer of Piper Jaffray. This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may not be eligible for solicitation in the states in which the client resides. Officers or employees of affiliates of Piper Jaffray & Co., or members of their families, may have a beneficial interest in the Company's securities and may purchase or sell such positions in the open market or otherwise. Notice to customers in the United Kingdom: This report is a communication made in the United Kingdom by Piper Jaffray & Co. to market counterparties or intermediate customers and is exclusively directed at such persons; it is not directed at private customers and any investment or services to which the communication may relate will not be available to private customers. In the United Kingdom, no persons other than a market counterparty or an intermediate customer should read or rely on any of the information in this communication. Securities products and services offered through Piper Jaffray & Co., member SIPC and NYSE, Inc., a subsidiary of Piper Jaffray Companies. Additional information is available upon request. No part of this report may be reproduced, copied, redistributed or posted without the prior consent of Piper Jaffray & Co Piper Jaffray & Co., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota Fixed Income Weekly Review Page 9 of 9 Piper Jaffray