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By Rom Badilla, CFA and Maulik Mody – Bondsquawk.com

Treasuries continued to lead a rally in government bonds and stocks slumped on a second day after the Fed decided to start another round of quantitative easing, increasing concerns that the economic recovery is wobbling. The Dow Jones index slid 265 points, losing more than 2.5% today as the two year reached a new low in intra-day trading.

Economic Data

The trade deficit widened for the fourth consecutive month on a jump in imports of consumer goods from China, signaling weaker economic growth for the U.S.  The Department of Commerce revealed that the U.S. Trade Balance for June totaled a deficit of $49.9 billion from a revised prior period gap of $42.0 billion.  The widening was driven by both a 1.3 percent fall in exports and a 3.0 percent increase in imports.  The June number disappointed the market as economists forecasted a negative trade balance of $42.1 billion.

Since January of 2010, the trade gap has widened 42 percent suggesting that economic activity during that period was weaker than originally thought.  Imported goods from China and Mexico highlight much of the activity as the numbers reveal.  Year to date, the trade balance with China totaled a deficit of $119.5 billion, a year over year increase of nearly 16 percent.  Similarly, trade with Mexico reflects a negative balance of$33.1 billion for an increase of 56 percent from a year ago.

In addition, the Mortgage Bankers Association released its weekly applications index.  For the week ending August 6, mortgage applications increased by only 0.6 percent from a prior period increase of 1.3 percent.  This anemic numbers partially coincides with stagnant mortgage rates, which influences demand for home purchases and mortgage refinancings.

According to Bankrate.com, the 30 Year Conventional National Average Rate was unchanged at 4.56 percent from the prior week.  Interestingly and given that interest rates are generally correlated, the 10-Year U.S. Treasury dropped 9 basis points to 2.82 percent during the same time-period.

Interest Rates

As fears about the economic recovery gripped the markets, investors flocked to Treasuries, sending the 10-Yr yield to a record low of 2.68%, pushing it down 8 basis points from yesterday. The 2-Yr slipped by a basis point to 0.51% as the belly of the curve slumped slightly more, with the 5-Yr shedding 2 basis points to 1.43%. The Long Bond rallied the most as yields plummeted 9 basis points since yesterday to 3.92%.

The Fed agreeing to that the economy needs stimulus to sustain the recovery has sparked fears of disinflation. Inflation expectations, as indicated by the yield differential between 10-Yr Treasury and TIPS, narrowed 8 basis points to 1.73%.

Across the Atlantic, most government bonds gained, pushing yields down as concerns about the U.S. recovery stuttering hit the markets. Germany’s 5-Year Bunds slipped 12 basis points to 1.37%. The French 5-Year declined 9 basis points to 1.68%. 5-Year U.K. Gilts gained the most, as yields fell 12 basis points to 1.84%.

Across the peripherals, yields were mixed. Portugal’s 5-Year rallied 9 basis points up to 3.93%. Ireland’s 5-Year bonds gained 10 basis points to 4.27%, whereas Italy’s 5-Year ended 5 basis points lower at 2.64%. Greece’s 5-Year bonds finished 10 basis points above yesterday’s close, at 10.83% as Spain’s 5-Year shed 3 basis points to 2.92%.

Credit Markets

For performance of high grade corporate bonds, check today’s ITB Corporate Bond Indices.

The BofA Merrill Lynch U.S. High Yield Mater Index rallied as its spread widened 28 basis points to 6.78% over Treasuries with comparable maturities.

The difference in yield between 30-Year Conventional Mortgage Backed Securities and the 10-Year Treasury widened 8 basis points to 0.75%.

Across the Capital Markets

Stocks may have rallied yesterday to recover some of their losses, but markets fell today on growing concerns of a slowdown in recovery. The S&P lost 2.82% or 31.59 points to 1089.47. NASDAQ shed 3.01% to close at 2208.63%. The CBOE VIX index, that reflects a measure of the future volatility, gained 13.5% to 25.39.

The Dollar Index, which measures the value of the dollar by comparing it to 6 major currencies of the world, rallied to 82.52, up more than 2% from yesterday. The Euro declined considerably against the green back, losing 2.4% to the dollar to 1.2863. The cable (Britain Pound) lost 1.2% to end at 1.5659.

Gold spot price fell half a percentage point, slipping below 1200 to 1198.10.