Credit indices improved along with stocks this week. Markit’s current 5-year investment grade CDS index improved 3 basis points to 93 bps, but we are still 8 bps off of the strongest levels of the current cycle reached in early November. Issues in Europe are driving the credit markets more than domestic economic data. The global flight to quality has come with a vengeance each time European problems pop up, and this most recent time was no different. The dollar index rallied 4.3% between 11/22 and 11/30, before falling back down to 79.2 after the risk trade became favorable again this week.

TIPS have leveled out after a very strong third quarter. 10-year breakevens have settled in at 210-220 bps, and seem content to track nominal Treasury’s for the time being. The inflation trade that gained a lot of traction in the run-up to QE2 has died down considerably and inflation expectations have settled much closer to the long-term average, compared to this summer when TIPS Breakevens bottomed at 1.51%.

QE2 Progress

The first group of operations announced on November 10 is almost complete. The initial announcement was for $105 billion by December 9, and the QE2 tally currently sits at $87.5 billion with the final four operations coming next week.

When QE2 was announced, the FOMC stressed their flexibility in regards to the final size of the buying program. In light of the strong economic data this week, some began to begin talking about the possibility of the $600 billion program being reduced.

Bernanke put a stop to that sort of thinking at a business school forum at Ohio State University on Wednesday by stressing the that the current level of growth is not enough to materially reduce the unemployment rate. It’s certainly not the first time the Chairman has stressed how important this portion of the data is to the FOMC, but it seems every time the market gets a hint that quantitative easing will be slowed the Fed reemphasizes its commitment to monetary stimulus. Today’s poor job’s data, should reassure the market that the Fed’s commitment to QE is strong, and if the Fed takes advantage of the flexibility it gave itself, it will only be used to make the program larger.

Have a great weekend.