Monday March 30: Economic Data Supports Markets

Stocks rise on economic data and dovish central bank expectations. The S&P adds 1.2% to 2,086 while the Dow adds 1.5% to 17,978. Home sales in February rose more than forecast, and incomes rise 0.4% versus the expectation of 0.3%. Following these positive economic numbers, Treasury yields increase across the yield curve with the 10 year rising 1 bp to 1.96%. The dollar index adds 0.75%, supported by an appreciation against the euro to $1.0811. To complement the dollar’s appreciation, gold falls. The VIX also falls to 14.51. Dovish comments from China’s central bank also contributed to the bullish attitude across markets today, as comments suggest that it may do more to boost investment and growth to combat disinflation through rate cuts and asset purchases.

U.S. corporate bonds have proved to be an attractive investment this year. With government bonds, commodities, and equities all reflecting weak returns so far in 2015, U.S. corporates have on average returned around 3% after the first quarter. This is partially due to an increase in demand from international investors, caused by low or negative yields in international developed fixed income markets. Currently investment grade bonds yield around 3%, with high yields at only 6.2% on average. Although these are low levels, these markets are the best alternative for many investors. One main concern for fixed income investors relates to oil markets. 17% of the $1.3T high yield market is in some way exposed to fluctuations in oil prices. High yield energy bonds lost 10.6% in 4Q as oil prices plummeted, however they have gained 1.8% this quarter as prices seemed to have stabilized this year.

A group of finance industry professionals commissioned by the NY Fed expressed concern over potential volatility in bond markets. Automated electronic trading platforms and increased regulation amplify these risks and could lead to large changes in yields on any given day. Due to increased regulation, banks are much less willing to make markets for certain assets, and they are less likely to buy and hold these risky assets in volatile conditions. These dynamics could lead to a liquidity risk in fixed income markets.

Many bond traders are becoming skeptical, in part due to their reliance on accomodative monetary policy for positive returns. Unorthodox monetary policy has contributed to above average returns in bond markets, and a sudden change in policy could lead to a large sell-off. The negative affects of this sell-off would be magnified by the lack of liquidity mentioned earlier. The idea of a “policy error,” traders mispricing the Fed, or not interpreting guidance correctly could have huge implications to markets and potentially the economy. A large increase in interest rates could spill over into other assets, such as equities.

The Brazilian real has depreciated 20% against the dollar this year and is expected to fall further due to a weakening economy, political scandal and subsequent social unrest. Petrobas, the state-owned oil company, is under investigation relating to directors working with politicians in order to get bribes. The effect of the depreciation on commodity markets is apparent, as prices for coffee and sugar (Brazil is the largest producer for both) have fallen significantly. In many commodities markets, the product or material is priced in dollars. As a result, the weakened real makes Brazilian exports much cheaper. To reflect this dynamic, Brazilian exports have increased, and the increase in supply has depressed prices. Prices for coffee and sugar have fallen 16% and 17% respectively so far this year.

Monday March 30: Economic Data Supports Markets

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