Stocks fall as investors take profits ahead of earnings season in addition to uncertainty regarding Greece and monetary policy in the United States. The S&P 500 lost 0.9% to 2,067 and the Dow falls 1.1% to 17,776. Today’s movements finish the first quarter, with the S&P showing a 0.4% gain for the last three months. Uncertainty relating to Greece and its creditors returned to plague markets, after discussions ended between the two parties with no positive outcomes. One economist says that markets are underpricing the potential Grexit and the possibility for a contagion in other eurozone countries. As a result, the euro depreciates to $1.0747, the bund yield falls 2bp to 0.19%, and Greek yields rise. The dollar index adds 0.5% contributing to concern heading into earnings season next week. Many companies and analysts have made downward revisions to earnings forecasts as a result of the stronger dollar. In commodities markets, gold and oil both fall. U.S. bond yields fall, with the 10 year losing 3 bp to 1.93%. Jeffrey Lacker, President of the Richmond Fed states that rates should be raised in June, citing the strong labor market, improved consumer spending, and increasing inflation expectations. Lacker is a voting member of the Fed, and he typically lies on the hawkish side of the spectrum.
In both the U.S. and Europe, five year forward inflation rates have been increasing in recent months. This could reflect that traders have faith in unorthodox monetary policy to support the economy. The 5 year forward rate increased to 1.9% and 1.7% in the U.S. and eurozone respectively. The U.S. numbers are significant since the Fed takes into account medium term expectations when looking at inflation. Expectations have shifted higher due to monetary stimulus measures around the world, such as asset purchasing programs in Europe and Japan. In addition, low interest rates, and rapid job creation in the U.S. and U.K. support the idea that inflation will increase in the future. In addition, oil prices seem to have stabilized which supports the idea that inflation will pick up. However, upward movements in the dollar could scale back these expectations. Typically a 20% appreciation in the U.S. dollar will result in a 1% drop in the consumer price index.
Foreign currency reserves in many emerging markets fell in 2014 for the first time in twenty years. This drop is partially due to capital outflows and uncertainty regarding U.S. monetary policy and potential rate hikes. Falling foreign currency reserves in emerging markets could hurt the U.S. and other developed markets, as emerging market central banks are major buyers of developed market government debt. In this way, developed countries have been able to finance their growth through issuing debt that was largely bought by emerging market countries.
Increased regulation in the U.S. is affecting private equity firms and banks both domestic and foreign. Regulators are aiming to prevent banks from underwriting private equity loans of more than 6x the EBITDA of the target company. Leveraged loan issuance in the U.S. fell to $119B in 1Q 2015 from $295B last year at this time. European markets have seen a similar decline, however not as dramatic. With a cheap currency and low interest rates, Europe could be an attractive place for private equity firms and investments. However U.S. regulators aim to inhibit risky lending overseas, saying that the location is irrelevant as long as U.S. banks are taking part. In addition, even if foreign banks are leading the deal, they may be subject to U.S. regulation since American investors would be buying the debt. European regulators take a different view, with the BoE saying that “At present no action is necessary to mitigate risks in this market.”
Many new hedge fund startups have been able to raise significant amounts of money following poor performance from well-known, established funds such as Paulson & Co. and Carlyle’s hedge fund division. Over the past 4 years, hedge funds have gained only 4.6% annually, compared to an 18% gain in the S&P500. This shortcoming has shifted investors towards new hedge funds, some of whom have been able to raise $1B+.