Stocks fall ahead of the start of earnings season and Wednesday’s Fed minutes. The S&P falls 0.21% to 2,076 while the Dow falls 0.03% to 17,875. The dollar index increases 1.22% as the dollar appreciates to $1.0822. Possibly contributing to the upward movement in the dollar was the JOLTS report, which showed that job openings are at a post-recession high. It’s possible that positive economic data led to speculation that the Fed will raise rates, which led to demand for the dollar. Also contributing to this idea was the flattening of the yield curve. The 2 year yield rose 2bp to 0.52% while the 10 year fell 2 bp to 1.88%. To contrast these movements, Atlanta Fed President Dennis Lockhart says that he thinks the Fed should delay rate hikes for the next two meetings. Lockhart is a voting member who is typically dovish. In addition, Narayama Kocherlakota of the Minneapolis Fed says that raising rates in 2015 would be a mistake. Kocherlakota is a non-voting member of the Fed and he is notoriously dovish. In global currency markets, the Australian dollar appreciates against the dollar to $0.7638 after the central bank defies expectations and does not cut interest rates.
The first month of quantitative easing in Europe resulted in e52.5B of government bond purchases. Of this total, 11.1B came from Germany, 8.75B came from France, and 7.6B came from Italy. The ECB purchased bonds from all member countries except Greece and Cyprus. This raises the question as to whether or not the ECB can use QE as leverage over Greece in convincing them to accept bailout terms. Although the program has gone smoothly so far, potential problems could arise with a lack of supply for government bonds. Some analysts have expressed concerns that issuance may not be able to keep up with the ECBs purchasing demand, which would result in a scarcity and the ECB wouldn’t be able to meet their goals. The ECB has targeted the middle of the yield curve, with the average maturities for their purchases in the 6 to 11 year range.
As a result of Europe’s QE, two thirds of outstanding corporate bonds in the region currently yield lower than 1%. Negative yields in government debt have pushed investors to corporates in the search for yield. It’s possible that investors are not being properly compensated for the risks they are taking. One half of European bonds rated BB yield less than 2%. As a result of these astoundingly low borrowing costs, companies may be willing to issue more debt and invest more. Consequently, debt issuance in the region has jumped 41% over the last year. In particular high yield issuance is up 73% as riskier companies seek to capitalize on lower rates. Due to the high level of investor demand, companies have been able to issue longer maturity debt.
Similarly in the United States, yield hungry investors are increasingly turning to high yield energy bonds. As a result of low yields on corporate and government debt, investors are accepting more risk for less yield than they would normally otherwise. High yield energy bonds on average yield 8.8% compared with more than 10% in December. By comparison the Barclay’s high yield index currently yields 6.6%. As a result of low borrowing costs in the energy industry, some private equity firms have seen an opportunity to invest by issuing debt at low rates. However investing in these companies and their bonds is risky, as energy companies (especially the ones that issue junk bonds) are expected to continue to struggle. According to Deutsche Bank analysts, the longer oil stays at current levels, the more problems at energy firms will compound.
The finance industry is skeptical of Rand Paul’s proposal to audit the Fed. His proposals would make interest rates and quantitative easing policies subject to political control and a formal revision process. Executives in the industry want to prevent the Fed and monetary policy from political pressure. However they are skeptical to speak out at the Republican party, as many fear that it could negatively affect the attempts to reverse aspects of Dodd-Frank. Rand Paul’s proposals are unlikely to materialize, as Obama has stated that he would veto any policy that limits the Fed’s independence.