Stocks fall slightly after continued Greek concerns and U.S. economic data. The S&P falls 0.08% to 2,105 while the Dow loses 0.04% to 18,105. In Greece, talks with creditors show little potential for an agreement. According to reports the Greek government asked the IMF for an extension on an upcoming payment, which was delcined. As a result greek bond yields spike with the July 2017 bond yielding 26.92%. The bund yield falls to 0.085% which reflects both ECB bond buying and haven inflows as a result of Greek news. In the U.S. jobless claims show 294k claims compared to the anticipated 280k, and housing starts also miss estimates. As a result of this weak economic data, the U.S. dollar depreciates continuing the recent trend of easing dollar strength as a result of recent economic data. The 10 year U.S. bond yield falls flat to 1.89%.
Greek bond prices fall as yields increase dramatically following a sharp selloff. Credit default swaps indicate a 79% chance of default within 5 years. The German finance minister expresses doubt about Greece being able to secure funding and meet their obligations. Officials recently told creditors they may run out of funds before making a payment to the IMF in May. Greece reportedly asked for an extension on this payment, however the IMF declined. As a result S&P downgrades Greek sovereign debt to CCC+ from B-. Greece’s yield curve is sharply inverted, with July 2017 bonds yielding 26.89% (up 281 bp today) and the ten year yielding 13.2%. In the event of a default or financial catastrophe, European banks have less exposure to the Greek economy compared to 2011.
Wall Street financial stocks post strong 1Q results. Goldman Sachs posted positive return on equity, profits, and higher trading and investment banking revenues relative to the period since the financial crisis. As a result Goldman’s stock is trading near a price that was last seen before the financial crisis, partly due to the 40% increase in net income from last year. Citi and JP Morgan also post better than expected net income, and JP Morgan’s stock rises to the highest level in 15 years. These trends show that banks are in the process of making a full recovery from the financial crisis. Many industry observers wonder whether or not the industry’s recent struggles over the past several years have been due to cyclical or structural problems. Cyclical factors are temporary, and are related to low volatilities and economic weakness that have been present in recent years. Structural factors are more permanent, and relate to increased regulation after the crisis. The upward momentum in the finance industry points towards evidence that the problems financial companies have seen in recent years have been due to cyclical factors.
Dennis Lockhart of the Fed disagrees with an IMF report that was made this week. The IMF expressed concern that traders are underestimating Fed rate hikes, and that the Fed’s expectations are not adequately priced in. As a result the markets could be shocked when the Fed does finally lift rates. The IMF is referring to the market for Fed funds futures, which reflect expectations for the lift off a little later than the Fed’s dot plot. The IMF this gap could be dangerous for markets. On the contrary, Lockhart believes this difference between the dot plot and traders expectations is due to different dynamics and factors between the two gauges. The dot plot reflects what the what Fed officials believe will be the most appropriate interest rates in the future. Fed funds futures reflect what traders believe rates will actually be. Lockhart argues that these two are not the same, nor should they be. The difference is due to uncertainty in the markets, and the gap would be smaller if the Fed definitively said they were on a steady track to raise rates by a certain point.
CLO’s in the form of U.S. junk rated loans are being securitized and sold in Japan. This dymanic proposes a win–win for both Japanese investors and U.S. issuers. It provides yield starved investors in Japan with exposure to some return. As a result of increasing monetary stimulus in the form of government bond purchases, yields in Japan are at 0.3% for 10 year government debt. In addition it provides demand for junk rated loans from U.S. companies, which will bring down borrowing costs. Loans denominated in U.S. dollars are being securitized and sold to investors in yen, and derivatives are used to eliminate any currency risk. Corporate default rates are currently low by historical standards, and Japanese investors believe that U.S. loans are the best alternative for yield in the current global environment.