Monday April 27: Stocks Fall Ahead of Fed Meeting

Stocks fall after weak biotech earnings ahead of Fed meetings this week. The S&P loses 0.4% to 2,108 while the Dow falls 0.2% to 18,037. Mylan falls after rejecting a $40B takeover offer, and an index of biotechnology stocks falls 4.1% after weaker than expected earnings. Markets will closely watch the Fed’s meetings this week. Eric Rosengren from the Boston Fed, who is a non voting member who typically falls on the dovish end of the spectrum, says that markets are not ready for an interest rate increase. Economic data this week is expected to show that GDP is expected to grow at a 2.8% annualized rate, in addition to the monthly employment report on Friday. Statements from the Fed are expected to have more of an impact on markets compared to the GDP report, as GDP is largely considered to be a lagging indicator. An auction of 2 year Treasury bonds saw relatively soft demand. The bonds sold at a discount with a yield of 0.54% and a coupon of 0.5%. The bid/ cover of 3.3 was lower than that of the last auction, which saw a bid/cover of 3.46. In addition, dealers took down 47% of the issuance which is higher than recent offerings. The 10 year yield holds flat at 1.92%. The dollar drifts downwards 0.2% against peers ahead of this week’s data, and the euro appreciates slightly to $1.0886 after a change to Greece’s negotiating team.

The uncertain situation in Greece has raised yields in peripheral eurozone countries. Yields in Italy, Spain, and Portugal have all edged higher in recent months despite quantitative easing by the ECB that started in early March. Although yields have increased in the periphery, the increases in borrowing costs have been less than those during the 2012 Greek crisis. This reflects the idea that exposure to Greece and the possibility for contagion is less. Some analysts say that the increases in yields are partially due to increases in debt issuance from these countries. JP Morgan sees a 50% chance of a Greek default in some way, as a result of high “event risk.” A partial default on Greek debt would create volatile markets in the eurozone in the weeks and months ahead. German bonds may appreciate in price as investors look to the bund as a haven asset as uncertainty and volatility increase.

Greek finance minister Yannis Varoufakis has been removed from the negotiations with creditors. This development comes after months of litlte to no progress with Varoufakis leading negotiations. Meetings ended poorly last week. Eurozone officials support the decision by Tsipras, as they have encouraged him to become more involved in the negotiation process in recent weeks. Tsipras also removed a member of the negotiation team who was appointed by Varoufakis. Varoufakis was unpopular with the negotiators for creditors, and he was considered to be a large impediment to any deal between the two parties. With Varoufakis in charge of the negotiations, visiting teams from the EU and IMF were only allowed to receive documents and emails at their hotel rooms, which is likely because Varoufakis wanted to delay talks. Markets react positively to this development. The July 2017 Greek bond yield fell 4 percentage points (400bps) to 21% and the 10 year fell 1 percentage point to 11.4%.

Gauges for U.S. inflation expectations have reached a high for the current calendar year, partially due to oil prices stabilizing. The breakeven rate is the difference between normal Treasury bond yields and the yields on TIPS bonds of equal maturities. Therefore, the breakeven rate is essentially equal to the inflation premium that investors pay for. The 10 year inflation rate reached a 1.53% low in January, but has risen to 1.92% which is the highest level since November. The 5 year breakeven rate is at the highest since September, and the 2 year is at the highest since July. These movements follow last Friday’s core inflation report which showed a 1.8% annualized core inflation rate. Economists expect wages to increase in the months ahead, and Friday’s personal income report will be closely watched. Some analysts expect that if inflation picks up, bond markets will not be prepared for the subsequent tightening from the Fed.

Monday April 27: Stocks Fall Ahead of Fed Meeting

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