Wednesday May 20

Stocks fall slightly after the FOMC minutes. The S&P loses 0.1% to 2,125 and the Dow falls marginally to 18,285. Treasury prices rise and yields fall which reflects the idea that the Fed will keep rates low for longer. The minutes showed the Fed’s data dependency as the central doesn’t expect to raise rates in June following the recent weak data. In the minutes which were recorded in late April, members of the Fed believed that the poor data reflected “transitory factors” and they still expected moderate growth. Since then, data has been further mixed. Treasury yields fall with the two year losing 2 bp to 0.59% and the ten year yield finishes at 2.26%. The dollar index appreciates 0.3% with the euro falling to $1.11 and the yen falling to Y121.22 (yen per dollar). Downward pressure on the euro comes from the ECB headline and the expectation that Greece will be unable to make its June 5 €300M payment to the IMF without further aid.

The FOMC minutes from the April 28 and 29 meetings show members of the Fed second guessing the strength of the economic recovery. Bad data reduces the odds of a rate hike in June, however members still have conflicting views as to when interest rates should rise. At the time of the minutes some still thought June, however they are outnumbered by those who thought the bad data should push back the timing. Members of the Fed expressed that the strong dollar and cuts to oil related investment could put downward pressure on the economy for long. Even though the dollar has lost momentum in the last month, it is still significantly higher than one year ago. The Fed expects inflation to pick up in the coming months supported by employment gains and oil price stabilization.

More monetary easing from the Bank of Japan is expected. The Yen has traded in a tight range of Y118 and Y120 (yen per dollar) for the last three months. Analysts expect the currency to depreciate to Y125 by the end of the year. Japanese equities have been an attractive investment for foreign investors as a result of the stability of the yen, however this may shift. “Abenomics” or monetary stimulus to spur inflation has depreciated the yen from Y75 in 2010. Further downward pressure on the yen comes from capital outflows in the form of Japanese pension funds and insurance companies buying foreign assets.

The credit default swap market is experiencing a revival. Single name CDS is an insurance contract that tracks the risk of default on specific bonds. Over the past several years investors have bought bonds and ridden the momentum from the Fed and QE. Now there are fears that a lack of liquidity could be a problem if investors sell at once when interest rates rise. CDS allow investors to gain exposure without directly buying or selling the bond. According to one hedge fund manager buying or selling large quantities of bonds takes three times longer than ten years ago. As a result the CDS liquidity is a beneficial alternative for fixed income investors.

Wednesday May 20

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