Wednesday July 22

Stocks fall after weak earnings in spite of positive economic data. The S&P500 loses 0.2% to 2,114 while the Dow falls 0.4% to 17,851. Apple posted disappointing earnings results, and a 4% drop in their shares dragged down indices today. Housing data was positive. Existing home sales were expected to be 5.4MM in the previous period and came in at 5.49MM. This is a sign of the continued recovery in the housing market. Petroleum inventory rose, which brought down WTI prices and stocks for oil companies. This is a light data week, and markets are largely responding to earnings. 73% of the companies who have reported so far have beat earnings, while only 55% have topped revenues. The yield curve today flattened as the Fed gets closer to raising interest rates. The 2 year yield increased 2 basis points while the 10 year yield fell 1 basis point to 2.33%. The German bund yield fell to 0.74%.

Companies in the US are rushing to issue debt before the Fed raises interest rates. Similarly, companies in the EU are issuing debt in large quantities after the Greek crisis appears to be subsiding. Uncertainty in Europe is decreasing and now pent up deals are reaching the markets. This trend is expected to continue over the next few weeks on both sides of the Atlantic. In the US $88bn investment grade debt has been issued in July, and analysts predict this figure could reach $135bn. Year to date $1.1tn has been raised compared to just $1.0tn at this time last year. Some M&A activity has led to issuance by acquirers such as Shell, Halliburton, GE, and Pfizer. Demand is falling for bonds at these low levels, and supply is increasing which is conducive for spreads widening.

TD analysts expect the yield curve to flatten if the Fed raises rates in September. In 2004 when the Fed began its most recent tightening cycle, short term yields rose and longer term yields fell. In that year, three month yields rose 26 basis points, 1 year up 40 bp, 2 year up 35bp, 5 year up 10 bp, 10 year up 20 bp, and the 30 year fell 6 bp. These movements show that all across the yield curve shorter term yields rose by more than longer term yields as the spreads between long and short maturity securities fell. Currently, the spread between the 2 and 10 year Treasury is 160 bp steep. As the Fed gets closer to tightening this may decrease.

The CEO of PIMCO Douglas Hodge is not overly concerned with regards to bond illiquidity. Hodge says that capital and liquidity regulations companied with low returns lead to less market making. As a result rules have reduced liquidity and support in the market. This is expected to result in sharper price movements and higher volatility. Hodge acknowledges one view that this dynamic may cause another financial crisis. However he says from his observance he sees that there are buyers and sellers of bonds, only the transaction costs are higher. The cost of capital is higher for banks, which means they must be more selective about when to create liquidity. On the buy side, the ability to generate returns will become more due to the ability to manage liquidity risk.

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Wednesday July 22

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