Monday November 23

Stocks ease back slightly to start the week after last week’s gains. The S&P500 fell 0.2% to 2,086 while the Dow Jones lost 0.2% to 17,792. Today’s losses may be attributed to sentiment ahead of the Fed rate hike as the dollar index continued to rise. Similarly commodity prices fell heavily with the strengthening dollar as well as fears about China. Copper, aluminum, iron ore, gold, and nickel all fell to test multi-year lows. Expectations for a rate hike were augmented by a statement by John Williams over the weekend that he sees a “strong case” for beginning the tightening cycle in December. Conversely Margio Draghi said recently that the ECB will “do what we must to raise inflation as quickly as possible.” Moves in markets adjusted to reflect these sentiments. The US two year yield gained 1 basis point to 0.93% while the German two year fell to -0.39%. The euro also fell 0.1% to $1.0634 against the US dollar. The US yield curve flattened as the ten year yield fell to 2.25%.

John Williams of the San Francisco Fed suggests that he is ready to lift interest rates as early as December at the 12/15 and 12/16 FOMC meetings. According to Williams, as long as economic indicators continue to show support and an improving economy then he appears to be in favor of a December rate hike. Williams said that the decision not to raise interest rates in October was a close decision among FOMC members. Since that point economic data has strengthened which may indicate that the decision to raise interest rates will be more clear now. Williams validated this trend by saying “the hiccup we saw in the couple labor reports has reversed… we’re seeing other signs the economy’s on a good track.” These statements reflect the idea that recent data will help the Fed be “reasonably confident” that inflation will rise toward 2%. Williams is a voting member of the FOMC and is typically on the dovish end of the spectrum.

Corporate defaults on debt around the world are approaching a record high. 99 companies have defalted on obligations year to date, with 62 of those defaults coming from US corporations. The only year in which there were more defaults was in 2009 when the Financial crisis led to 222 defaults throughout the year. Companies have utilized low interest rates over the last few years and borrowed heavily to invest and finance operations. This led to speculative grade borrowers taking advantage of low interest, and over the past eight years the percent of junk-rated issuers has risen from 40% to 50%. Now that rates are set to rise and commodity prices are putting a great deal of pressure on many issuers, defaults are starting to tick up. Around 60 of the 99 defaults have come from energy companies so far. At the start of 2014 junk bonds on average yielded 5.6% however now that yield has risen to 8% reflecting a decrease in prices as investors shift into higher quality debt. Similarly 19 of the defaults have come from emerging markets, 13 from Europe, and the rest coming from other developed markets.

With interest rates set to rise in the US, issuers are shifting their attention towards the European debt market attracted by enticingly low borrowing costs. Issuance has risen to 249bn euro this year which has in part been driven by M&A activity. Similarly the duration on issued bonds is increasing as companies are trying to lock in record low interest rates for an extended period of time.

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Monday November 23

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