Tuesday December 1

Stocks start off the month on a strong note in spite of economic data. The S&P500 gained 1.1% to 2,102 while the Dow Jones gained 1% to 17,888. Economic data today showed that the ISM manufacturing index fell to 48.6 reflecting contraction in the manufacturing sector. Consensus estimates had previously called for a reading of 50.5. Weakness in manufacturing is being driven by poor global demand and low commodity prices. The dollar slid back against the euro to $1.0634 as a result of the weak data ahead of the ECB meeting on Thursday. Also contributing to upward momentum in the euro was manufacturing and employment data from that region beating expectations. Futures markets continue to price in a 74% chance of tightening this month ahead of Yellen’s speeches later this week. Treasury yields fell with the two year yield down 3 basis points to 0.91% and the ten year down 7 basis points to 2.15%. Commodity prices such as gold and copper rebounded slightly partly as a result of the dollar’s decrease.

Brazil continues to suffer with GDP contracting by 4.5% from the previous year in the third quarter. Low commodity prices and high interest rates are just two of the many problems that the economy is facing. In the quarter the economy shrank 1.7% and second quarter readings were both revised downward. Corruption is also taking its toll on political and corporate sentiment as the Petrobas scandal continues to spread, now including the former CEO of BTG Pactual. Unemployment is continuing to rise now approaching 8% while inflation has broken above 10%. The primary deficit now stands at 9.5% of GDP, something which may lead to further credit downgrades from ratings agencies especially Moody’s which still holds the country as investment grade. Analyst revisions for 2015 GDP contraction continues to be downgraded. In addition to the multitude of domestic problems foreign headwinds such as China also will continue to weigh on growth.

Puerto Rico was able to make a $350mm payment on principal and interest which means that the island has still been able to avoid a default on its debt. The Government Development Bank (GDB) used tactics such as delaying tax returns to find the money to be able to make these payments. These methods are unsustainable and the island will still need additional support in order to manage its $72bn debt pile. GDB 2019 bonds drew some support from the payment with the prices rising to nearly 28 cents on the dollar from 26 cents the previous day. At the beginning of the year they were priced at 63 cents to par. Larger payments are due on January 1, and analysts still expect a default in the months ahead. The Obama administration has proposed a plan to possibly allow the island to gain access to US bankruptcy courts, as well as implement financial controls on the island in order to help them weather the storm.

Treasury yields fall as investors price in the trajectory of rate increases. Weak economic data today further supports the idea that once rates do rise (potentially this month) subsequent increases will be small and gradual. The manufacturing data today is not expected to deter the Fed from raising this month in part since the service sector is a much larger component of the economy and those industries are doing very well currently. Yet investors believe the trajectory will be very shallow which put buying pressure on bonds today. The yield curve flattened with the spread between the ten and two year falling to 125 basis points. While the yield curve has inverted in the past during periods of monetary tightening this is not expected to happen this round since the rate trajectory will be so shallow.

Tuesday December 1

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