Tuesday December 15

Stocks rise for the second consecutive day as rising oil prices contribute to positive sentiment in markets. The S&P500 gained 1.1% to 2,043 while the Dow Jones gained 0.9% to 17,524. Markets are expecting an increase to the Fed funds rate tomorrow as the Fed funds futures market is reflecting an 80% chance of a 25 basis point hike. Data today showed that core inflation (which excludes food and energy prices) rose to reflect 2% annual inflation, which the Fed will view as favorable when deciding whether or not to raise rates. Oil prices rose today which contributed to positive sentiment in stocks. Brent rose 1.4% to $38.45 while WTI rose 2.3% to $37.13. The US dollar gained after the inflation data rising 0.7% to $1.0913 against the euro and 0.6% to Y121.69 against the yen. The dollar index rose to 98.26 which put downward pressure on gold. Yields rose for the second straight day this week with the two year gaining two basis points to 0.97% and the ten year rising 5 basis points to 2.27%. The German bund yield moved in accordance with US yields rising 7 basis points to 0.63%.

No matter how well the Fed communicates its changing policy and no matter how well markets have priced in higher rates, there remains a great deal of uncertainty regarding the outcome of the Fed’s decision and subsequent action. Markets are vastly different now than in previous tightening cycles as it relates to regulations and current market trends and conditions. From a technical standpoint the Fed will raise interest rates by increasing the overnight interest rate that it pays banks on funds held at the Fed, as well as raising the rate it pays banks on repo transactions. The Fed uses reverse repos to let financial institutions hold Treasuries overnight with the agreement to buy them back the next day at a higher price. This represents a reverse repo from the perspective of the bank and a repo from the perspective of the Fed. By raising these rates, rates across other types of loans and debt instruments will also rise. However the repo market in particular is drastically different in recent years as a result of regulatory restrictions. In addition the unprecedented extent of the liquidity that the Fed pumped into the system through QE may mean that the central bank will have to extensively use these two mechanisms to guide rates into their target range.

Mark Carney of the Bank of England is standing by his most recent policy announcement and subsequent guidance that interest rates in the UK will not rise in the near future. Until recently the BoE was expected to raise rates in tandem with the Fed however sluggish inflation in England altered those plans. Carney subsequently said that rates may not rise until 2017. He is facing criticism that he did too much to telegraph a rate rise by the end of 2015 before changing tone and drastically altering his guidance. Carney defended his actions by saying that conditions changed and the economy and trends did not develop in the way that he expected at the time of his optimistic forward guidance. Inflation in the UK is currently at 0.1% annually compared to the 2% target.

South Korea issued Rmb3bn ($464mm) in debt in China’s markets. The issuance is being dubbed a “panda” bond which is a renminbi-denominated debt issued by a foreign entity in China’s markets. This further reflects China’s efforts to become a more international capital market as it relates to fixed income through allowing issuances and investments from foreigners. China’s on shore markets are $6tn in size which places them third behind the US and Japan. Up until recently international issuers and investors were kept out of this market and instead participated in the offshore market which is known as “dim sum” market. China is now opening up the onshore capital market to international companies, which is reflected through the Rmb7bn that has been raised by companies so far this year in comparison to just Rmb6bn sold in the previous ten years combined. South Korea’s issuance is the first sovereign issuance in the onshore market. The offering was five times oversubscribed which reflects high demand for these types of issuances. The South Korean government’s issuance paves the way for South Korean companies to raise capital in China going forward as it will serve as a benchmark for South Korena companies in those markets.

Tuesday December 15

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