Tuesday January 5

Stocks follow Monday’s losses with modest gains. The S&P500 gains 0.2% to 2,016 and the Dow Jones adds 0.06% to 17,159. Developments in China continued to drive markets. The Shanghai Composite fell nearly 3% before rallying to finish just 0.3% lower on the day. The rally came after the PBoC intervened with Rmb130bn to support prices, as well as reports of further intervention through government controlled funds in both stocks and the currency market. It is possible that the regulator may even extend bans that were set to expire this week. The extent of the measures that the PBoC is taking to support prices indicates the seriousness of the problem. China this year will continue to be burdened with heavy private debt, an economy that is dependent on investment, as well as industrial and manufacturing overcapacity. China’s ability to overcome these problems through reforms will be a major theme in 2016. In the US the ten year yield added 1 basis point to 2.25% and the dollar rose 0.7% against the euro to $1.0750. Also in the eurozone the CPI report was disappointing, showing that inflation increased just 0.2% from the previous year which was unchanged from the previous report. Brent oil fell 2.2% to $36.42 as markets appeared to not be impacted by the Saudi Arabia and Iran tension.

The PBoC is actively trying to put a stop to the stock market selloff, as the regulator reportedly intervenes to support the renminbi from capital outflows today. International investors are dissuaded from investing in China with the threat of the renminbi falling further. As a result the PBoC feels the need to support the renminbi to give the image of stability to reassure investors. The PBoC supported the currency with Rmb130bn ($19.2bn) in order to restore confidence. The regulator uses state run banks to buy renminbi and sell US dollars to accomplish this. The currency today went from Rmb6.5338 to 6.5199.

Puerto Rico pays some if its debt holders at the expense of others. The governor announces that the country will make a $300mm payment to the most senior debt holders, who own the constitutionally guaranteed general obligation bonds. This is disadvantageous to investors with weaker legal protections who fall lower on the creditor line of preference. The island plans to miss a $37mm payment on Puerto Rico Infrastructure Financing Authority bonds. This cold spark legal tension between junior bondholders and the commonwealth, and it pressures US Congress to somehow facilitate the process.

New risks are becoming apparent in emerging market debt. A recent study showed that corporate bonds are being offered with implicit backing from sovereign governments. This poses a problem because this debt doesn’t necessarily appear on the country’s balance sheet. As a result countries may carry higher debt levels and be on the hook for more than it may appear in the event of certain corporate defaults. $800bn in debt currently meets these characteristics. They are referred to as quasi-sovereign bonds and they are typically issued in hard currency. The use of such bonds keeps the official debt to GDP ratios low even though countries may be responsible for more debt. This issue could unwind as rates rise in the US, local currencies fall and commodity prices plummet, making it more difficult for certain issuers to make payments. Governments may not have the financial stability to meet this obligations if needed. The government guarantee allows companies to issue at lower borrowing costs.

The Riksbank may intervene to further weaken the Swedish krone. The central bank is struggling to reach its 2% inflation target the the strength of the krone is one of the reasons. The currency is up 5.75% against the euro over the last three months and currently stands at SKr9.25. The appreciation of the krone is in part caused by the ECB’s QE program, which weakens the euro at the expense of neighboring countries and trade partners such as Sweden. This continues the trend of competitive devaluations that have been popular over the last year. Analysts expect possible Riksbank intervention when the currency reaches between Skr9.00 and Skr9.10 against the euro. The Swedish economy is healthy but interest rates are already negative, household debt levels are high, and QE is already in place. This leaves the Riksbank with limited tools to spur inflation.

Tuesday January 5

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