Tuesday January 19

Stocks rise marginally in spite of stronger gains earlier in the day. The S&P500 rose 0.1% to 1,881 and the Dow Jones gained 0.2% to 16,016. It was a volatile session, as the S&P opened upwards from 1,880 reaching as high as 1,901 before falling to 1,864 and then finishing the day marginally higher. China’s economic data slightly missed expectations across the board and GDP reflected 6.9% annualized growth in the fourth quarter. Although the data was not good, it was slightly reassuring as for now China is avoiding a hard landing. Brent oil rose 0.7% to $28.76 while WTI fell 3.3% to $28.46 as oil market sentiment is being plagued by Iranian oil hitting the market. Disinflation is persistent in China, which may lead to more accomodative action from the ECB, the BoE, and the Fed. The BoE governor says that the UK economy cannot currently withstand rate rises, and as a result the pound fell to $1.4131 as investors expect that rates will not rise until 2017. The 10 year US yield touched as high as 2.09% before finishing up 2 basis points at 2.05%. The dollar rose against the yen 0.2% to Y117.59 and gold prices fell as haven assets sold off.

Investors fear that debt levels in emerging markets have reached such a high level that going forward may be a large headwind on global growth. Many emerging market corporations have borrowed heavily in recent years, and given market conditions these companies face challenges and strained finances going forward. As a result interest rates on this debt are rising as investors anticipate a large wave of corporate downgrades from rating agencies. In a sign of risk aversion, according to the IIF nearly $500bn flowed out of emerging market assets last year. The threat remains as to how the financial system in developed markets is linked to emerging market debt. Foreign banks have lent heavily to emerging markets and foreign investors are large holders of this debt. Yields have risen across the board, and according to a BAML index of emerging market corporate bonds excluding financials the yield has risen from 5.5% to 7.2% in the last six months. Christine Lagarde has repeatedly warned about this problem, and the hope is that countries have increased foreign reserves in preparation for capital outflows.

Inflation in the United States remains elusive in spite of the fact that the Fed was willing to raise interest rates last month. James Bullard of the St. Louis Fed last week said that inflation conditions were “becoming worrisome” and since then conditions have worsened. Oil prices are plummeting seemingly without bottom, and interest rates have fallen indicating that investors are not overly concerned about inflationary pressures. The 10 year breakeven rate recently touched 1.39% compared to a six year low of 1.38%. The 5y5y forward inflation rate (which measures what five year inflation expectations will be five years in the future) touched 1.95% compared to the record low of 1.92% and the average of 2.84%. Last month the Fed indicated that investors should expect four rate hikes this year, but given market expectations that seems very unlikely.

European debt markets have been experiencing a selloff into little liquidity which has resulted in a dramatic increase in credit spreads. The investment grade credit spread reached a level not seen in three years when the sovereign debt crisis was at its peak. The fact that credit spreads have remained above 1.5% has concerned some investors pointing out that typically this level is not reached except in times of high stress such as the financial crisis in 2008. In the US market these signs of stress are for the most part only evident in the high yield market which is concentrated into energy issuers. Going back to Europe, this environment will result in higher borrowing costs for companies and a large decrease in issuances.

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Tuesday January 19

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