Stocks reverse yesterdays losses and the correlation between equities and oil continues. The S&P500 rose 1.4% to 1,904 and the Dow Jones added 1.8% to 16,167. Contributing to the gains in equities today were oil prices. Brent rose 4.3% to $31.80 and WTI rose 3.2% to $31.31. According to Reuters the 20 day correlation between oil prices and the S&P500 has reached more than 95% which is significantly above the long term average. Equity markets were able to shrug off steep losses in Chinese stocks which breaks with the recent trend between these two markets. The VIX fell to 22.55. The Fed meets this week to discuss monetary policy, and it is largely expected that the FOMC will come across with a dovish statement given the current environment and imminent easing from the ECB and potentially the BoJ. The yield curve lowered in preparation for the FOMC statement tomorrow. The two year yield fell 3 basis points to 0.84% as investors prepared for the Fed to issue a dovish statement. The ten year yield similarly lost 2 basis points to 2.01%. The dollar rose 0.1% against the yen to Y118.39, lost 0.1% against the euro to $1.0858, and lost 0.8% against the pound to $1.4356 resulting in a 0.3% decline for the dollar index to 99.05.
The Fed’s credibility may be questioned in the next few months. Many analysts are expecting that the Fed will not raise interest rates in the current market environment. By delaying further increases in interest rates critics will question whether or not they should have raised rates at all in the first place. This further increases the challenges that Janet Yellen and the FOMC face in addition to deflationary pressures. If the Fed materially changes its statement and forward guidance this week the FOMC’s ability to forecast and successfully execute its monetary policy goals will be critiqued. In spite of these pressures, with China’s economy reeling, oil prices plummeting, stock markets falling in the US, the Fed will be very hesitant rates to maintain its tightening cycle.
Puerto Rico will continue to meet with bondholders regarding how to handle and restructure the island’s $70bn+ pile of debt. Puerto Rico has struggled to reach agreements with bondholders in recent weeks and it is also in the process of trying to secure some form of assistance from the US government. A deal that was struck last month between Puerto Rico and its creditors expired and $37mm of payments on Prepa bonds were missed in January. So far Puerto Rico has been reluctant to approve a deal in a hurry with creditors since it is hoping to get assistance from the US. By rushing into a deal with creditors, which include hedge funds and asset managers, Puerto Rico may miss out on assistance and therefore pay more in a restructuring deal then they would otherwise.
Given high debt burdens of Chinese companies and unfavorable economic conditions in the country analysts are expecting a wave of corporate defaults in the country. Chinese companies have a total of $15tn in debt outstanding, which is an very large figure especially considering the economic struggles facing the country. S&P has predicted that defaults will increase to a record this year as 15% of the Chinese companies it monitors on watch and a ratings analyst said that even in the last four weeks credit conditions have materially worsened. This time last year Fitch considered 7.4% of the Chinese companies it rates were on watch for a downgrade, and how that figure has nearly doubled to 12%. The amount of corporate debt outstanding is equivalent to 145% of GDP and it’s clear that if a large enough number of companies begin to default then a financial crisis may be triggered in the country. As a result analysts believe that the Chinese government will go out of its way to prevent this from happening. Nevertheless some increase in the amount of defaults is inevitable and the government may allow the most indebted companies in the most negatively affected sectors to default.