Tuesday March 8

Stocks fall as economic data out of China ends the five day rally. The S&P500 fell 1.1% to 1,979 and the Dow Jones fell 0.6% to 16,964. Haven assets rallied as investors eased back on risk. Economic data in China showed that imports fell 13.8% for the 12 months ended in February which coming off the back of a heavy drop for January. Additionally data showed that exports fell 25.4% which is significantly worse than what was estimated. This reflects weakening output from China as well as falling demand for its exports, and represents an overall slowdown in the region. Oil prices fell with brent losing 2.9% to $39.65 and WTI falling 4.2% to $36.30. Government bond yields also fell, with the 10 year Treasury losing 7 basis points to 1.83% and the German bund losing 4 basis points to 0.18%. The Japanese yen gained against the dollar rising 0.8% to Y112.57.

Even as some areas of the bond market has been quiet this year, Warren Buffet is finding ample demand for his largest bond deal in his career. Warren Buffet announced a $9bn issuance which is going ot be used to finance the Precision Castparts deal. The proceeds from the issuance will go towards paying down a $10bn bank loan which also helped finance the deal. Bank of America underwrote the deal, and it included seven tranches of varying sizes and maturities. The deal was more than three times oversubscribed, attracting $30bn in orders for the $9bn deal. The debt, which is rated AA by S&P and Aa2 by Moody’s sold at a +130 for the ten year maturity, and +115 for the seven year. The demand for these bonds reflects investor appetite for liquid and high quality offerings.

Junk bonds have rebounded in recent weeks in a sign that investors are willing to take on more risk. This coincides with easing concerns of a recession in the US, and China has somewhat taken a backseat to a rally in oil as well. This could provide support to the credit market in the near term, and encourage high yield issuers to enter the market after being quiet in the start of the year. High yield bond performance can be seen as an indicator of general sentiment surrounding economic health, since the riskiest borrowers are often most susceptible to swings in the economy. Similarly stocks have also rallied in the risk on shift. Investors are stepping into the sector opportunistically after prices were slashed following the Third Avenue closure in December and the selloff to start the year. Trading volumes have also risen suggesting liquidity conditions are improving. Over the past two weeks on average $10.3bn in high yield have traded on any given day, which is up roughly 25% from $8.2bn over the previous year. The average spread between high yield bonds and US Treasuries is 669 basis points which compares to the long term average of 590 basis points. This may suggest that prices are still low, and that the rally may continue if US economic data continues to remain solid and oil prices firm in the coming months.

At first glance a trade betting on the stronger US dollar might be a good idea, so far it has not worked out. US being the only country among virtually all developed markets in the world that is on a tightening cycle, while other central banks such as the ECB, the BoJ and others are aggressively easing. This divergence should result in a stronger dollar, however the euro has been firm against the dollar and the yen has appreciated in recent weeks. The euro over the past year has been firm around the $1.10 level even as many analysts have called for parity or even lower with the dollar. With the US economy seemingly heating up with stronger employment inflation reports, it may be time to reconsider the trade. Market expectations for inflation have risen, which in theory should result in higher rates in the US. Additionally the high yield differential between the US two year and the equivalent maturity German bund may appear attractive to investors which would put upward pressure on the dollar. How the ECB’s inability to use monetary policy to influence markets, and the preference for haven assets such as the Japanese yen have resulted in a relatively stagnant dollar.

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Tuesday March 8

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