Thursday March 31

Stocks fell ahead of the March non-farm payrolls report while still finishing the first quarter with modest gains. The S&P500 fell 0.2% to 2,059 while the Dow Jones lost 0.2% to 17.685. These movements brought the quarterly gains for the S&P500 and the Dow to 0.8% and 1.5% respectively. US stocks are the only indices in positive territory for the year compared with other indices around the world. Japanese stocks have suffered from the strength of the yen and the BoJ’s inability to weaken the yen and restore economic growth. Indices in Europe have suffered from similar concerns. Yields continued to fall along with the US dollar. Investors continue to focus on priorities made by Janet Yellen that suggest she is in favor of keeping rate hikes slow and shallow given the present risks. The dollar rose 0.1% against the yen to Y112.54 and the euro rose 0.4% against the dollar to $1.1378. The two year yield fell four basis points to 0.73%, and the ten year yield fell 5 basis points to 1.78%. The US two year and ten year are down 33 and 50 basis points respectively since the start of the year. Yields have fallen this year as investors have priced down the Fed and risks have weighed on the global financial markets. Gold prices have benefited significantly from the Fed’s more cautious tone, rising 16% this quarter.

The level of uncertainty in both the domestic and US economies has resulted in a volatility in the bond markets. As signs of inflation start to pick up and Janet Yellen still emphasizes caution when lifting rates, bond markets will experience stresses from inflationary pressures. Janet Yellen appears willing to let inflation overshoot the 2% target, which would not be ideal for the bond market as higher inflation erodes fixed income returns over time. Higher inflation diminishes the real value of the coupon payments and principal repayments that bond investors receive in the future. As the Fed keeps short term rates low and CPI starts to pick up, the yield curve will likely steepen if investors sell long term debt. However this selling may be met by foreign investors who still see US yields as attractive given the extremely low yields in other areas of the world. The 10yr-2yr spread touched as low as 95 basis points last month which was the lowest level since December 2007, which reflects a very flat yield curve. Some analysts believe the flatness of the yield curve does not align with current economic indicators. A flat yield curve typically indicates times of stress in the economy, however there are few such signs currently.

The IPO market remains silent in spite of the comeback for the stock market. IPOs are seen as an indicator for stock market health as companies typically opt to issue equity in favorable conditions and hesitate when markets are more challenging. Even though stock markets have risen nearly 15% since the beginning of February, the IPO market is still stagnant. The high level of uncertainty in the global economy is pressuring investors and issuers to wait for more stable times to enter the market. This trend has similarities to the recent story regarding haven assets; while risk assets have rallied over the last month, haven assets have remained close to where they were when markets were stressed at the beginning of the year. Over the rest of the year, it is very likely that these abnormal trends will reverse themselves. That is either haven assets will fall/ IPOs will pick up, or the stock market will return to lower levels seen early in the year.

As political and social unrest in Brazil have increased over the last month, the Brazilian real and other Brazilian financial assets have rallied. This is because markets are expecting that the more unrest there is in the country, the more likely it is that Dilma Rousseff will be removed from office which will result in improvements to Brazil’s fiscal position. It is clear that investors are not a fan of Rousseff’s policies, as over the last two years markets have tended to respond favorably to signs that Rousseff was faltering politically. The Brazilian real has risen 9% this year against the dollar after a terrible year last year, and the Ibovespa has fared well also. Rousseff’s political struggles have coincided with rising oil prices and a return of demand for risk assets, all of which have benefited Brazil’s financial markets. Rousseff is faced with terrible opinion ratings, and a potential impeachment as a result of corruption. She has been losing coalition partnerships in the government, and her predecessor and main supporter Luis Inacio da Silva is the subject of a police investigation. The level of uncertainty over the impeachment process leaves room for a sharp decline in the real if Rousseff is not impeached. Corporate credit spreads in Brazil have tightened significantly, falling 150 basis points to 425 basis points as investors hope have returned to the emerging market country after a terrible year last year. Even if Rousseff is impeached, any new government would still face considerable difficulty in improving the economy. The economy is set to contract 3%, the deficit is 10% of GDP, and interest rates are nearly 14.25% and on a rising trend to reign in double digit inflation.

Thursday March 31

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