Thursday April 7

Stocks fall in the US as investors shift out of risk assets. The S&P500 fell 1.2% to 2,042 and the Dow Jones fell 1% to 17,541. Haven assets rallied significantly as the Japanese yen, Treasury prices, and gold all experienced heavy gains. The recent upward pressure on the yen comes after comments made by Shinzo Abe that the Bank of Japan does not want to engage in competitive devaluations. That leaves markets expecting that he is leaning against further cuts to interest rates, which opens up space for the yen to appreciate. This is not ideal for Japanese companies, and the Nikkei has fallen this year to reflect this. The US dollar fell 1.3% against the yen today to Y108.37 after touching an intraday low of Y107.71. These are the lowest levels in nearly two years, and it shows that negative rates used by the BoJ have not been very effective. Language used by Finance Ministry officials has led some analysts to believe that FX intervention may be a logical next step for Japan if the appreciation continues. Oil prices fell with WTI falling 0.9% to $37.43. Peripheral yields in the eurozone rose with Spanish and Italian yields rising 9 and 12 basis points to 1.61% and 1.40% respectively. The European banking sector is struggling in the environment for low rates, and further talk from the ECB of more easing does not help that. Emerging market currencies fell. Gold prices rose.

The European Central Bank appears willing to continue monetary stimulus as the region’s growth and inflation readings remain subdued. Today the minutes from the ECB’s March meeting were released, and the minutes show that members of the ECB remain divided as to the best method to deliver additional monetary easing. Mario Draghi continued his “whatever is needed” rhetoric when referring to how the central bank will fight against deflation. Inflation was -0.1% in March and growth is expected to have slowed in the first quarter. Investors are expecting further expansion of the ECB’s monetary easing program. While at the last meeting Draghi appeared to take future rate cuts off the table, increasing the size of asset purchases is still an option, as is more unconventional methods of monetary policy. Members of the ECB’s governing council have differing opinions over the best course of action. Some say that further rate cuts are the best way to drive down the currency to boost inflation. However its clear that rate cuts have already done significant damage to banks in Europe, and further rate cuts will intensify the harm that low rates put on bank margins.

Investors anticipate that the US credit cycle has turned which will result in a wave of defaults across the high yield sector. Currently the default rate is around 3% however investors expect that it will rise to around 5%. As the Fed continues its rate hike cycle as the year goes on, it will become more difficult for these companies to refinance and meet their obligations. Spreads have fallen since the start of the year, and are currently around 700 basis points for the high yield sector on average. This has resulted in a rally in high yield bonds after the dismal start to 2016. Already 36 companies have defaulted this year which marks a significantly faster pace to reach that mark compared to last year. However the significant amount of debt in the global market with low and negative yields make junk bonds more attractive on a relative basis. The sector with the worst outlook is without a doubt energy, followed by materials and industrials. Consumer staples and utilities are the sectors that have the best outlook based on investor expectations surveys.

The auto loan ABS market continues to show signs of pressure. Over the last year lending has shifted from larger, more well established lenders to smaller auto lenders. These small lenders are providing the majority of loans that are now being used new securitizations. The loans being put in ABS from small lenders have not performed well since the smaller lenders are providing loans to buyers with lower credit scores by comparison to the larger lenders. The percentage of subprime loan balances that lenders are unable to recover has been on the rise, and was at 11.2% as of January compared to 7.8% two years ago. Smaller lenders have been venturing into the “deep subprime” territory, which is considered loans that are made to borrowers with FICO scores lower than 550. These borrowers are the least creditworthy and the most likely to miss payments. Credit standards have been declining as the number and amount of subprime auto loans given out has risen dramatically to $109.5bn last year. Similarly, the securitization business for these bonds has also been on the rise, with the number of auto loan securitizations last year rising 16% from the prior year.

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Thursday April 7

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