Tuesday April 5

Stocks fall for the second day in a row as investors flock to haven assets. The S&P500 fell 1% to 2,045 and the Dow Jones 0.8% to 17,603. In the US the ISM non-manufacturing index indicated that the service sector grew at a quick pace last mont. The service sector makes up roughly 80% of the US economy so today’s report is a positive for first quarter GDP growth. On the other hand data also showed that the trade deficit widened in February which will negatively affect 1Q GDP. In Europe economic data disappointed as German factory orders came in worse than expected. Also contributing to the cautious tone in markets were comments by Christine Lagarde which warned of the risks to the global economy that could derail both developed and emerging markets. The dollar fell 0.8% against the yen to Y110.37 and gold prices rose. The euro was flat around $1.1387. Oil prices rose slightly with WTI finishing at $36.56 and Brent at $38.42. The ten year Treasury yield fell 4 basis points to 1.72% and the two year fell 1 basis points to 0.72%. The VIX rose to 15.42.

The currency wars that took place over the last year have been largely ineffective. The BoJ and the ECB over the last 12 months have been very active and vocal about their attempts to restore growth through weakening their respective currencies. In spite of large scale monetary easing both the yen and the euro stand at notable highs against the US dollar. Competitive currency devaluations in both developed and developing economies seem to offset one another and the yen and euro have rallied as investors expect a shallower trajectory of interest rates in the US. Although many investors have placed bets that the PBoC will further devalue the renminbi, the PBoC at least right now appears to be willing to defend its currency. While devaluing currencies in the past was successful in growth, the widespread devaluations that have taken place over the last few years have rendered this monetary policy tool less effective.

The ECB is set to begin buying corporate bonds which will likely harm liquidity in these markets. When the ECB buys bonds it typically holds them to maturity which reduces secondary market trading activity in those bonds. Already through the previous round of ECB QE purchases, the ECB has taken up a significant portion in the covered bond market which has made these assets harder to transact. The ECB currently owns 28% of the current covered bonds outstanding and is expected to own nearly half by the time the calendar year is over. Monthly trading volumes have declined by more than half over the last year, indicating deteriorating liquidity as the central bank’s inventory increases. Monthly trading volumes in Eurozone government bonds have fallen for a similar reason however not to the same extend since it is a deeper market. This trend is set to hit the Eurozone corporate bond market as the ECB begins buying corporate bonds.

A deal offered by Cerberus Capital Management is indicative of the resurgence of the MBS market in the aftermath of the financial crisis. In the fallout of the crisis the UK Treasury purchased 80,000 loans that were made by Northern Rock, a bank that soon failed. Those loans were later purchased by Cerberus which then securitized the mortgages and is offering them in an 8.2bn pound issuance. The offering has experienced solid demand. The AAA-rated tranche priced at LIBOR +118. This represents an asset manager stepping in and performing a function typically reserved for investment banks. With investment banks scaling back from such activities due to capital requirements, alternative asset managers such as Cerberus are stepping in to perform that function. The entire offering will be denominated in pounds, and 5% of the 6.2bn pounds will be kept by Cerberus per capital regulations. Leading banks such as Morgan Stanley, BAML, Credit Suisse, Lloyds, Natixis, HSBC, and Wells Fargo were all involved in the deal.

Tuesday April 5

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