Thursday April 21

US stocks fall back after consecutive days of gains. The S&P 500 fell 0.52% to 2,091 and the Dow Jones fell 0.6% to 17,982. Once again stock prices followed oil prices. Brent fell 2.2% to $44.60 and WTI lost 1.7% to $43.43. Both benchmarks are still at elevated levels as a result of a recent draw down on inventories and hopes that a production freeze will occur. Most equity indices around the world today finished lower, however the Nikkei was a notable exception. The Nikkei rose 2.7% as investors hope that the BoJ will expand its purchases of equity ETF as part of its quantitative easing program. The yen rose modestly against the dollar to Y109.45. In Europe the euro fell slightly after Mario Draghi left policy unchanged. The euro closed at $1.1287. Also driving US equities lower were poorly received earnings from Google, Microsoft, and Starbucks. Economic data showed that jobless claims remain at a historically low level, which suggests that the labor market is continuing to strengthen. Yields in the US continued to rise. The two year yield gained 1 basis point to 0.81% and the ten year yield rose 2 basis points to 1.87%. The British pound weakened against the dollar to $1.4321 after economic data disappointed.

At the ECB meeting today the central bank elaborated further on its purchases of corporate bonds. The parameters were largely received as generous, as it includes a wide scale of bonds. If a US company establishes a European subsidiary and issues debt (what is called a “reverse Yankee” bond), then those bonds are eligible for purchase under the ECB’s program. The ECB is allowed to by as much as 70% of each issuance and it may buy at auction. This information was well received by markets, as previously there had been some debate surrounding which bonds were actually eligible under the QE program. Reverse Yankee bond issuance has been rising in recent years, and totaled $74.6bn last year. This figure is likely to rise this year and next as a result of the new program and the increase in demand from the ECB. The ECB’s program may even benefit US stock prices. Companies have over the last few years been issuing debt to finance share repurchases or boost dividends. This may go against the intentions of the ECB’s program. The ECB is hoping to put downward pressure on yields in order to spur and encourage investment in the eurozone, as opposed to benefit investors in US stocks.

Similarly, bond prices for insurance companies also rose after the ECB’s announcement. Insurance companies have been struggling, especially in the eurozone as low interest rates put significant pressure on the business model. Insurance companies must invest premiums over long time periods in order to meet obligations far out in the future. Low rates make it more difficult for insurance companies to meet these obligations. Also the ECB previously mentioned that the QE program would include corporate debt from non-financial issuers. Initially there was uncertainty surrounding what was considered a non-financial issuer, and as a result insurance bonds were for the most part excluded from the corporate credit rally that followed the ECB’s announcement that it would purchase corporate debt. At today’s meeting Mario Draghi made it clear that bonds from insurance companies were eligible for purchase, and as a result bond prices jumped.

The pickup this year in corporate defaults has been followed by a pickup in junk downgrades, which suggests that the wave of defaults may not be over. So far this year 51 companies were downgraded into junk yield territory, which is a rating of BB+ or lower on the S&P rating scale. In 2015 in total 45 companies were downgraded into junk. Companies whose ratings go from investment grade to non investment grade are referred to as “fallen angels”. Of the 51 companies that have been downgraded, nearly half of them are commodity companies, reflecting the impact of low oil prices on the sector. While the number of fallen angels has increased dramatically, the number of rising stars (companies who go from junk to IG) have dropped off. While some see this as an indication that the credit cycle is about to experience a downturn, the market’s concentration in the energy sector somewhat distorts the numbers. Additionally a large number of companies downgraded to junk were Brazilian companies, whose downgrades came after the downgrade of the Brazilian government.

Thursday April 21

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