Friday June 3
Stocks fell today after economic data fell short of expectations. The S&P 500 fell 0.3% to 2,099 and the Dow Jones fell 0.2% to 17,807. The S&P 500 was virtually unchanged and the Dow Jones fell 0.37% over the Memorial Day shortened week. Economic data today showed that nonfarm payrolls in May rose by 38,000. The prior month’s reading were revised downwards as well. This compares unfavorably to consensus estimates, which called for gains of 158,000. The unemployment rate fell from 4.9% to 4.7% however this represents a 0.2% decline in labor force participation. This sent yields and the US dollar down sharply on the day as expectations for further rate hikes were pushed back. The ten year Treasury yield fell 10 basis points to 1.70%. The ten year yield was down 15 basis points on the week. The two year Treasury yield also fell 10 basis points to 0.78%. The dollar index was down nearly 1.7% on the day. The dollar lost 1.9% against the euro to $1.1364, and 2.15% against the Japanese yen to Y106.53. The KBW Bank index fell nearly 2.3%, while utilities rose more than 1.6% as investors clearly priced in lower interest rates. Following today’s data, investors reflected that a June rate hike was virtually off the table for the FOMC. Before the release Fed funds futures reflected a 22% chance of higher rates in June, however after the data were released that number fell to just 4%. July is still on the table, however economic data will need to decisively prove that it is warranted by that meeting.
Investors have been attracted to municipal bonds in record fashion over the last year. Inflows into municipal bonds funds have been strong since the end of last year and have been strongly positive throughout 2016 so far, totaling more than $23bn. In May municipal bonds experienced nearly $4bn in inflows. At the same time yields have fallen to a record low of 1.83% on average. Contributing to this higher demand is international buyers, as the amount of muni debt held by international investors has risen 44% since 2009. This comes after low interest rates around the world have pushed investors into other areas of the market. Munis have also served as a haven in times of risk aversion, such as earlier this year when equity markets sold off. The market has been undeterred by high profile defaults such as Puerto Rico, and other struggling municipalities such as Atlantic City and Chicago. However with all of the inflows some analysts have noted that the market may be slowing down. Munis have returned 2.89% year to date, compared to 3.88% for Treasuries, 6.14% for investment grade credit, and 8% for high yield. Returns may be decreasing in munis as the number of bargain opportunities dwindles. However prices have remained supported by a decrease in supply. For example yields on CT bonds have fallen even after a ratings downgrade.
Aetna’s $13bn issuance of bonds today marked the third highest of 2016, behind AB InBev ($46bn) and Dell ($20bn). These bonds will be used to finance the $34bn acquisition of Humana. While the risk of mergers and acquisitions being turned down by the US government in recent months has risen, investors interpreted the completion of this deal as an indication that the process was moving along favorably with regulators. Accordingly, shares of the acquirer (Aetna) and the target company (Humana) both rose. The spread between Humana’s spot stock price and the offer price also decreased to around 17%. However the deal is not yet finalized, a risk that bore itself recently in the Halliburton Baker Hughes situation. Halliburton in the fall issued $7.5bn to finance the acquisition, however the deal was turned down by regulators on anti-trust grounds and now some of the bonds must be called at a premium. Staples sunk $94mm in banking fees related to the Office Depot acquisition before that deal was scrapped by regulators. Aetna’s deal was split into eight tranches. The 10 year tranche, comprising $2.8bn of the offering sold at +145 (yield of around 3.24%). Sizeable offerings such as these have attracted high demand from investors as a result of liquidity benefits. A bond with more investors and more bonds outstanding is likely to be more liquid than a smaller, more particular issuance.
Bond fund inflows into both emerging market and investment grade bond funds slowed down in May after investors took a breather after a rally between February and April. Emerging market bond inflows slowed down from around $15bn in April to just $1.4bn in May. Funds experienced inflows in March and April after a selloff over the previous eight months. The slowdown in inflows in May could be attributed to investors pricing in higher interest rates in the US over the summer, but after today’s data EM bonds may become en vogue again. US junk bond yields did not show much sign of risk aversion in May, which suggests that the slowdown in EM may be due to potential higher interest rates in developed markets. At the same time inflows into IG corporate bonds slowed down at well. Since the start of the year investment grade bond funds received around $54bn from investors. However inflows consistently dropped throughout May. This asset class has rallied since the start of the year, and the recent slowdown in inflows may be due to a lack of investment opportunities.
Thursday June 2
Stocks rose today, ahead of tomorrow’s all important non-farm payrolls report. The S&P 500 and the Dow Jones each rose 0.3% to 2,105 and 17,838 respectively. The fact that these indices are close to record highs while markets are pricing in higher rates by the end of summer is a sign that investors are confident. Oil prices were a main focus today. Brent crude oil initially fell as low as $48.84 after Opec delivered no further hopes for a production cap, however it finished 0.6% higher on the day at $50.04. This came as data showed that US inventories fell by more than expected. The Nikkei lost 2.3% today after the yen rose 0.7% to Y108.79. The euro fell 0.3% to $1.1151 even after the ECB modestly upgraded the Eurozone’s CPI and GDP growth forecasts. Nevertheless, some analysts believe that the ECB will unveil further stimulus measures in the future. The German bund yield fell 2 basis points to 0.11% as investors prepare for the ECB to expand its QE program. The ten year Treasury yield fell four basis points to 1.80%, and the two year yield fell 3 basis points to 0.88% ahead of Friday’s report. Economic data today showed that 173,000 jobs were added last month which met expectations, setting the stage for the May non-farm payrolls report tomorrow.
The ECB left its monetary policies unchanged at today’s meeting, and detailed the corporate bond purchase plan that is set to begin this month. Draghi said that the ECB will act without hesitation if needed, however he said patience was important in hitting the ECB’s targets. This suggests that the ECB is still in wait and see mode. It will assess the effects of the current QE program before taking further action. European stocks were little changed on Draghi’s comments, and the euro and yields fell. Like the Fed, the ECB targets a 2% inflation rate. However inflation has remained below this target since early 2013, and inflation has been negative for the majority of this year. Analysts expect the ECB to downwardly revise its forecasts, and expand QE before next March (when the current plan is set to end). The BoJ and the FOMC will both meet later this month as monetary divergence is set to resume. The Fed is likely to come across as hawkish, while some expect the BoJ to expand asset purchases.
Robert Kaplan of the Dallas Fed becomes just the latest FOMC member to speak in favor of higher interest rates this summer. Kaplan said he is “getting to the point” where he would support another increase to the Fed funds rate provided that economic data meets his expectations over the next several weeks. In particular Kaplan is eyeing growth around 2% this year, further labor market tightening, and evidence that inflation is rising towards the 2% target. Kaplan is not a voting member of the FOMC this year. This echoes comments made by several Fed officials over the last few weeks, including Janet Yellen and William Dudley. Daniel Tarullo today suggested that the Fed needs to see some more positive economic data releases before raising rates again.
More regulation lies ahead for the largest US banks. Daniel Tarullo and Jerome Powell of the Fed are both in support of higher capital requirements for eight systemically important institutions in order for them to pass “stress tests.” Tarullo suggested that the intention behind the higher capital requirements is to force the banks to ask themselves whether or not it is better to break themselves up. The formal proposal will take place later this year and won’t take effect until 2018 if it is passed. Larger banks face additional capital surcharges depending on the size of the banks. The largest institutions, such as JP Morgan are the most negatively effected. The eight banks that are being considered in this proposal are JP Morgan, Citi, Bank of America, Goldman Sachs, Morgan Stanley, Wells Fargo, State Street, and BNY Mellon. Banking executives are widely opposed to this proposal, saying it hurts bank customers (both retail and institutional) and shareholders. Tarullo said that he doesn’t think the move would have an effect on banks ability to make markets or on liquidity in markets. This rule change in particular would make it so that banks would have to hold the capital surcharge (tax on bigger banks) in times of market stress as well as normal market conditions.
Wednesday June 1
US stocks rose marginally to start the month of June as oil prices and Opec were once again in the headlines. The S&P 500 rose 0.1% to 2,099 and the Dow Jones rose 0.01% to 17,789. Economic data today out of the US showed that the ISM manufacturing index came in at 51.3, which beat expectations of 50.6. The new orders and export orders both were strong. Investors focused on recent Brexit polls, which renewed concerns that the UK may vote to leave the EU later this month. Oil prices fell as Opec leaders convened for a meeting in Vienna. Brent fell 0.3% to $49.72 and WTI lost 0.4% to $48.91. The Japanese yen rose 1% to Y109.54. The euro rose 0.6% to $1.1190 as the dollar index fell 0.5%. The two year yield rose 3 basis points to 0.90%. The ten year Treasury yield fell 1 basis point as the yield curve flattened.
Economic data has shifted forward expectations for when investors believe that the Fed will next raise interest rates. As a result investors have placed trades that will become profitable if interest rates rise this summer. Investors are able to do this by shorting eurodollar futures, since the price of those will fall if short term interest rates rise. Shorts in eurodollar futures hit $730bn last week, which is the highest level in two years according to TD Securities. Fed funds futures reflect a 58% chance that the Fed will raise interest rates by the end of July, compared to 28% last month. This has coincided with signals from Fed officials that they are more willing to raise interest rates, as well as economic data which has shown that the US economy is moving forward. In spite of the short positions in rates markets, an index of bond volatility has been falling for the last few months. The probability that the Fed raises rates in June is 23%. It’s important to note that in the past the Fed has raised interest rates when the market has assigned at least a 60% chance, however the FOMC is by no means bound by what markets are showing.
Opec leaders held a meeting in Vienna, and talks of a production ceiling are back on the table. Saudi Arabia now appears willing to discuss a potential cap on production, which is a shift from its previous stance. Previously Saudi Arabia has been a proponent of producing as much oil as possible to maintain market share. As low oil prices begin to weigh on the country’s finances, they may be forced to shift their stance. The new discussions are centered around a collective output for OPEC. In the past countries have each been responsible for their own output, and proposed production caps have put limits on countries individual outputs. The production ceiling clearly has an impact over markets. When OPEC abandoned the production ceiling in December, prices plummeted in the first weeks of 2016 into the high $20 range.
The most recent polls out of the UK were a source of concern for investors today. The polls today suggested that the Brexit was a higher probability event than investors had previously been expecting. Two polls today gave the Leave group a 52-48 edge over the Remain camp. As a result implied volatility in the pound rose significantly. Implied volatility also represents the cost of insuring against value changes of the pound versus the dollar. This measure rose higher than 20 for the first time since early 2009, and rising nearly 10% over the last few days. Analysts note that in spite of this heightened level, implied volatility is likely to edge higher if the Leave camp gains momentum. The British pound has fallen 1.4% to $1.4433 over the last couple of days. This comes after the Organization for Economic Cooperation and Development said that a Brexit could potentially shave 0.5% off of UK GDP through 2018.
Tuesday May 31
Stocks finished slightly lower after investors finished the month of May on a hesitant note. The S&P 500 fell 0.1% to 2,096 and the Dow Jones lost 0.5% to 17,787. Over the month of May the S&P 500 and the Dow Jones were 1.5% and 0.08% higher respectively. The Shanghai composite performed very strongly today, rising 3.3%. This comes as Chinese stocks may begin to be included in MSCI global indices. Investors do not appear to be concerned about recent declines in the yuan, which fell 1.6% during the month of May. The dollar index continued its rise today on expectations that the Fed will raise rates this summer. The dollar index added 0.3% today, bringing the monthly gains to 3%. Economic data today showed that the PCE price index rose 0.3% last month, and 1.1% over the last year. The core PCE measure rose 1.6%. This was roughly in line with expectations, and supports the Fed’s case that inflation is rising to the 2% target. Brent crude oil fell 0.1% to $49.69 after touching $50.05. WTI fell 0.7% to $48.99 after touching $50.10. The two year yield was flat on the day at 0.88% after touching 0.94%. The ten year yield fell 1 basis point to 1.84%.
Saudi Arabia is set to issue $15bn in bonds, and is on the process of selecting international banks to arrange the deal. This will be the first dollar denominated bond for the country. Saudi Arabia is facing fiscal challenges as low oil prices have had an impact on finances. GDP growth as slowed to 1%, social spending has been cut, and foreign reserves have decreased significantly. The country is attempting to shift its economy away from the oil and energy sector, and this bond issuance is the first step in doing so. Local banks don’t have a lot of liquidity, which is why international banks are stepping in to coordinate the deal. This follows similar actions from oil countries such as Qatar in recent months. Oman and Bahrain are also in the process of raising international capital using debt markets.
Economic data out of Europe today showed that the region entered deflation territory, as prices fell 0.1% in the year ended in May. This marked the fourth month straight of falling prices. In spite of the lower inflation reading, bond prices fell. The ten year German bund yield rose 2 basis points to 0.18%. This comes as Germany, Spain, France, and Italy are all set to issue debt this week, resulting in e15bn of new government bonds hitting the market. The higher supply may be driving down prices contrary to low inflation. The ECB continues to buy e80bn in bonds each month, which will continue to ensure that sovereign bonds are in demand in thus drive down yields.
Goldman Sachs loans $75mm to private company Nutanix, which is a private company that GS is hoping to take public in the coming months. Nutanix filed for IPO six months ago, and GS is leading the deal and owns equity in the company through its asset management arm. This loan reflects recent troubles for private tech companies. The IPO market for tech companies has dried up this year, sending valuations down and leaving companies with little access to capital. This loan fills that need until Nutanix is able to IPO. From Goldman’s perspective, the bank is set to earn a nice return regardless of the outcome. If Nutanix IPOs within the next three months Goldman will earn a 36% annualized return. If the IPO does not go through, the loan will pay an annual rate of 10% over three years. Although the company is in the IPO stage, Nutanix is still losing money. It’s YTD loss through April was $119mm, which is significantly higher than the $89mm loss at that time last year. However revenue nearly doubled to $305mm. As a result of the losses, Nutanix needs ongoing access to capital, and GS is providing them access at a hefty price. Based off of valuations of large startup companies held by mutual funds, valuations have peaked and are now flatlining. This deal by Nutanix follows a deal earlier in the year by Spotify, in which the music service company’s debt will convert to discounted equity upon IPO. Startups (and banks) need to become increasingly creative, and give up terms in order to attract demand for their bonds.
Friday May 27
Stocks finish the week off with gains, rising significantly over the course of the week. The S&P 500 rose 0.4% to 2,099 and the Dow Jones added 0.3% to 17,873. Over the week, the S&P 500 rose 2.3% and the Dow Jones gained 2.1%. Stocks were driven higher this week by economic data which surprised to the upside. In spite of expectations that the Fed will raise rates this summer, markets performed very strongly this week suggesting that investors believe the economy is ready for higher rates. Stocks in Europe also posted a strong day and week following the most recent resolution of the Greek situation. Stocks were undeterred from oil prices which slid back today but were still higher on the week. Brent fell 0.5% to $49.32 and WTI was unchanged at $49.47. Brent and WTI were 1.3% and 3.6% stronger over the five day period. Today Janet Yellen made hawkish comments suggesting that the Fed funds rate may be raised at some point in the summer. Fed funds futures now reflect a 50% chance of another hike by the end of July. The dollar index rose 0.6% to 95.76 today, which is the highest level in two months. The euro fell 0.7% to $1.1110 and the yen lost 0.6% to Y110.41. Accordingly gold prices were down today and on the week. The two year Treasury yield rose 5 basis points on the day and was 4 basis points higher on the week. The ten year yield rose 2 basis points on the day and 1 basis point on the week. The yield curve continued to flatten.
Janet Yellen suggests that the economy will be ready for a higher Fed funds rate at some point over the summer. In a speech at Harvard, she said she may be eying higher rates in the “coming months.” In doing so she added on to the number of Fed officials who have made hawkish statements in the last week about potentially higher interest rates this summer. She said that the economy was showing sighs of ongoing improvement after slow growth in the first quarter. She expects the labor market to continue to improve. In addition downward pressures on inflation, such as the effects of low oil prices and the stronger dollar, are dissipating. Fed funds futures now reflect a 54% chance of higher interest rates before the end of July. Retail sales and housing data are both signs that the economy is ready for higher interest rates. However lower growth and falling productivity remain to be sources of concern.
LendingClub and Citi are in discussions for Citi to either buy or provide funds for LendingClub’s loans in the future. LendingClub needs such a partnership in order to reassure investors after recent bad publicity. LendingClub matches lenders with borrowers on an online platform, and it makes some consumer loans on its own. The loans that it makes using its own balance sheet, LendingClub wants to sell to banks and securitize. Going forward this may be difficult seeing as LendinbClub recently received bad press for mis-selling loans to banks. LendingClub’s needs for such a partnership to restore investor confidence. This is significant since it suggests new upstart online banking companies may need the support of traditional lenders. Some had previously predicted that new financial services companies may take the place of traditional banks, however this deal suggests that may not be the case. Citi has been a big buyer of loans in the past from both LendingClub as well as Prosper Marketplace, however stopped making deals with LendingClub after it discovered previous loans were mispriced.
The IPO market has come back to life since the start of the year, in a sign that investors are willing to take on risk with less established companies. Philips Lighting shares jumped 7% today after the parent company spun off a 25% stake in the subsidiary. Additionally US Foods IPO’d this week after a $7.1bn LBO. The stock price also rose more than 8% upon IPO.
Thursday May 26
Stocks pause after two days of gains. The S&P 500 was virtually unchanged at 2,090 and the Dow Jones fell 0.1% to 17,828. Investors took caution after strong performances over the previous two days, however investors did not take profits en masse which is a positive. Contributing to the hesitant tone in markets was the mixed durable goods orders report. The headline number was strong, as new orders rose 3.4% from the previous month versus expectations for a 0.3% gain. However core capital goods fell by 0.8% on the month, bringing the yearly decline to 5%. The dollar index fell 0.2% in response. The euro rose 0.3% to $1.1189 and the yen added 0.4% to Y109.72. Similarly interest rates fell on the day. The two year fell four basis points to 0.87% and the ten year fell 3 basis points to 1.83%. Additionally oil prices fell slightly on the day after briefly breaching $50 late yesterday. Brent fell 0.3% to $49.59 and WTI fell 0.5% to $49.30. Analysts note that a correlation between spot oil prices and energy stock prices has decoupled over the last few months. Spot crude prices have risen 33% year to date, however energy company stocks are only up 12%. These two are likely to converge in the future.
Over the last few weeks financial markets have adjusted to reflect that investors believe the risk of a Brexit has reduced. Polls of British voters show that the Remain group is gaining momentum. At the same time betting odds that the UK votes to leave the EU have fallen from 37% last month to 19% now. This comes after the BoE and the IMF, among other prominent international institutions, have both spoken out against the Brexit. Investors have consistently downgraded the risk of a Brexit. Stock markets have not been negatively impacted, and yields have fallen over the last year. While the pound fell 11% at the start of the year, it has since risen by 4%. Short positions in the pound have decreased since March. Nevertheless risks are still present in UK markets. Morgan Stanley expects the pound to fall as low as $1.30 in the event of a Brexit, and Goldman Sachs predicts that stocks could fall as much as 20%.
Jerome Powell of the Fed Board of Governors becomes just the latest Fed official to send hawkish signals to markets. Powell said that he believes that interest rates will be raised “fairly soon” and that data could support this action. He cited risks of the UK referendum, China’s exchange rate, and low growth and inflation in the global economy. He said that the US economy has progressed significantly in recent months and that data is on track to hit FOMC targets. This echoes similar comments from several other Fed officials last week. He issued an upbeat statement on the health of the labor market, wage increases, and second quarter GDP growth. He suggested that he expects terminal interest rates will be lower in this tightening cycle will have to be lower than they were in previous cycles to keep inflation and employment at the targeted levels.
Gogo Inc cancelled a bond offering after it revealed that it was in negotiations for a deal. Gogo provides internet on flights, and said it was in talks with an airline about a deal. Gogo had already agreed to terms on the bond issuance, which makes it a rare move that it chose to cancel at such late notice. The $525mm bond offering was expected to carry a junk credit rating and a yield of 12%. It must be that Gogo believes that it will be able to secure more attractive terms after the negotiation with the airline is complete. The move frustrated bond investors since the deal had already priced and bond investors would have benefitted from the deal if they had owned the bonds before it went through. Now Gogo will take that benefit for itself. Gogo stock price rose 16% on the news. The junk bond market has experienced a resurgence in recent weeks as investors have been more willing to take on risk. The issuance is being led by Bank of America, Morgan Stanley, and JP Morgan.
Wednesday May 25
Stocks rose for the second straight day as financial and energy stocks continued to lead the way. The S&P 500 rose 0.7% to 2,090 and the Dow Jones added 0.8% to 17,851. Investors today drew confidence from Greece’s agreement with creditors as well as oil inventory data from the US. Greece reached a tentative debt relief agreement with Germany and the IMF. As a result indices across Europe rose, with the German DAX and the Stoxx rising 1.5% and 1.3% respectively. Additionally the Greek 10 year yield fell below 7%. This provided support for other peripheral Eurozone bonds. The Spanish and Italian 10 year yields each fell 6-7 basis points to 1.48% and 1.36% respectively. Fed funds futures continue to reflect a 33% that the Fed will raise rates in June. The two year yield was flat on the day at 0.92%. The ten year yield was also flat at 1.86%. The dollar index eased back slightly. The euro rose 0.2% to $1.1159 and the pound rose 0.6% to $1.4715. The strength of the dollar over the next month will be very important as a potential rate hike gets closer. If the dollar strengthens significantly the Fed may be more hesitant to raise rates. Oil prices rose after data showed that inventory drawdowns were larger than expected by a significant margin. Brent rose 2.3% to $49.74 and WTI gained 2.2% to $49.69.
Today’s deal between Greece and creditors once again wards off a Greek crisis for the time being. This progress will allow e10.3bn of bailout funds to be released to the country. In contrast to last year, Greece did not come down to the deadline before a payment needed to be made. Analysts are now expecting that the ECB may begin to accept Greek bonds as collateral. This move would increase debt for Greek bonds, and drive yields lower. Accordingly, over the last three months the spread between Greek and German debt has tightened from 11% to around 7% now. Additionally if the ECB includes Greek debt in its QE program that would further increase demand and put downward pressure on yields. Either of these measures would provide relief for Greece’s banking sector. Investors believe that if these changes are made, then the ECB will announce next week at a meeting in Vienna.
China has been weakening the yuan against the dollar over the last few weeks, which is reigniting some concerns over further devaluations. The daily fix today was set at Rmb6.5693, which is 0.3% weaker than yesterday and it also marks the lowest level in five years. The strengthening dollar makes it less attractive for the PBoC to set the renminbi closer to the dollar. The dollar index is now at the highest level in the last two months as investors expect that the Fed will raise rates this summer. Analysts have said that the weakening of the renminbi has for the most part been expected, which explains why it has not yet had a significant impact on global indices as it did at the end of last summer.
Tuesday May 24
Stocks rose as US economic data surprised to the upside. The S&P 500 rose 1.4% to 2,076 and the Dow Jones added 1.2% to 17,706. Economic data today showed that housing reports came in stronger across the board. New home sales were significantly higher than expected, rising more than 16% from last month. Markets drew confidence this report, and stocks rose even in spite of heightened rate hike expectations. Following this report the KBW Bank index rose more than 1.5%. Also contributing to the bullish tone was rising oil prices. Brent rose 0.5% to $48.61 and WTI added 1.1% to $48.62. The dollar was stronger against peers as the dollar index rose 0.4%. The euro fell 0.7% to $1.1139 and the yen lost 0.7% to Y109.99. This came as the market for Fed funds futures now reflects nearly a 33% chance that the Fed will raise rates in June. In accordance with the stronger dollar, gold prices fell. The two year Treasury yield rose 1 basis point to 0.91% and the ten year yield rose 2 basis points to 1.86%.
The flattening yield curve suggests that markets are doubting the Fed’s ability to restore inflation and growth. The yield curve has been flattening in recent weeks across nearly all maturities as investors have shifted from short term bonds to longer term bonds. The term premium between the ten and two year Treasuries is now 0.92%, which is the lowest level since 2007. Short term yields have been driven higher as markets bet that the Fed will raise interest rates at least once this year. Long term yields have been driven lower as a result of low inflation expectations, as well as demand from international investors. The flattening yield curve does not bode well for the global economy. The steepness of the term structure and world industrial production have become increasingly correlated in recent years. This suggests that as a result of globalization, the factors that drive the US term structure flatter also result in lower global industrial output. The shape of the term structure is also closely positively correlated to world export volume and S&P 500 revenues. This means that as the yield curve flattens, S&P 500 revenues and global exports have historically fallen. The unprecedented scale of quantitative easing in the global economy may distort this relationship.
IHeartMedia won a court ruling that allows the heavily indebted company to avoid default for the time being. Creditors, including private equity firms and asset managers, that own around $3bn had alleged that an equity transfer violated terms of debt contracts, and as a result the company should enter default. The courts today ruled that the equity transfer was allowed according to the bond indentures. IHeartMedia transfered around $1.2bn from one subsidiary to another unrestricted subsidiary. Lenders were frustrated by this maneuver because the shares were originally supposed to be used as collateral for the debt. IHeartMedia is struggling to manage nearly $20.6bn in debt following the 2006 LBO from Bain Capital. The company says it is looking to continue to discuss options with lenders.
Moody’s downgraded Deutsche Bank’s credit rating to Baa2 (this is equivalent to S&P’s BBB rating). This is just two ratings above junk territory. The downgrade comes as low interest rates and global economic weakness have hampered bank financial statements since the start of the year. Deutsche Bank earlier suffered a dramatic drop in stock price, and analysts still expect further declines. Moody’s cited doubts in Deutsche Bank’s ability to reach its profitability improvements without headwinds that affect the sector as a whole. Deutsche Bank at the end of last year presented a plan to restructure the bank, and shy away from less profitable activities and focus more on consistently profitable divisions. Deutsche Bank’s CFO in response said that credit risk for the company remains low and that counterparties should not be concerned. Also contributing to negative sentiment for the bank, on Monday US courts reopened a lawsuit against the 16 banks involved with the rigging of LIBOR. DB last year paid $2.5bn related to these allegations, and the bank this year has another e5.4bn set aside for legal costs and settlements.
Monday May 23
Stocks fall on the day to start the week with modest losses. The S&P 500 fell 0.2% to 2,048 and the Dow Jones fell fractionally to 17,492. Contributing to the downward momentum in equities was lingering concerns about interest rates and falling oil prices. Japanese stock prices fell on new strength for the Japanese yen. This weekend at the G7 finance ministers weekend the Japanese finance minister said that they would refrain from devaluing the currency. The yen rose 0.9% against the dollar to Y109.15. The dollar index was little changed on the day, and the euro closed at $1.1215. Oil prices fell, with Brent losing 0.8% to $48.35. WTI fell 0.6% to $48.15. Greek stock and bond prices rose after the country agreed to further fiscal reforms which led investors to bet on some form of debt relief. The ten year Treasury yield fell 1 basis point to 1.84%, and the two year rose 1 basis point to 0.90% as the yield curve flattened. Also reflecting higher rate rise expectations, the market for Fed funds futures reflects a 30% chance that the Fed raises rates in June and more than 50% chance that the Fed moves in July.
Hedge funds and asset managers are taking a bearish view on the future of Australia’s financial sector. Investors expect large Australian banks to face bad debts, falling earnings, and a real estate bubble. In the past investors holding these stocks have enjoyed large returns, however times may be changing. Short positions in Commonwealth Bank of Australia, Australia & New Zealand Banking Group, Westpac Banking, and National Australia Bank have increased by 50% this year. The ROE for these four large Australian banks are among the highest in the world, between 14 and 18%. Like financial shares in other areas of the world, Australian banks are down significantly this year, underperforming the domestic stock market. Jonathan Tepper of Variant Perception believes that there is a large housing bubble, comparable to what happened in the US in the early-mid 2000s. Tepper expects that similar to the US financial crisis, banks and other financial institutions will be the hardest hit. At the same time Moody’s expects decreasing earnings and an increase in bad debts. Research analysts at Morgan Stanley, Goldman Sachs, and UBS all expect dividend cuts.
Credit quality has been deteriorating over the last few years as companies have been increasing leverage to boost returns and finance M&A. To reflect this trend, the number of companies rated AAA has fallen from 98 in 1992 to just two currently. After ExxonMobil was recently downgraded to AA-, the only two companies to carry AAA ratings are Microsoft and Johnson & Johnson. As interest rates have fallen over the last decades, companies have increased their debt level. That has resulted in credit downgrades. Between investment grade and high yield issuers, debt levels have risen by $4tn since 2008.
The CLO market has picked up in recent weeks in a sign that investors are willing to step back into the asset class. Banks use the CLO market to offload risky loans to investors. Over the last month or so banks have been increasingly using CLOs to bundle corporate loans. Bain and Carlyle have sold $7.8bn since April 22, compared to just $3.4bn for all of January and February. The market suffered in the start of the year as traders shied away from taking on risk. The resurgence in the CLO market is a positive development for banks, since it allows them to reduce credit risk on risky loans. In a sign that investor demand for such bonds has increased, loans that were unable to sell at the end of 2015 have sold in recent weeks. These loans have performed well for investors. Year to date high-yield loans have increased 4.51%. CLOs typically pay floating rates, which makes them attractive as the Fed prepares to raise the Fed funds rate for the second time. In spite of the resurgence in recent weeks issuance is still 62% below where it was last year. Analysts expect that roughly $50bn in CLOs will be issued this year, which is half of the amount that was issued last year. Regulatory concerns are also contributing to lower issuance in CLOs. Banks and issuers are now required to retain a 5% stake in their offerings. Yields have fallen, reflecting higher demand. BB rated CLO tranches recently yielded 9.9%. As recently as March, it yielded 12.6%.
Friday May 20
Stocks finish the week on a stronger note, rising slightly on the week. The S&P 500 rose 0.6% to 2,052 and the Dow Jones rose 0.4% to 17,500. Over the five day period the S&P 500 rose 0.3% and the Dow Jones fell 0.2%. The week was marked by a big change in expectations regarding the next rate hike by the Fed. Futures markets place a 51% chance that the Fed will raise rates before the end of July, which is up significantly compared to the start of this week. Accordingly the two and the ten year Treasury yields were 13 and 14 basis points higher on the week. The two year yield was flat today at 0.88% and the ten year fell 1 basis point to 1.84%. The dollar index rose 0.8% on the week. The euro was little changed today at $1.1226 and the yen fell to Y110.12. WTI fell 1% to $47.67 and Brent fell slightly to $49.29.
US financial stocks benefitted this week from the higher rate rise expectations. Even though the yield curve has flattened, which narrows bank margins, stocks have risen on hopes for higher revenues. Financials in the S&P 500 rose 3.4% this week, trimming the year to date losses to 8.3%. JP Morgan, Bank of America, and Wells Fargo rose 3.8%, 4.6%, and 1.1% respectively. At the same time utilities fell on higher rate expectations. Utilities fell 2.4% this week, bringing YTD losses to 11%.
The differences between on the run and off the run Treasuries continues to widened. Yields for off the run Treasuries are significantly higher, reflecting poor liquidity conditions in secondary markets. Off the run Treasuries on average yield four basis points higher than more recently issued Treasuries. This is more than twice of what the average spread was between 2010 and 2013. Investors prefer to hold more recent issues since they are more liquid. As this spread widens, it becomes a self fulfilling destiny and the spread is likely to continue increasing. The Treasury uses a so-called G-spread to find the difference. The G-spread measures the difference between an existing old bond and the price of the same exact bond if it were to be issued today. Although the current G-spread is wider than it was between 2010 and 2013, and it has been widening since 2014, it is lower than it was in 2009. The current G-spread is in line with the levels last seen between 2005 to 2007. The Treasury disagrees in part with the narrative presented by fixed income traders. Market makers argue that the rising difference is a result of liquidity only between a few select players in the market.
Low yields in the international financial markets have pushed international investors into US bonds. As a result US corporate bond funds received $1.1bn in new money this week which marks the 11th consecutive week of inflows. Nearly $10tn of bonds in the global market carry negative yields. This sends international investors into areas of the world where yields are more attractive, such as the US. The demand for yield in the US may encourage further bond sales since there is demand for more corporate bonds. This also is likely to keep yields in the US low even if and when the Fed raises rates this summer. Recent bond sales from Dell, Southern Company, and AbbVie have all attracted high demand from investors. It’s clear that there is demand for quality bonds, however in the high yield market this has been less predictable. Inflows have been more erratic in high yield funds. At the same time funds that track emerging markets in Europe, Middle East, and Africa recorded the 15th consecutive week of outflows.
Corporate defaults around the world hit the highest level to date since 2009. Seventy two defaults have occurred since the start of the year compared with just 113 all of last year. In the last week alone there have been ten defaults including Tervita and Breitburn Energy Partners. A large portion of the defaults are concentrated in the energy sector as well as companies with exposure to that industry. Of the 72 defaults, 29 have been oil and gas companies, 12 were from commodity mining companies, and one came from a utility company. The rating agency S&P expects pressures in these industries to continue throughout this year. Nevertheless, the agency suggested that high yield spreads in the US may be tightening somewhat. The US distressed ratio measures the percentage of companies with a spread of 10% of more over equivalent maturity Treasuries. The distressed ratio fell to 21.3% last month which marked the first consecutive monthly fall in the last two years. This could be an indication of the high yield market gaining momentum, which coincided with rising oil prices during March and April.
Thursday May 19
Stocks fall again in the aftermath of the FOMC minutes. The S&P 500 fell 0.4% to 2,040 and the Dow Jones fell 0.5% to 17,435. This marks the third consecutive days of losses for the Dow Jones, and with today’s decline US stocks entered negative territory for the year. The S&P initially fell 0.9% before recovering slightly later in the session. Investors continued to focus on the chances that the Fed raises rates this summer, and skepticism for that outweighed positively received earnings from Walmart. Treasury yields fell back slightly in the after a sharp increase yesterday, however still remained elevated compared to where they were before the minutes. The two year yield fell 2 basis points to 0.88% and the ten year yield fell 4 basis points to 1.84%. The market for Fed funds futures now reflects a 32% chance that the Fed raises rates in June. The dollar continued to strengthen, as the dollar index rose 0.3% to 95.33. The PBoC set the daily fix to the dollar 0.5% weaker at Rmb6.5531. The Japanese yen on the other hand rose 0.3% to Y109.88. The stronger dollar weighed on gold prices. Brent crude prices fell 2.7% to $47.60.
Bill Dudley of the New York Fed becomes the latest member of the FOMC to suggest that a rate rise this summer is a distinct possibility. This echoes comments by Dennis Lockhart and Eric Rosengren earlier this week. Dudley expects further tightening in the labor market which will put upward pressure on inflation, which warrants higher interest rates. He referred to June as a “live meeting” referring to a real possibility that rates be raised then. He reiterated that markets had been downplaying the probability that the Fed would take action, and suggested that he was satisfied that expectations had shifted back into focus. Dudley also said that the outcome of the Brexit referendum would be hard to predict, and the potential effects on the US financial markets were uncertain.
Republicans reach an agreement of how the government is going to handle the Puerto Rico default. Republicans and Democrats over the last several weeks have been in discussions regarding how Puerto Rico’s debt burden would be restructured. The bill stipulates that Puerto Rico will be allowed to write down debt, and the island will have to submit finances to a federal oversight board. That board will monitor the island’s financial statements and budgets in an attempt to restore fiscal health. No taxpayer money will be spent under this plan. Puerto Rico has already missed more than $1bn in payments payments on several bonds, and it has another $2bn due on July 1. The country is very tight on cash, and the governor has stated that he plans on using funds to finance civil expenditures rather than repay investors in the near term. Democrats appear poised to accept this bill, and it has been met positively by Treasury Secretary Jacob Lew as well. Puerto Rico’s debt burden relative to the size of its revenues far exceeds that of any other US state. Democrats, Republicans, and Puerto Rico all missed out on parts of the deal they previously wanted, which is indicative of a fair compromise.
Eurozone peripheral bonds appear to be decoupling from several risk indicators according to UniCredit. The spreads between Italian and Spanish yields and German bund yields reflect heightened levels of risk compared to several variables that UniCredit is using to gauge volatility and risk in the Eurozone. The bank uses the Greece – Germany yield spread, the VStoxx (equivalent of VIX for European stocks), as well as implied EUR/GBP volatility to measure the levels of risk priced into the European financial market. By these metrics, peripheral bond spreads are elevated. Ten year Italian and Spanish bonds yield 132 and 142bp higher respectively than the German bund. These appear high assuming that the UK remains in the EU and that Greece comes to an agreement with creditors before July.
Wednesday May 18
Stocks were little changed on the day after the FOMC minutes suggested the Fed is still willing to raise rates June. The S&P 500 and the Dow Jones both moved fractionally to finish at 2,047 and 17,526 respectively. The Fed minutes showed that members of the FOMC thought that a rate hike in June would be warranted if economic data relating to the labor market and inflation continued to meet expectations. Some members of the FOMC expressed concern regarding the outcome of the Brexit referendum. The minutes were received by traders as hawkish, and a rate hike sometime this summer shifted back into focus as a result. The market for Fed funds futures now reflects a 24% chance of higher rates in June and a 42% chance of a hike by July, both of which are up dramatically from earlier in the week. US Treasury yields rose in response. The two year yield rose 6 basis points to 0.89% and the ten year yield rose 8 basis points to 1.85%. The KBW Bank index rose 3.8% on expectations for higher interest rates. The US dollar enjoyed a broad rally, rising 0.8% against the euro to $1.1221 and 1% against the yen to Y110.19. The pound bucked the trend against the dollar rising 0.9% to $1.4593 as the Remain group gains support. Oil prices slid back after a few days of increases. WTI fell 0.9% to $47.86 and Brent lost 1.5% to $48.54.
Members of the Fed are open to another rate rise in June, even though several members cited still present risks to the outlook. The minutes showed that the Fed believed a rate rise would be “appropriate” if economic data continued to come in strong. Since that date the April non-farm payrolls report missed expectations, however this week data on inflation, the housing market, and industrial production all came in stronger than anticipated. One of the chief risks that remains is the Brexit. The referendum takes place one week after the Fed meets on June 14 and June 15. If the UK votes to leave the EU, that could create unwanted turbulence in financial markets. Coupled with the affects of a rate rise, the Fed may be unwilling to take on that degree of uncertainty risk. Nevertheless markets responded in accordance to the hawkish Fed minutes. Stocks fell following the release, yields rose, and the dollar strengthened. In particular utility stocks were hit hardest, losing 1.5% because they are known to pay dividends. Financial shares rallied since banks benefit from higher interest rates. Coupled with comments made Tuesday by John Williams and Dennis Lockhart, it appears that a rate hike this summer is very much in the cards. Both of these members of the Fed suggested that investors were downplaying the chances of a rate hike. Following the release of the minutes the odds of a rate hike rose dramatically. Earlier this week Fed funds futures reflected just a 4% chance that the Fed raises rates. That probability jumped to 28% after the minutes were released, and the odds that the Fed raises rates at least once rose to 75%.
Petrobas issues bonds at high yields which reflect the issues plaguing the company, the country, and the oil industry. Petrobas issued $6.75bn from international investors. The five year tranche, which totaled $5bn sold at a yield of 8.625%. The $1.75bn 10 year tranche yields 9%. Less than a year ago Petrobas issued a century bond at a yield of 8.45%. In the last year Petrobas has been rocked by a bribery scheme that implicates politicians and high ranking officials in the country. At the same time oil prices have plummeted, damaging Brazil’s finances. The high yields also reflect the high degree of debt that Petrobas has. This year alone Petrobas has $13.2bn due and in the following two years another $28.5bn due. The use of proceeds is to pay down existing debt. Initially the size of the deal was supposed to be $5bn. The offering attracted $20bn in bids and as a result the size was bumped. BB Securities, JP Morgan, Merrill Lynch, and Santander led the deal.
LaGuardia issues a $2.5bn municipal bond to finance upgrades to the airport. The deal included a 30 year and 35 year maturity tranches. The 30 year bond priced at a yield of 3.27% and the 35 year yields 3.41%. The offering carries a Baa3 rating (equivalent to S&P BBB-). A BAML index of BBB rated munis for all maturities currently yields 2.88% on average for all maturities. International investors have been a new source of funding for the municipal bond market, increasing demand and driving down yields. The deal was led by Citi, Wells Fargo, and Barclays and was met with high demand from more than 150 investors.
Tuesday May 17
Stocks fall as a potential Fed rate hike shifts back into focus. The S&P 500 fell 0.9% to 2,047 and the Dow Jones lose 1% to 17,529. Economic data today reflected a healthy US economy. Headline CPI rose 0.4% last month compared to estimates which called for a 0.3% monthly gain. Headline and core CPI rose 1.1% and 2.1% respectively on an annualized basis. Industrial production and manufacturing rose 0.7% and 0.3% respectively on the month, both of which were higher than consensus estimates. Additionally housing starts came in higher than expected. This data, as well as comments made by Fed officials suggest that the FOMC may choose to raise rates sooner rather than later. Accordingly Treasury rates rose today. The two year Treasury yield rose 3 basis points to 0.83% and the ten year Treasury yield rose 2 basis points to 1.77%. Oil prices rose on the day. WTI gained 1.7% to $48.51 and Brent rose 1% to $49.45. The dollar index fell slightly on the day. The dollar rose slightly against the euro and the yen to $1.1314 and Y109.09 respectively. The dollar lost 0.4% against the British pound to $1.4464 as opinion polls suggest that the Remain group is gaining momentum.
The US yield curve flattens as investors begin to expect the Fed may take action sooner than previously anticipated. Recent economic data showed that the housing market was on stable ground and that inflation continued its rising trend. Last week’s strong retail sales data and today’s rise in housing starts are both positive indicators for the US economy. Additionally industrial production and CPI both increased by the largest amount in two and three years respectively. This led traders to believe that the Fed may raise short term interest rates. As a result two year yields rose relative to long term interest rates, and the spread between the ten and two year Treasuries touched 94.7 basis points which is the lowest level since 2007. The yield curve has flattened over the last few years as investors anticipate a tightening cycle coupled with low expectations for growth and inflation. Those occurrences put upward pressure on short term yields and downward pressure on long term yields. A flatter term structure negatively affects banks, which is partially why financial shares have been selling off this year. Fed funds futures now reflect an 11% chance of higher rates in June, compared to just 4% yesterday.
The Dell bond issuance was more than four times oversubscribed as demand for credit remains healthy. The issuance attracted $85bn in bids and the size of the offering was bumped to $20bn. That marks the fourth largest bond issuance in history, and comes in second in 2016 behind the AB InBev deal in January. Dell is selling some of its assets to reduce the company’s leverage, and the bond has been secured and structured so that it carries an investment grade rating. In particular high demand came from Asia and Europe, indicative of the low yields in those parts of the world. The thirty year portion priced at 8.36%, and the ten year priced at 6.03%.
Dennis Lockhart of the New York Fed indicates that traders are downplaying the possibility that the Fed will take action on the near end of expectations. Lockhart is not a voting member of the FOMC this year. Over the last few months the market for Fed funds futures has shown a very low probability that the Fed raises rates. Lockhart believes that this may be miguided considering inflation data and signs that growth in the US is improving. Lockhart said that if data continues to show signs of improvement leading up to the June meeting, he may be a proponent of higher rates. This follows similar comments from Eric Rosengren last week. The Brexit referendum complicates matters, which is leading some to predict that July may be a better time to act than June.
Duration risk continues to be a main concern in fixed income markets. As yields have fallen in the US over the past few decades, bond prices have continued to increase and investors have ventured further out on the yield curve in search for higher returns. As a result the duration of a common index of Treasury bonds has risen to a fifteen year high of 6.29. This leaves investors exposed to an increase in interest rates. As economic data out of the US begins to show signs of improvement, some analysts fear an increase in rates. As economic growth rises coupled with inflation, typically Treasury yields rise which should alarm investors with high duration exposure. However other analysts point to signs, such as the international landscape, as reasons that yields will not increase significantly even if the US grows at a healthy pace. For example, weekly inflows into Treasuries from international investors have been positive throughout most of this year. Contributing to this trend is the fact that 80% of outstanding developed market sovereign bonds yield less than US Treasuries according to JPM. This puts downward pressure on US yields.
Monday May 16
Stocks rise along with oil prices as the week starts off on a bullish note. The S&P 500 and the Dow Jones each rose 1% to 2,066 and 17,710 respectively. The bullish sentiment in equities was driven higher by a rally in oil prices, and a 3.7% jump in Apple’s stock price after an investment from Berkshire Hathaway. WTI prices rose 3.6% to $49.95 and Brent rose 2.5% to $49.02, approaching the $50 threshold. Currencies for oil exporters such as Russia, Norway, and Brazil all were stronger against the dollar. Markets were not shaken by data out of China that showed that retail sales, fixed asset investment, and industrial production all missed expectations. As investors bought stocks bond prices fell. The two year Treasury yield rose 3 basis points to 0.79% and the 10 year yield rose 5 basis points to 1.75%. The dollar index fell marginally to 94.56. The euro rose 0.1% against the dollar to $1.1316 and the yen fell 0.3% against the dollar to Y108.95.
Dell is in the process of pricing its $16bn bond issuance to help finance the EMC acquisition. The secured bonds will offer high yields to investors, with the 10 year tranche expected to price around a 6.5% yield. Yields on recent offerings from tech companies have been high as investor demand for bonds from Western Digital and Micron has been low. At the same time large investment grade issuances last week from AbbVie and Chevron may have fulfilled some of the pent up demand. Investment grade bond issuance this year has totaled $506bn, and is moving at a record pace for the fourth consecutive year. The Dell bond is expected to include six fixed rate tenors between three and thirty years, as well as floating rate bonds with maturities of three and five years. The ten year bond is expected to price at +475, which is significantly higher than the +200 that comparable bonds yield on average according to the Barclays corporate bond index. These higher yields are a function of the high level of debt that Dell will take on with this issuance, as well as long term uncertainty in the tech industry.
Credit Suisse is going to issue self-inflicted catastrophe bonds, which marks the first time such a product will be used. These bonds will pay investors a high interest rate, but Credit Suisse will be able to keep principle if self-inflicted events like rogue trading, accounting errors, or IT failures lead to losses in excess of $3.5bn for Credit Suisse. Investors are shielded from one event triggering the bonds. The highest amount that a single operational event could contribute to the $3.5bn threshold is $3bn. Therefore at least two events would be required to trigger the catastrophe bonds. Credit Suisse estimates that the odds of such an event occurring is 1 in 500. European banks are required to calculate the odds of such operational risks, and are allowed to use insurance against such events as capital. The size of the issuance is expected to total $646mm with a yield in the “mid-single digits.” In effect Credit Suisse is using the bond as insurance in the event of those “catastrophe” events. Similar bonds are used by insurance companies who are insuring against the risk of natural disasters.
SandRidge Energy files for bankruptcy protection, becoming just the latest oil company to do so as low prices put pressure on oil producers. Other companies who have met similar fates include Linn Energy, Midstates Petroleum, Ultra Petroleum, and Breitburn Energy Partners among dozens of others. The company will swap $3.7bn in debt that is owned by creditors to equity and control of the company. The reorganized company will concentrate on oil and gas exploration. These issues are also affecting sovereign credit ratings. Moody’s recently downgraded Saudi Arabia, Oman, and Bahrain’s credit ratings also because of oil prices. Saudi Arabia now carries an A1 rating, Oman Baa1, and Bahrain carries a junk rating of Ba2. UAE, Qatar, and Kuwait were not downgraded yet but negative outlooks were assigned. These countries are dependent on oil prices to finance infrastructure projects and other generous social spending programs. In response to low oil prices they have had to cut spending, raise taxes, issue debt, and utilize their foreign reserves.
Friday May 13
Stocks follow oil prices lower and finish off the week with losses. The S&P 500 fell 0.9% to 2,046 and the Dow Jones fell 1.1% to 17,535. The S&P 500 fell 0.6% over the week and the Dow fell 1%. Stocks fell today even in spite of strong retail sales data. Economic data showed that retail sales in the US rose by 1.3%, and excluding cars, gas, and other volatile components sales were up 0.9%. This sends the message that the US consumer is positively contributing to economic growth to start the second quarter. Similarly consumer confidence hit an 11 month high. These data sent the US dollar higher against most peers. The dollar rose 0.6% against both the euro and the British pound to $1.1309 and $1.4365 respectively. The dollar also gained against most emerging market currencies as well. The WSJ dollar index rose 0.5%. The yen bucked the trend and fell 0.4% against the dollar to Y108.64. In spite of the data the market for Fed funds futures still reflects just a 6% chance of higher interest rates in June. The two year Treasury yield fell 1 basis point to 0.75% and the ten year fell 6 basis points to 1.70%. Over the course of the week the yield curve flattened with the 10YR-2YR spread falling nearly 9 basis points over the course of the week. This corresponded with a drop in the KBW Bank Index. Sending stock prices lower today was the oil market. Brent fell 0.5% to $47.83 and WTI fell 1% to $46.25. Brent and WTI were up 5.4% and 3.6% over the week respectively.
Fallen angel debt has outperformed the broader high yield market so far this year. The aggregate bond market has returned 3.7% year to date, and high yield bonds have returned 7%. At the same time, an ETF that tracks fallen angels has returned 10% year to date. This year commodity companies that previously carried investment grade ratings and were subsequently downgraded to junk when oil prices dropped, have rallied as oil prices and other commodities have rebounded. Moody’s has downgraded 19 energy names so far this year, with the majority of those coming before February 11. Since that date oil prices have jumped nearly 80%, which has boosted the prices for energy company bonds. For example a 5 year Freeport McMoRan bond fell to 43 cents on the dollar immediately following a Moody’s downgrade at the end of January. Since that date the price of that bond has risen to 86 cents on the dollar. There is currently $189bn in fallen angel debt outstanding and this total is expected to grow.
Equity funds have experienced outflows as investor demand for the asset class wanes. Equities have benefited dramatically from central bank policies since the financial crisis, however now investors seem to be taking the view that those policies are less effective in driving returns in stocks. So far this year nearly $90bn has flowed out of equity funds, and this week’s total alone is $7.4bn. Investors were not convinced by US company earnings season, and instead are opting to remain on the sidelines. While concerns for a hard landing and plummeting oil prices have eased, new risks have arisen. These include a potential Brexit, elections in Spain, and elections in the US. A recent survey showed that only 20% of investors are optimistic about the stock market, compared to the historical average of 40%. Money market funds and bond funds have been the beneficiaries from outflows in equities. Global bond funds have experienced 11 weeks of inflows in the last 12 weeks. Such funds have received a total of $59bn this year, which exceeds the total amount for the entirety of 2015. Money market funds have had three consecutive weeks of inflows. Investment grade funds in the US also have experienced inflows.
Distressed debt is becoming an attractive investment opportunity in India. Some international asset managers have raised entire funds dedicated to investing in Indian distressed debt while others have increased their allocation for such investments. Companies targeting this strategy include The Canada Pension Plan, PE firm JC Flowers & Co, KKR, and Apollo. This comes after new bankruptcy laws makes it more attractive for debtholders in the event of a bankruptcy. The market size for such debt is large and increasing. The IMF recently said that nearly 40% of corporate debt in India is risky, and that percentage is expected to rise as the economy slows and the dollar rises. The nominal amount of stressed loans has been on a rising trend since 2011 and is continued to increase along with the ratio of stressed loans to overall loans. Banks are attempting to unload exposure to risky companies at the request of the governor of the central bank. This provides favorable opportunities for distressed debt investors. One risk to these strategies is local courts which may not be sympathetic to international investors seeking to profit opportunistically in the country. According to the world bank investing in insolvent companies typically yields 26 cents on the dollar in India following a four year process. This compares unfavorably to the US where distressed creditors typically earn 80 cents on the dollar after 1.5 years of proceedings.
Thursday May 12
US stocks finish little changed after recovering from early session losses. The S&P 500 fell 0.02% to 2,064 and the Dow Jones rose 0.05% to 17,720. Equities swung with oil prices which had a volatile session. WTI touched as high as $47.02 and as low as $45.61 before finishing 0.6% higher at $46.50. Brent rose 1% to $46.08. This week’s jobless claims data was also a minor source of concern. Jobless claims showed that claims rose by 20,000 last week. Over the last three weeks jobless claims have risen by a total of 46,000. While this number seems to be large, it is coming off of a record low in mid-April which may distort the size of the recent gains. Nevertheless it is another negative number that the Fed will pay attention to going forward. The dollar index rose 0.4%. The US currency rose 0.6% against the yen to Y109.05 and 0.5% against the euro to $1.1370. The Nikkei rose on the weaker yen. The British pound rose against the euro and gilt yields rose. The BoE voted to keep interest rates unchanged and updated the inflation and growth outlook. The MPC said that a Brexit would result in a lower growth trajectory and higher inflation. US yields rose. The two year rose 2 basis points to 0.75% and the ten year rose 1 basis point to 1.75%. The Brazilian real fell against the dollar even after impeachment proceedings against Dilma Rousseff advanced. This reflects the economic challenges that the country faces regardless of who is in power.
Municipal bonds in the US have become a popular destination for international investors seeking to find yields. Foreign investors are so starved for yield that they are opting for munis even though they don’t receive the same favorable tax treatment as domestic investors. At the end of last year, international investors owned $85bn of the $3.7tn muni market. That is up from just under $30bn in 2005. US bonds, including munis, are expected to experience a tailwind from inflows from international investors. Muni bonds earlier this year benefited from the risk off trade that was apparent in the first month of the year. The 10 year muni bond yield is currently 1.7% compared to 1.73% for the comparable maturity Treasury. Also reflecting of higher demand is mutual funds and ETFs that track munis. Such funds have received inflows for 31 consecutive weeks, totaling just under $20bn in new money flowing into the asset class. Muni bond issuances have been attracting high demand. At the same time supply has been reduced in part due to political stigma associated with high levels of municipal debt in the aftermath of the financial crisis.
In spite of the heightened uncertainty relating to the potential Brexit next month, bond issuance has followed issuance in the US and EU higher. USAF issued a p125mm bond today. Yesterday the retailer Next issued a p350mm bond, with both bonds attracting strong demand. As a result of Brexit uncertainty issuance in the UK is down significantly this year, falling 63% compared to this time last year. The BoE said today that a Brexit would have heavy economic costs including higher unemployment and higher inflation. Other negative ramifications that have already been observed include delays in household spending and delays in business investment. The BoE refrained from offering any additional information regarding how the referendum outcome may affect interest rates. The EU and the US are both becoming increasingly important sources of funding for companies relative to the UK, which may also account for part of the drop in sterling issuance. The heavy supply in the EU market has provided support for sterling issuance. At the same time recent issuance may reflect banks and corporations attempting to complete deals before the referendum occurs.
Gold was in high demand in the first quarter as a result of low interest rates and volatility in other asset classes. Demand for gold rose 21% in the first quarter, which pushed prices up 17%. Gold demand reached the highest level since 2009 at the height of the financial crisis. It is expected that ongoing central bank policies will continue to encourage demand for the metal. Low and in some cases negative interest rates make gold more attractive relative to bonds. Goldman Sachs recently downgraded its forecast for interest rates in the US over the next year, and at the same time raised its 12 month gold price target. This refers to higher investment demand for the commodity. Physical gold demand for gold has fallen this year as jewlery demand in countries such as China and India has dropped.
Wednesday May 11
Stocks experience losses in a broader risk off movement. The S&P 500 fell 1% to 2,064 and the Dow Jones fell 1.2% to 17,711. Poorly received earnings from Disney and Macy’s led to concerns relating to the US consumer and retail industries. The Japanese yen rose 0.8% against the dollar to Y108.41 in the absence of any verbal intervention from Japanese officials. The euro rose 0.5% against the dollar to $1.1425. The dollar fell against emerging market currencies, and the weaker dollar pushed up gold prices. Data from the Department of Energy showed that crude stockpiles fell by more than 3 million barrels versus expectations of a gain. As a result oil prices rose with Brent gaining 4.6% to $47.60 and WTI gaining 3.2% to $46.09. The two year yield was flat at 0.73%. The ten year US yield fell 2 basis points to 1.74%. Yields on Greek debt continued to fall, losing 30 basis points to 7.47% on continued hopes for some type of debt relief agreement.
Investors are trying to gauge the potential effects of a Brexit on financial markets. Within Britain, the pound, stocks, and real estate markets have already been affected so far with traders trying to get ahead of the potential ramifications. The British pound is widely expected to depreciate in the event of a vote to leave. This is because a Brexit may result in capital outflows, as well as a reduction in capital inflows going forward. A senior economist at Citigroup expects that the pound may depreciate by 15-20% in the event of a Brexit. To reflect these concerns the pound has fallen 11% over the last year and the cost for investors to protect themselves against depreciation has risen. Stock prices, especially financials, are also likely to fall in the event of a Brexit. Companies based in the UK may lose the ability to easily sell their products and services in other EU countries, which would reduce their prospects going forward. Financial shares may slide as a result of lower commercial credit growth in the aftermath of a Brexit. The effect on the gilt market is more uncertain. On one hand gilts may outperform as a result of expectations for lower growth, lower inflation and expectations for lower rates for longer. On the other hand international investors so far this year have been net sellers of gilts as uncertainty around the Brexit grows. Lastly the property market is expected to fall in the event that the UK votes to elave the EU. These concerns have already been reflected in falling stock prices for commercial real estate and homebuilders. The high end corner of the market has been especially hit hard, as investors fear that the Brexit would lessen Britain’s appeal as a store of wealth for international buyers.
Spain continues the trend of issuing long maturity debt with a 50 year bond sale. European countries have been able to lock in low rates for long periods of time due to demand for yield and demand for bonds under the ECB’s QE program. At the same time long maturity debt has had healthy returns this year both in Europe and in the US. For example Eurozone government debt with maturities greater than 15 years have returned almost 9% year to date. As a result of demand for such bonds countries have been eager to issue long maturity debt. France and Belgium last month issued 50 year bonds. Switzerland recently announced a 42 year bond. Ireland and Belgium have both sold 100 year bonds in private placements. Spain’s half-century bond will have a coupon of just 3.5%. Demand for these bonds has been quite high. For example France was originally supposed to issue e2bn, however the bond attracted e6.75bn in bids and the size of the offer was raised to e3bn. The Spanish issue attracted e10bn in orders. This is a function of the fact that half of the eurozone government debt market has a negative yield.
Dell is planning a $16bn bond issue to finance the $60bn acquisition of EMC. The bonds will carry an investment grade rating. In addition to this issuance Dell plans on raising secured loans and unsecured bonds to finance the deal. While the demand for corporate credit has been sporadic this year, high quality large issues have been en vogue for investors. To reflect this on Monday of this week $25bn in investment grade bond issuance hit the market which was the fourth largest total for any day since 2006. The $16bn sale from Dell would be the largest issuance of this year. The secured bonds from dell will carry an investment grade rating, while the unsecured bonds will carry a junk rating with a maximum yield of 12%. Analysts believe that by telegraphing the issue ahead of time Dell will help increase the demand.
Tuesday May 10
Stocks have a strong day after oil prices rebound. The S&P 500 and the Dow Jones each rose 1.3% to 2,084 and 17,928 respectively. Rising oil prices contributed to optimism today. WTI rose 2.5% to $44.53 and Brent rose 4.3% to $45.50. Also, lingering expectations that the Fed will keep rates lower for longer after Charles Evans comments and Friday’s data may be pushing equities higher as well. The dollar continued its rally against the Japanese yen after comments made from Japanese officials suggest FX intervention is a possibility. The dollar rose 0.9% against the yen to Y109.37. The dollar also rose 0.1% against the euro to $1.1367. Thus, the dollar index rose 0.2% on the day. US yields ticked up from Monday’s lows. The two year yield rose 2 basis points to 0.73% and the ten year rose 2 basis points to 1.76%. The VIX fell to 13.45. Also contributing to the positive sentiment today was news out of Greece. It appears that Greece and its creditors are closing in on a debt relief deal. As a result the Greek 10 year yield fell 59 basis points to 7.84% and stock prices in Greece rose.
Goldman Sachs and Jefferies announce that they will hold off from buying LendingClub loans in the aftermath of revelations that the former CEO previously mismarketed loans it sold to banks. Lending club makes consumer facing loans and matches borrowers with lenders. It is therefore reliant on the ability to resell those loans to investment banks, who securitize the loans and sell them to investors. The founder and former CEO of LendingClub, as well as three other senior executives were removed after it was discovered that loans were sold to Jefferies that did not meet investment criteria. Jefferies had been looking to issue around $150mm in securitized consumer loans from LendingClub in early May. Goldman Sachs had planned on offering a similar deal in the near future as well. These deals have both been delayed now pending further review of LendingClub’s own investigation. LendingClub shares have fallen dramatically in response to this situation.
At the same time the US Treasury issued a report that criticized this business model. In the aftermath of the financial crisis and subsequent regulations on large financial institutions some financial service activities shifted outside the traditional banking sector to upstart companies like LendingClub, SoFi and OnDeck Capital. This sector so far has evaded regulation, however the white paper released today is the first time a regulatory authority has tried to supervise the industry. The report called into question the ability of these companies to function in the downturn of a credit cycle, and warned of a deterioration in loan quality. These companies have had relative success when the credit cycle was in an upswing, when rates are low, unemployment falling, and credit conditions easy. Fortunes may change as the credit cycle starts to turn, which many analysts are warning about. The Treasury recommended the creation of an agency to monitor online lenders, among other initiatives.
Distressed investing opportunities may become available in China as the credit cycle starts to mature. China’s GDP growth is being driven exclusively by credit growth. As this cycle becomes less sustainable and non-performing loans in China begin to tick up, which seems inevitable, there will be an abundance of opportunities to invest in loans at highly depressed prices. Credit growth in China has been unprecedented since 2008. Private sector debt, excluding financials comprises nearly 250% of GDP, and this dramatic increase has been spurred by the government. Increasingly in recent months the PBoC has further stepped on the gas pedal. Defaults have already started to pick up this year and credit spreads have widened. Chinese banks ICBC and Cinda with the help of the government have each set up groups within their asset management divisions to invest in distressed loans. So far these businesses have attracted strong yields. In 2015 alone nearly Rmb400bn ($61.4bn) in distressed loans were purchased in China. So far the activity in this area has been contained to entities within China. Some international investors are skeptical to enter this opportunity due to a lack of transparency from a regulatory perspective.
Monday May 9
Stocks start the week on a mixed note as oil prices fall and the dollar appreciates. The S&P 500 rose less than 0.1% to 2,058 and the Dow Jones lost 0.2% to 17,705. Oil prices fell after the oil minister in Saudi Arabia was removed. WTI fell 3% to $43.32 and Brent fell 4% to $43.55. This comes even as wildfires in Canada risk a decrease to production. Additionally the dollar index rose 0.6% on the day. The dollar rose 1.1% against the Japanese yen to Y108.34 after indications that the BoJ may be willing to intervene in the FX market. The dollar also rose 0.2% against the euro to $1.1385. The dollar also gained against emerging market currencies, most notably the Mexican peso. Also contributing to the cautious sentiment was a 3% plunge for the Shanghai Composite as a result of concerns for the sustainability for the Chinese recovery. The two year yield fell 2 basis points to 0.71% and the ten year fell 3 basis points to 1.75%.
Corporate bond issuance is picking up after a sluggish start the year in both the US and in Europe. In Europe Shell, Airbus, AstraZeneca and Deutsche Bank sold a total of e4bn today. AstraZeneca is expected to pay around 0.5% for a five year bond and Shell is expected to pay 1.5% for 12 years. These companies are timing their issuances ahead of the beginning of the ECB’s corporate bond buying program, the UK referendum, and the Spanish elections. In hitting the market now these companies hope to attract the lowest borrowing costs. In the US Chevron and AbbVie both announced deals. Especially in Europe, yields have been consistently falling as spreads tighten and coupons get steadily lower. Gains from increasing prices have offset some of the negative attributes of lower coupons. Eurozone investment grade debt has returned 3% year to date. This week alone analysts are expecting e25bn in new deals to hit the market in Europe. This is expected to eclipse the week earlier this year in which e23bn was raised (much of it from the e13.5bn issuance from AB InBev). With earnings season coming to a close companies are looking to raise new debt. “Reverse yankee” bonds currently account for 28% of the Eurozone issuance year to date, and that amount is expected to increase further according to some analysts.
The finance minister in Japan says that he is “prepared to undertake intervention” if the yen appreciates further in a dramatic fashion. The Japanese yen has appreciated sharply this year even in spite of extensive efforts by the BoJ to weaken the currency. The finance minister view the sharp appreciation as out of line with fundamentals and excessive and thus are willing to intervene. Comments out of Japan suggest that the US Treasury sees the yen appreciation differently, and is opposed to any intervention. This coincides with a report issued last month that noted Japan as a country whose exchange rate policy should be monitored relating to potential efforts to gain unfair competitive advantage. In response Japan said that this action by the US won’t have any affect over its future policies.
Charles Evans of the Chicago Fed says that the Fed should aim to overshoot the 2% inflation target. Given how evasive inflation is right now across the world, the Fed should be on the safe side and try to overshoot its target. By being willing to let inflation go higher than 2%, the Fed hopes that it will be easier to hit the target. Evans suggested that this will help the FOMC more easily and sustainably restore inflation. Slow GDP growth in the first quarter and the recent slowdown in payrolls both pose challenges. Brexit uncertainty further complicates matters. This argument from Charles Evans reflects the idea that risks are not balanced and that it is better than be safe than sorry.