Wednesday August 17

Stocks in the US today rose marginally after the Fed minutes were released. The S&P 500 rose 0.2% to 2,182 and the Dow Jones rose 0.1% to 18,573. Utilities reversed course from yesterday and outperformed as the minutes were interpreted as dovish. The minutes showed that the Fed is still in wait and see mode and that there are still ample amounts of both hawks and doves. USD was flat against JPY at Y100.31 The euro rose slightly to $1.1281 after touching as high as $1.1315 post minutes release. Treasuries rallied slightly, with the 10 year falling 3bp to 1.55% and the 2 year falling 1bp to 0.73%. Consequently 10s 2s bull flattened on the day. Oil prices rose after US crude inventories fell. Brent fell 1.3% to $49.85 and WTI rose 0.6% to $46.86.

Credit investors are not willing to invest in long term corporate bonds in light of expectations that the Fed will raise rates. Companies have been selling less debt with maturities greater than 10 years which is partially a reflection of low investor demand for those bonds. Up until this year the percentage of corporate debt issuance with maturities greater than 10 years was on a rising trend, however this year it has fallen from 30% to 25%. This could indicate that investors are anticipating a rate hike, and as a result they are less willing to lock up capital for long period at current levels. Similarly bonds with longer durations will be the most negatively affected by higher interest rates. Companies on the other hand prefer to issue long term debt to lock in rates at the lowest possible level for a longer period of time.

The minutes show that the Fed is divided over the best course of action, while a rate hike at some point this year remains in the cards. Right now it appears as if the FOMC is in wait-and-see mode. Some Fed members are in favor of a rate hike in the very near term while others want more signs of inflationary pressures. Two officials wanted a rate hike at the last meeting. Minutes note that the continued strengthening of the labor market and favorable market reaction to the Brexit helps reduce some of the uncertainty for the time being. With growth expected to pick up in the third quarter, continued tightening in the labor market as well as improvement in inflation numbers could result in another 25bp hike. Continued easing by foreign central banks makes it more difficult for the Fed to take a tightening stance.

Portugal’s bonds sold off as a result of sovereign ratings concerns. Concerns are mounting that the country’s bonds may not be eligible in the ECB’s bond buying program. The 10 year yield rose 11bp to 2,94% after DBRS (rating agency) cast doubt over the country’s investment grade credit rating. DBRS is the only institution that holds Portugal as investment grade, which is the only thing keeping it eligible for ECB purchases. The IG designation also maintains cheap access to funding for Portuguese banks. 0.2% annualized growth in the second quarter reaffirms concerns for growth in the country. Portuguese banks are in a struggle since they currently borrow e24.8bn from the ECB with PGBs making up a large amount of the collateral. However yields are still not at their highest level YTD. In February 10 year yields hit 4.4%, and after Brexit they hit 3.6%. The next rating decision for Portugal will come on October 21.

Wednesday August 17

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