Friday September 9

Stocks and rates sold off today on continued monetary policy concerns. The S&P 500 fell 2.5% to 2,127 and the Dow Jones fell 2.1% to 18,085. Utilities and transportation shares fell 3.8% and 3.1% respectively. Bank shares outperformed indices since they benefit from higher interest rates but still fell 1%. Investors drew concern today from hawkish comments made from FOMC officials coming off of the ECB’s statement yesterday. The VIX shot up nearly 40% to 17.5. Over the course of the week the S&P 500 was 2.4% lower and the Dow Jones was 2.2% lower. Driving volatility today was comments made by Eric Rosengren of the Boston Fed who suggested that higher interest rates may be warranted. In response to those comments rates sold off in both the US and in Europe. The 10 year yield sold off 7bp to 1.67%. The 2 year yield rose 2bp to 0.79%. The spread between 10s and 2s bear steepened to 0.89%. Hawkish statements typically affect the short end of the yield curve more than the long end, so it is counter-intuitive that the yield curve steepened. In Europe yields also continued to rise. The 10 year bund yield rose 7bp to 0.01%. Equivalent maturity Italian yields rose 9bp to 1.25% and Spanish yields rose 10bp to 1.08%. Markets are currently pricing in a 36% chance of higher rates at the Fed meeting later this month however Jeff Gundlach suggests that the market is underpricing the possibility. The dollar was stronger across the board, which put pressure on commodity prices. USD rose 0.3% against EUR to $1.1234. USD rose 0.2% against JPY to Y102.71. USD rose 0.2% against GBP to $1.3269. WTI fell 4% to $45.71 and Brent fell 4.2% to $47.88.

The German 10 year bund yield entered positive territory for the first time since July. Investors had been building up long positions in bunds under the expectation that the ECB would continue and even expand its asset purchases. Traders hoped that the program would be expanded in both size and duration, however their expectations were not met when the ECB met yesterday. That along with hawkish comments made from the FOMC today led to a selloff in rates in Europe. Investors are also worried that the BoJ’s easing program is nearing the end of its rope. If it is the case that central banks are planning on stepping back from their easing stances then their may be a large correction in global fixed income markets. More hawkish statements from the ECB and the Fed also reduce pressure on the BoE to maintain its easing bias.

Eric Rosengren of the Boston Fed said that there is a “reasonable case” to be made in favor of raising interest rates slowly. He cited concern that the economy may begin to overheat which could potentially cause problems such as asset bubbles and imbalances in the economy. He pointed to the commercial real estate market as a place that might be starting to overheat. He said he is a proponent of gradual tightening so that they aren’t forced to tighten aggressively and abruptly if the economy starts to overheat. This comes after comments he made last month that investors were getting too complacent. Rosengren also said that he views the risks skewed in favor of the economy running too hot as opposed to deflationary risks. Rosengren is typically on the dovish end of the spectrum and he is a voting member of the FOMC. Daniel Tarullo also made a statement that although it was not as hawkish as Rosengren’s, it certainly was not interpreted as dovish.

The BoJ is running out of JGB’s to buy which is posing a challenge to its currently monetary policy programs. The share of government bonds that are held by the BoJ has risen significantly since 2011 while the share of JGBs owned by Japanese banks has fallen. The BoJ currently owns nearly one third of the government bonds outstanding which is expected to rise to 60% within the next two years according to some analysts. At the current rate the BoJ is buying nearly $750bn worth of debt each year. Japanese banks need to hold a certain amount of government bonds according to regulations and that is becoming increasingly difficult given the current environment. As a result there are practical limits to the BoJ’s current stance and it may not continue for an extended period of time.

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Friday September 9

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