Tuesday September 6

Stocks rose today and yields fell as dovish expectations continue. The S&P 500 rose 0.3% to 2,186 and the Dow Jones rose 0.25% to 18,538. Utilities rose 1.11% while financials fell 1.07% which reflects the change in monetary policy expectation. Also contributing to this change in sentiment was the ISM non-manufacturing index which came in at 51.4 versus the estimated 55.0. The service sector is a big component of the US economy, and a slowdown in that sector may leave the Fed to exercise more caution. Following this data the US dollar dropped and Treasuries rallied. USD fell 1% against EUR to $1.1253. USD fell 1.4% against JPY to Y102.03. USD fell 0.9% against GBP to $1.3429. The two year Treasury rallied 5bp to 0.74% and the ten year rallied 7bp to 1.54%. The spread between 10s and 2s bull flattened 1bp to 0.80%. Accordingly the market for Fed funds futures priced down the probability of the Fed raising rates later this month. WTI finished at $44.83 while Brent finished at $47.27. Energy companies led indices as a result of the headline over the weekend that Saudi Arabia and Russia may cooperate to cap output.

Banks have been offering new types of CDs to customers in response to low interest rates. CDs allow bank customers to lock up their savings for a period of time in return for earning higher interest rates. By giving up liquidity they earn a higher return. Banks are now offering market-linked or structured CDs, and the return on those depends on the performance of underlying stocks or assets over the life of the certificate. Depositors will receive the original amount they put into the CD at the end of the certificate along with some performance return. The volume of these CDs has risen consistently since 2012 and currently stands at $22.7bn. However returns on such products tend to be lower than those on ordinary CDs. Analysis from the WSJ showed that between CDs issued by BNP Paribas and Barclays over the last six years only between 25% and 38% produced returns higher than a conventional CD would have. According to the WSJ approximately 80 structured CDs of the 118 issued had returns lower than the average conventional CD. Banks like these products because it is a cheap source of funding and they are able to collect fees for arranging these types of deals. Financial advisers, wholesale brokers, and bank tellers all receive high commissions for selling these products to clients. Returns are capped both on the high and low end which could distort returns for investors. Gains are typically capped at a tighter level than losses.

Many investors are turning to emerging markets as a source of yield in the current environment, however there may not be enough bonds to go around to accomodate the new demand. Yields in emerging markets are significantly higher than they are in developed markets. Those range from 1.4% South Korea to as high as 8.4% in Russia, with an average of 6.0% according to BAML indices. In search of these attractive returns investors have poured funds into emerging markets, which have recorded $20bn in inflows each month for the past couple of months. The total amount of outstanding emerging market bonds available for investors is around $18.5tn, however $15.5tn of that total is local currency debt which isn’t actively traded by investors. Sovereign bonds total $850bn, and internationally issued bonds from EM banks and non-financial corporations totals $2tn. As large institutional investors continue to move into this space supply is likely to dry up quickly. This would quickly lead to a rally and lower yields. Investors would have to then assess if they are being adequately compensated for taking the risks entering emerging markets.

Two European multinational companies recently issued debt at negative yields for short term debt. Henkel (Germany) and Sanofi issued bonds with yields of -0.05% which is indicative of how unconventional monetary policy has changed capital markets. These companies now join BP, BMW, and Deutsche Bahn as companies that have issued negative yielding debt to public investors. The ECB continues to purchase corporate bonds, which is putting significant downward pressure on yields.

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Tuesday September 6

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