Wednesday September 7

US stocks were flat on the day along with yields and the US dollar. The S&P 500 fell very marginally to 2,186 and the Dow Jones fell less than 0.1% to 18,526. Economic data today showed that job openings rose to 5.871 million which continues to indicate labor market strength. The market for Fed funds futures shows just a 22% chance of higher rates in September. The 10 year yield was unchanged at 1.54% and the 2 year yield was unchanged as well at 0.74%. The dollar index rose less than 0.1%. USD rose 0.1% against EUR to $1.1243. USD fell 0.3% against JPY to Y101.73. USD rose 0.74% against GBP to $1.334. Brent rose 2.6% to $48.49 and WTI rose 2.9% to $46.11.

John Williams of the San Francisco Fed came out with a hawkish statement. Williams seemed upbeat on the future for the labor market the the US economy, and suggested that it was still appropriate to raise interest rates. This comes after the August NFP report pared back expectations for when the Fed will next raise interest rates. The probability of higher rates this month is currently less than 20%. He expects unemployment to fall to 4.5% and that inflation will hit the target over the next couple of years. He also suggested that he would prefer to raise rates too soon rather than too late, which is contradictory to comments made by some other FOMC officials over the last year. He expressed concern over letting the economy overheat which could potentially cause imbalances such as bubbles and excessive inflation. Williams is typically hawkish and he is a non-voting member of the FOMC this year. Williams recently published a report saying that he believes the natural rate of interest will be lower going forward. In that report he stated that the lower natural rate of interest will leave the Fed with less room to maneuver in the event of a downturn, which could result in longer and deeper recessions. In response to this problem Williams said the Fed should let inflation run a little high going forward.

Social Finance (SoFi) is in the process of raising $500mm through a private equity offering. Peer lenders lately have been struggling as investors have raised concerns about the online lending platforms. Risks include the credit risks to the loans being given out on the platforms and the sustainability of the business model. SoFi plans on using the proceeds of the issuance to finance growth to bring more loans to more people. Some online lending platforms have postponed IPOs as markets are still assessing the impact of the LendingClub scandal earlier this spring on the sector. Investors have been backing away from those loans and banks have been turned off after LendingClub got in trouble for mismarketing loans. Additionally loan volumes fell 34% in the first half of this year. Companies facing these problems include LendingClub, Prosper, and Avant and each have been forced to cut jobs and raise interest rates for borrowers. SoFi is a little different in that it focuses on student loans as well as borrowers with high incomes but that are not rich yet. Additionally SoFi is expected to earn a profit this year, which also makes it a safer investment in some ways than peers who are not yet generating positive income.

Similar to emerging markets, investors have been pouring funds into high yield which is putting downward pressure on yields. Year to date investors have put $6.4bn into high yield funds, which compares with a total of $47.7bn in outflows over the previous three years combined. Spreads on high yield bonds according to Barclays indices have fallen from 700bp to just over 500bp currently. After initially rising to 900bp at the start of the year spreads have been on a downward trend since February. Many investors, including Bill Gross have argued that investors are not getting compensated enough for the risks they are taking in that sector. In some ways it is a crowded trade that is exposed to the possibility of a correction. Sprint has two year bonds that carry a 4% yield, which is down 200bp since June in spite of fairly significant credit risk. Although spreads are low now, they are still relatively high compared to before the 2008 financial crisis, when spreads were just 2.5%. Risks to high yield include a pickup in defaults (which is forecasted by many analysts) as well as higher interest rates from the Fed which makes high yield look worse from a relative value perspective. However they will remain supported from a technical perspective, and as long as defaults and yields in the US remain muted the high yield rally may continue.

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Wednesday September 7

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