Thursday September 15

Stocks and rates both rallied as the strong correlation between the two continue. The S&P 500 rose 1% to 2,147 and the Dow Jones added 1% to 18,212. Information technology shares led the S&P 500 as a result of a strong performance from Apple. Economic data today showed that jobless claims continued to indicate strength in the labor market. Additionally the producer price index showed no change in prices from the prior month which was slightly below expectations. Retail sales fell 0.3% in August compared to the prior month compared to expectations which called for no change. These data indicate that there is not much immediate pressure on the Fed to raise interest rates, and the weakness of PPI and retail sales take some ammunition away from Fed hawks. As a result short term rates rallied resulting in bull steepening of the yield curve. The two year yield fell 3bp to 0.73% and the 10 year yield fell slightly to 1.69%. The spread between 10s and 2s bull steepened to 0.96%. USD fell against JPY to Y101.92. USD moved slightly against EUR to $1.1245. USD was for the most part unchanged against GBP to $1.3238. Brent rose 1.6% to $46.59 and WTI rose 0.6% to $43.86. One of the reasons for the rally in oil prices is a pipeline crack in the US.

As a result of low yields globally international investors have been buying US Treasuries to find yield. They then use cross-currency swaps to hedge themselves against a depreciation in USD relative to their home currency. However demand for these hedging transactions is so high, that the cross currency basis has gotten expensive to the point that the benefits to holding Treasuries has fallen. The cost of hedging has eroded returns of returns for some international investors that they are now indifferent between holding hedged Treasuries and their own domestic bonds. For example the yield between the 10 year Japanese government bond yield and the currency-hedged equivalent maturity Treasury has fallen to the point where they are roughly equivalent now. That spread was as wide as  2% at the start of 2014 but has fallen to just 0.02% now. Japanese investors earn -0.02% on a hedged 10 year UST compared to a -0.04% on a 10 year JGB. As international investors become indifferent to buying and holding UST that could reduce some of the downward pressure on Treasuries. Accordingly over the last few weeks investors from Japan have been net sellers of US Treasuries for the first time in several months. With overseas buyers being taken out of the market that could be a headwind for Treasuries which have been some of the strongest performers year to date as a result of international buyers.

The rate selloff over the last week and a half has reduced the value of negative yielding debt outstanding. Before the selloff began analysts noted that there was close to $14tn in negative yielding sovereign debt. As yields have risen that amount has fallen to $12.6tn this week. Among other bonds the German 10 year rose to 0.04% from negative territory. The ECB failed to mention any continuation or expansion of its quantitative easing program and the BoJ also cast doubt over the future of its easing program which led to the selloff. Yields in peripheral eurozone countries have been the hardest hit as it appears that ECB quantitative easing expectations had been largely supporting prices. Next week policy announcements from the BoJ and the Fed will provide some more clarity on monetary policy and thus direction for global rates.

Real estate companies now have their own classification on stock indices and there are now 11 industries. Formerly those companies were part of financials, however they share different characteristics in a variety of ways. For example banks have struggled with low interest rates since it reduces net interest margin. However real estate companies benefit from low interest rates, as low rates push up valuations and push investors into the dividend heavy sector. Real estate companies pay a dividend of 3.2% which is nearly 1% higher than that of the broader S&P 500. The new sector will include REITs, management, and development companies. Real estate companies now make up slightly more than 3% of the S&P 500 and have returned 2.88% year to date. Financials make up nearly 13% of the S&P 500 and have returned -0.55% year to date. Financials are just one of three sectors that have negative returns so far this year. Weekly inflows into REIT ETFs have been on the rise consistently throughout the week, surpassing $6bn in September. Now that real estate companies have their own weighting in the S&P 500, asset managers may have to increase their holdings of REITs since they are no longer classified with financials.

Thursday September 15

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