Wednesday September 14

Stocks fell marginally today after the three day bout of volatility comes to an end. The S&P 500 fell less than 0.1% to 2,125 and the Dow Jones fell 0.2% to 18,034. Utility shares outperformed today and the KBW Bank index fell 0.6%. Economic data today showed that both import prices and export prices fell by more than expected which continues to indicate muted inflationary pressures from abroad as a result of a stronger USD. Oil prices continued their selloff as the EIA data showed that inventories fell by less than expected. WTI fell by 2.7% to $43.69 and Brent fell by 2.4% to $45.99. Accordingly energy companies in the S&P 500 fell 1.1%. In Japan financials sold off as reports circulated that the BoJ would focus monetary easing on lower interest rates rather than additional asset purchases. Even so the dollar fell 0.2% against JPY to Y102.39. USD was lower 0.3% against EUR to $1.1251. USD fell 0.3% against GBP to $1.3237. Rates rallied as the 10 year fell 2bp to 1.70% and the 2 year fell 3bp to 0.77%. The spread between 10s and 2s bull steepened to 93bp.

Although banks and hedge funds in some ways benefit from higher volatility, in other ways it creates challenges for their business. Funds that use leverage may be subject to margin calls as prices of bonds and stocks swing wildly. Additionally risk-parity funds use a strategy that involves the use of leverage, futures, and other derivatives to magnify the returns of safer assets such as bonds. However these funds are subject to large losses in the event of volatile selloffs which has happened over the last few days. Risk-parity funds use leverage to equalize the volatility of safe assets such as bonds with more volatile assets such as stocks, which could result in favorable risk-return characteristics. This strategy is attractive during times of low volatility however during selloffs, funds may be forced to deleverage. Some analysts have expressed concern that deleveraging and forced selling from risk-parity strategies may pose systemic risk since the selling could cause even further volatility.

More clarity is being provided on the BoE’s bond buying plan. The central bank still plans on buying 10bn GBP in corporate bonds over the next 18 months, and the size of each sector will be proportionate to its share in the market. As a result bonds from energy companies, which make up 25% of the outstanding market, will be the biggest recipient. Consumer non-cyclicals will be the second most and industrial & transportation will makeup the third largest recipient of BoE purchases. This comes at a welcome time for energy companies, who’s spreads have been volatile along with oil prices. As the BoE steps in as a buyer that could put some downward pressure on spreads. The BoE will target bonds of companies that make “material contribution to the UK economy” and will steer clear of more complex structures. Significant contribution may include number of employees in the UK, headquarters there, or customers served. They will only buy bonds in the secondary market. Foreign companies on the list include Apple, Verizon, AT&T, BMW, and Daimler. This is one of the BoE’s actions that was taken into effect to counteract the Brexit vote. The BoE hopes to stimulate the economy and encourage higher spending from business and households.

Noble Midstream Partners tests the IPO market and raises $281mm in equity. The shares prices at $22.50 which was outside the high end of the expected range of $19 to $21. This was the first MLP IPO in more than a year which may partially explain why it was met with decent demand. MLPs are not directly tied to oil prices since they make money on volume and flow of oil through the pipes as opposed to value. They strike long term contracts with oil producers who want to transport oil through their pipeline. However the sector struggles as the oil selloff intensified over the last few years as some investors speculated that oil companies may try to break their agreements with MLPs. For example last November when Noble Midstream Partners tried to IPO it was not met with enough demand from investors. Inflows into MLP funds last year fell 78% from the prior year. That trend has reversed this year as $3.8bn has flowed into the sector. Since todays deal priced well maybe other MLPs may elect to follow suit over the next few months. Barclays, Baird, and JP Morgan led today’s deal.

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Wednesday September 14

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