Friday September 30

Stocks rose today as Deutsche Bank’s concerns seemingly subsided. The S&P 500 rose 0.8% to 2,168 and the Dow Jones rose 0.9% to 18,308. On these tailwinds financials and energy shares led indices rising 1.4% and 1.3% respectively. Economic data today showed that personal income and personal income came in roughly as expected. The PCE deflator on a year over year basis was 1.0% and the monthly number was just 0.1% which was just lower than expected. The core number on an annual basis was 1.7% which met expectations. On this backdrop rates rose, as the two year Treasury yield rose 3bp to 0.76%. The ten year Treasury yield rose 3bp to 1.59%. 2yr vs 10yr bear flattened 1bp to  0.83%. USD was down 0.1% against EUR to $1.1235. USD was virtually unchanged to GBP at $1.2972. USD rose 0.3% against JPY and finished at Y101.35. WTI rose 0.5% to $48.05. Brent rose 0.8% to $40.19 eclipsing the $50 mark for the first time since the start of the month. The market for Fed funds futures currently reflects a 60% chance of higher rates by the end of the calendar year.

Clients are reducing exposure to Deutsche Bank as a counterparty. In this way hedge funds are replacing their contracts with DB in exchange for derivatives with other banks. There is no upside to maintaining Deutsche Bank exposure but the downside is huge. Additionally hedge funds have been pulling cash from their prime brokerage accounts held at DB. This is creating a great deal of volatility in the financial sector and the broader markets in general. Shares fell as much as 8% at the open in Germany on these concerns. Similarly CDS spreads on DB’s European senior debt are up to 240bps. This comes after reports that AQR, Capula, Citadel, Magnetar, and Millennium have all cut exposure to the bank and the amount of exposure pulled is said to be in the billions. This becomes a self-fulfilling prophecy over time since when clients cut business DB gets worse financially so their problems magnify. John Cryan and other senior executive have been meeting with top clients to assure them of financial stability. DB insists that its liquidity position is stable and that it is not a repeat of the Bear Stearns or Lehman Brothers situations. Deutsche Bank currently holds liquid assets that amount to 12% of its assets, compared to 7.5% for Lehman Brothers before it went bankrupt. It did not help matters earlier this week when Angela Merkel said that the German government would not step in and support DB if needed.
Institutional investors in the UK are facing low interest rates just like investors in many other locations around the world. To combat these issues they are choosing to go further out on the yield curve and extend their duration risk. Low interest rates due to low growth as well as quantitative easing by the BoE have led gilt yields to fall to notable lows, pushing investors further out on the term structure. The longest maturity UK gilt has fallen 1.11 percentage points over the last year, compared to a 0.99 decrease for the Japan 40 year which is the next largest decrease. By comparison the US 30 year yield has fallen 0.59 percentage points. Defined benefit pension plans are obligated to return a set amount to their pensioners as opposed to defined contribution plans. This increases demand for long dated assets, so much so that the 50 year yield at 1.27% has fallen below the 30 year yield at 1.39%. Researchers estimate that pension funds take up roughly 80% of the market for that longest maturity.
Subprime auto loans continue to show signs of deterioration. From the pool of collateral that backs ABS 4.86% of the loans were delinquent on payments by at least 60 days. That number compares to just 3.98% last year. Annualized net losses was up nearly 2 percentage points to 8.89%. Underwriting standards have deteriorated over the last few years as lenders seek to keep selling cars, and loan terms have gotten longer to accommodate more borrowers. Falling values for used cars is also not ideal for investors, as recovery rates will decrease as a result.
Friday September 30

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