Wednesday October 26

Stocks today were mixed as Treasury yields continue to tick up. The S&P 500 fell 0.2% to 2,139 and the Dow Jones rose 0.2% to 18,199. The KBW Bank index continued its ascent. Economic data today showed that the PMI Services flash index rose to 54.8 which is a healthy pickup from last month. New Home sales missed expectations however still indicates strength in the housing market. EIA data showed that stocks fell by 553k barrels versus expectations which called for an increase of more than 1mm barrels. Prices still fell as investors continue to doubt that production cuts Opec will materialize, as Iraq recently requested to be exempt from the cap. Apple’s outlook gave investors reason to sell, Southwest also missed expectations, as did Chipotle. Rates in the US and Europe rose today. Two year Treasuries rose 1bp to 0.87%, and the ten year rose 3bp to 1.79%. 2yr vs 10yr bear steepened to 0.92%. In Europe the German 10 year bund rose 6bp to 0.09% after Draghi said that the threat of a deflationary spiral had been removed, which heightened inflation expectations putting upward pressure on yields. The US dollar was mixed today. USD fell 0.2% against EUR to $1.0906. USD fell 0.4% against GBP to $1.2235. USD rose 0.3% against JPY to Y104.51. Oil prices had a volatile session. WTI finished 1.7% lower at $49.13, and Brent fell 1.8% to $49.86. The market for Fed funds futures continues to price in a 70% chance of higher rates in December.

China’s yield curve has been flattening contrary to yield curves in other major economies. The spread between the 10 and 2 year Chinese government bond has fallen to 0.30% which is very flat. This comes as yield curves in the US and Europe have been steepening slightly over the last few weeks as inflation concerns have crept back into investor minds. On the short end of the Chinese curve, rates are pressured upwards because the government wants to keep short term rates high to ward off speculators from using excessive leverage. Overnight interest rates have risen to as high as 2.41% which has caused leveraged funds to sell off some of their holdings. On the long end rates are pressured by concerns over the growth outlook. The Chinese economy per the official numbers has grown steadily at 6.7% over the last three quarters, and some investors are skeptical over the viability of that number. They would flock to long term government bonds if they think that growth is going to slow. Additionally China has been attempting to curb speculation in the housing market. Now that less money is flowing into real estate, investors are turning to fixed income markets as an alternative source of value. Lastly international investors have been flocking to China as the central government just recently opened its market for international investors. Foreign investors currently hold 710bn yuan in Chinese bonds, compared to just 523bn at the start of the year. Together all of these factors are contributing to a flatter yield curve.

The weakening of the renminbi versus USD over the last few years has really benefitted Blackstone in particular. Blackstone has been able to liquidate many investments to Chinese conglomerate buyers who are eager to convert their assets out of renminbi to safeguard their assets as the PBoC devalues. Most recently Blackstone sold a 25% stake in Hilton to a Chinese conglomerate called HNA Group for $6.5bn. Earlier this year the private equity firm sold another hotel group to Anbang Insurance for $5.5bn. This followed a 2014 sale of the Waldorf Astoria to Anbang for $1.95bn. In total Blackstone has sold $16bn in real estate investments to Chinese investors seeking to preserve capital. In total year to date there has been $199bn in outbound investments from China. Chinese buyers have paid high premiums for spaces, more than what is typical (nearly 15% for the stake in Hilton for a minority stake) indicating their high demand to convert assets to USD.

Many auto lenders have issued negative outlooks over the future of the used car market. Used car prices are poised to fall which will lead to losses for auto loan ABS investors as recovery rates will be much lower. Further compounding this issue is the fact that credit underwriting standards for auto loans have been deteriorating significantly over the last year. Ratings agencies have given negative outlooks along with large auto-loan lenders, in large part driven by an increase in loss severity and lower recovery values. Capital One has increased capital against such loans experiencing losses, and Wells Fargo and JP Morgan have reported that they issued less loans into that space. Year to date prices of used cars have fallen nearly 4% which is the first time since 2008 they have fallen to such a degree. Higher supply (due to expiring leases) is making an impact. Annualized net losses for subprime auto ABS is running at nearly 9% which is up 2 percentage points from the prior year.

Wednesday October 26

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