Wednesday November 2

Stocks fell today as political risk continues to be a concern for investors. The S&P 500 fell 0.7% to 2,097 and the Dow Jones fell 0.4% to 17,959. The S&P 500 has now fallen every day going back to October 24. Economic data today showed that less jobs were added last month than expected according to the ADP Employment Report. According to ADP 147k jobs were added compared to the consensus estimate 170k. The prior month was revised upward nearly 50k to 202k. Data from the EIA also showed that crude oil inventories rose by 14.4mm barrels last week which was the largest weekly increase in four years. Utilities as well as the KBW Bank index both fell around 1.2%. The yield curve bull flattened today. The two year yield fell 2bp to 0.82% and the ten year yield fell 3bp to 1.80%. The 2yr vs 10yr flattened to 0.98%. In FX markets the dollar was for the most part weaker against peers except the peso. USD fell 0.3% against EUR to $1.1095. USD fell 0.7% against JPY to Y103.44. USD fell 0.4% against GBP to $1.2292. The dollar rose 1% against MXN to P$19.3793 as Trump’s odds are perceived to be rising. On a similar note gold prices continued to rise to $1,298. Oil prices following the EIA data fell. WTI fell 2.5% to $45.50. Brent fell 2.1% $47.12. The market for Fed funds futures is pricing in a 78% of higher rates in December.

At the FOMC meeting today the Fed elected to keep interest rates unchanged at 0.25 – 0.50%. The Fed’s next meeting takes place on December 13 and 14. In today’s statement the FOMC said that the case for a rate hike continued to rise and that it is waiting for “some” further evidence to tighten. Markets, both equities and rates, were little changed following the announcement. It also indicated that it was more likely for inflation to hit the 2% target as inflationary pressures have picked up slightly. Esther George and Loretta Mester once again dissented while Rosengren voted with the rest of the group. The fact that the markets were little changed indicates that traders had largely priced in and expected the outcome.

One of the consequences of increased regulation post-financial crisis is that lending activity is shifting away from traditional banks. For the first time in more than 30 years data in the third quarter showed that banks gave out less than half of the total value of mortgages that was extended to borrowers. Regulation has resulted in banks being less willing to take on risk, especially in the mortgage market. They have paid significant fines as a result of mortgage related activity during the financial crisis and thus are wary to take on a lot of risk in the space. To reflect the shift in this market, 5 years ago JP Morgan, Bank of America, and Wells Fargo made up 50% of the total amount of mortgage origination amount. Now they make up just 21%. At the same time nonbanks are taking up an increasing portion of the mortgage market rising from less than 10% in 2009 to more than 50% currently. As a result of fines imposed during the crisis and increasing regulation post crisis banks are both unwilling and unable to take on risk in the mortgage market. Instead nonbanks such as Quicken Loans and PennyMac have been taking market share. Banks favor borrowers with better credits while nonbanks have focused more on the riskier portion of the market. Nonbanks rely on the financial sector for funding, and therefore that corner of the market will be first where loan volumes slow if liquidity dries up. Banks have focused more on affluent borrowers by giving out jumbo loans.

Several hedge funds such as Stone Ridge Asset Management and RiverNorth Capital Management are breaking into the online lending space. These asset managers are looking to raise funds that invest in consumer and small-business loans made through LendingClub and Prosper. RiverNorth is looking to raise around $1bn following a $1.26bn capital raising from Stone Ridge earlier this year. These online loan funds would be open to the public, retail investors with the hope that those will be a stickier source of funds. Other potential loan buyers have turned away from the sector after LendingClub got in trouble for mismarketing loans. This is good for the FinTech companies because their revenues come from loan volume (as opposed to loan performance) so increased demand for their loans is good. They will provide retail investors with a healthy return which is expected to be between 6.37% and 7.17% net of losses. As such the emergence of this sector could be tied into the search for yield that is happening globally right now. The RiverNorth fund has a minimum investment of $1mm, and they will carry fees of around 3.78% of net assets as a result of a 1.5% management fee and loan servicing fees. They are pretty illiquid since they are intended to be a permanent form of capital. They are interval funds meaning that the managers will only offer money back periodically, in this case once a quarter. Real estate funds and others tracking illiquid assets have also taken to this structure.

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Wednesday November 2

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