Thursday January 5

Stocks eased back slightly today while the US dollar and rates fell. The S&P 500 fell less than 0.1% to 2,269 and the Dow Jones lost 0.2% to 19,899. The KBW Bank index fell 1.4% while utilities were relatively unchanged. The ADP Employment Report showed that 153,000 jobs were added last month in December, which was far below consensus of 172,000. The PMI Services Index came in strong at 53.9 with solid new orders and hiring. That report also showed that input costs are on the rise which is a sign of inflationary pressure. The ISM non-manufacturing index was 57.2 which is higher than the consensus 56.8. New orders were strong along with business activity. The ADP report may have led some traders to scale back their expectations for tomorrow’s December NFP report. On that backdrop rates rallied pretty significantly. The two year Treasury yield fell 5bp to 1.17%. The ten year Treasury yield fell 9bp to 2.35%. Accordingly 2yr vs 10yr bull flattened to 1.18%. The US dollar was also weaker on the day. USD fell 1.1% against EUR to $1.0609. USD fell 1.6% against JPY to Y115.41. USD fell 0.8% against GBP to $1.2421. Oil prices rose today for the second consecutive day. WTI rose 0.9% to $53.75. Brent rose 0.7% to $56.87.

The yuan has posted two consecutive strong days against the US dollar. These are the strongest two days on record for the Chinese currency. This may be an attempt by the PBoC to squeeze out excessive short positions against the renminbi. The yuan rose 0.6% to Rmb 6.8264 against USD, compared to estimates that the currency would dip below 7 sometime this month. This is a strong appreciation of the renminbi as it was at Rmb 6.9895 only Tuesday. This also could be partially driven by dollar weakening in the aftermath of the FOMC minutes that were released yesterday. Officials have raised interest rates in Hong Kong in order to reduce liquidity and make shorting the currency more expensive. The overrnight borrowing rate in Hong Kong was 16.95% on Wednesday and it reached 38.3% today. Investors have to borrow renminbi in Hong Kong in order to bet against future declines, so officials seek to make that trade prohibitively expensive. Market based expectations for yuan depreciation throughout 2017 have as a result been pared back from Rmb 7.3343 at the start of the week to Rmb 7.1470. Additionally positive service sector data in China as well as expectations of further capital restrictions could put upward pressure on the currency.

Supply of NPLs in structured products is set to increase this year, led by Italian banks looking to offload their most distressed assets. S&P anticipates that NPLs issued as parts of ABS will total $50bn this year with 80% of that coming from Italy. That is a very sharp increase compared to just $3bn in public deals last year. Investors will want to wait and see what the political outcome in Italy is and how the government intervenes in the financial sector. Italian banks as a whole currently have an estimated EUR 360bn in NPLs on their balance sheets which is 20% of total outstanding loans in the country. Investors might want the Italian government to provide some protections to investors willing to take on that risk, however since Renzi stepped down that outcome has become unlikely. According to S&P ABS issuance across many sectors will either fall or be flat in supply. Only credit card ABS and “other ABS” have a rising supply trend. On the other hand, equipment/ fleet/ floorplan ABS, CMBS, CLOs, and RMBS are all on downward trends.

Analysts have high hopes for corporate earnings in the fourth quarter which are set to be released over the next few weeks. Research analysts will also be paying close attention to forward guidance given by corporate executives regarding how their respective businesses will benefit from the prospective increase in fiscal spending and deregulation. Investors will look for earnings to justify the high P/E ratios that are currently prevailing. In 2017 analysts predict that S&P 500 earnings will increase by 11.5% with the biggest benefit coming from the energy sector and financials rising 11%. Companies may also benefit longer term if Trump’s policies encourage and incentivize businesses to invest domestically instead of hoarding cash offshore. Some strategists are expecting some corporate outlooks to be revised higher in the aftermath of the election. One risk is the continuing strength of the US dollar which will weigh on earnings throughout the year. With wages in the United States rising, pricing power will also be an important factor in S&P 500 earnings going forward.

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Thursday January 5

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