Monday January 9

Stocks fell to start the week on a cautious note. The S&P 500 and the Dow Jones each lost 0.4% to 2,268 and 19,887 respectively. Financials lost 0.7% while utilities fell 1.3%. Eric Rosengren of the Boston Fed spoke today and came across as hawkish, saying that the Fed should raise interest rates more regularly. Falling oil prices also weighed on sentiment as market participants consider the possibility that an increase in US production could outweigh Opec cuts. Nevertheless interest rates fell after Rosengren’s comments. The two year Treasury yield fell 2bp to 1.19%. The ten year Treasury yield fell 5bp to 2.37%. Accordingly 2yr vs 10yr bull flattened to 1.18%. In Germany the 10 year bund yield fell 2bp to 0.28%. The US dollar was weaker against peers except for the pound. USD fell 0.4% against EUR to $1.0571. USD fell 0.8% against JPY to Y116.06. USD rose 1% against GBP to $1.2161. WTI and Brent each fell 4% to $51.86 and $54.84 respectively. Gold prices have risen given the recent rally in rates to $1,181.70. The VIX is also at historically low levels and currently stands at 11.56.

The British pound fell this morning after comments made from Prime Minister Theresa May pertaining to the Brexit. In an interview May said that the U.K. was going for a clean break from the European Union. She spoke intending to dispel the idea that the U.K. was going to leave the EU but still keep some of the benefits of EU membership. As a result investors moved to price in a “hard Brexit” and the British pound fell 1.2% to $1.214 at the open. These comments overpowered a series of positive economic data out of the UK, and is also exacerbated by dollar strength. Data out of the UK showed strength in manufacturing as well as retail sales. Investors fear that since May seems to be prioritizing policies such as immigration over economics and access to the single market that the UK economy will suffer as a result. The eurozone is the biggest customer for British exports currently. EU officials don’t seem to be willing to budge on immigration issues either. May made similar comments back in October. Analysts at Morgan Stanley predict that the pound will fall to $1.17 by the end of the first quarter, and UBS analysts estimate it will be at $1.13 by the end of 2017.

High yield has been in demand as investors are expecting the sector to perform well over the next year. Given the expected increase in corporate earnings and economic outlook under Trump some investors anticipate that those changes will disproportionately benefit risky companies. In the second quarter and third quarter of 2016 earnings from junk rated companies improved 14% and 72%. Additionally higher oil prices and less defaults from the energy sector will also benefit high yield. According to Bank of America the average junk bond yields 5.86% which is a two year low. The strong performance will have to follow a 17.1% return in 2016. JP Morgan, Wells Fargo, Bank of America and Goldman Sachs are all bullish on high yield. They are also a good fixed income asset to hold in a rising rate environment given that less of their yield is composed of interest rate risk on a relative basis. High yield issuance has also been lower which has supported prices as investors are looking for new supply.

Indonesia is angry with JP Morgan regarding ratings activity coupled with the country’s bond issuance. JP Morgan until recently acted as a primary dealer for Indonesia’s government bonds. However the bank’s research analysts downgraded Indonesian equities which the government did not like and as a result severed all ties with JP Morgan. Additionally finance ministry officials met with other primary dealers and said that while research analysts can say whatever they want they should be careful not to create “false perceptions at the expense of Indonesia.” This creates problems for the banks, as research opinions are not supposed to be influenced by activity with other areas of the bank. Indonesian officials want a clear separation between what is factual research and what is opinion. JP Morgan downgraded Indonesian equities to underweight from overweight in the aftermath of Trump’s election as a result of broader risk in emerging markets. It also downgraded other emerging markets as part of the same action. However the Indonesian government seemingly took offense, saying that the ratings action was not credible and that it could destabilize Indonesia’s financial system. The country is coming up with more stringent rules for companies that act as primary dealers for government debt. This whole situations shows how banks have to be careful not to breach conflicts of interest when doing business in foreign countries where customs are different. The country wants to limit what it calls unnecessary reports as well as draw a line between internal research and research that is circulated publicly.

Monday January 9

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