Thursday January 26

Stocks were mixed today as the Dow Jones rose to another new record high. The S&P 500 fell less than 0.1% to 2,296 but the Dow Jones rose 0.2% to 20,100. The KBW Bank Index rose 0.4% while utilities were mostly flat. Economic data today showed that the trade deficit widened to $-65bn dollars which was slightly smaller than expected. Additionally the PMI Services Flash Index rose to 55.1 with strength in new orders and input costs higher. Some announced M&A activity today also could have contributed to some optimism. The two year Treasury yield fell 2bp to 1.22%. The ten year Treasury yield fell to 2.51%. Accordingly 2yr vs 10 yr bull steepened to 1.29%. In Europe rates are on an upward trend with the German 10 year rising 2bp to 0.49%. The dollar was stronger today across the board. USD rose 0.7% against EUR to $1.0674. USD rose 1.2% against JPY to Y114.58. USD rose 0.3% against GBP to $1.2592. The peso was 0.8% weaker after some tension between Trump and Mexico’s president. The VIX continues to reach notable lows falling today to 10.63. Oil prices rose today with WTI and Brent both gaining 1.9% to $53.73 and $56.10 respectively.

Johnson & Johnson started off the M&A activity for this year with an announced $30bn acquisition of Actelion Pharmaceuticals. Actelion is the largest biotech company in Europe and it totals J&J’s biggest acquisition ever. J&J pursued the acquisition in order to increase sales and increase its pipeline for diseases such as multiple sclerosis and hypertension. Actelion shares rose 21% after the deal was officially announced. J&J will acquire the company at $280 a share. Actelion has been reporting sales growth of 20% a year and it will also help J&J expand geographically. Actelion produces drugs that treat rare diseases and therefore J&J will have good pricing power over the drugs Actelion produces. J&J’s highest selling drug is facing patent expiration and thus competition from competitors with cheaper products. This acquisition will help J&J compensate for revenue lost from that situation.

Also in M&A activity Verizon said it is exploring the possibility of merging with Charter Communications which is another very big deal in the telecommunications landscape. Charter has a market cap of $80bn compared to Verizon’s $194bn and the talks are in the very earliest of stages. Growth in the wireless market has slowed substantially over the last few years and companies have lost pricing power. Cable TV has been threatened by cord cutting and content going directly to consumers. That could suggest why Verizon is looking to do this deal. Any potential deal would also face obstacles in clearing anti-trust procedures given the size of the companies involved. Trump has already spoken out against AT&T’s announced acquisition of Time Warner. Charter is the second largest TV provider. Verizon’s share price today fell 1.3% while Charter rose 7.4%. Verizon hopes that it will be able to use high speed cables that Charter has set up in order to help it bring 5G to customers. Verizon also would be able to expand geographically into new markets with this acquisition. Given high debt levels of both companies however, $100bn for Verizon and $60bn for Charter, the deal could be difficult. A credit rating downgrade would likely follow any official announcement. JP Morgan estimates that cost savings between the two companies would total $300mm each year.

The Bank of England is in a precarious spot regarding the growth and inflation in the UK. Since the Brexit GDP growth has remained relatively healthy and inflation is on a rising trend as a result of the depreciation in GBP. Given resilient growth and rising inflation the BoE could be looking to raise rates. After the Brexit the BoE cut interest rates and restarted a small QE program. However with those purchases winding down the conditions in the kingdom could call for higher interest rates. However considerable uncertainty remains regarding the Brexit process and outcomes. In the long term it may be damaging to the economy and the monetary authority should be accommodating. However in the short term the economy looks like it is able to withstand higher rates given rising inflation and growth. However the BoE may be skeptical to kick start any Brexit related slowdown by raising rates too soon, but on the other hand it may want higher rates now so that it has room to accommodate the economy if indeed the Brexit does have negative effects on the economy. Nevertheless some analysts believe that the BoE will look to raise interest towards the end of this year.

European sovereign debt has been selling off in recent days and it has been driven by both global factors as well as regional factors. Post U.S. election sovereign debt around the world sold off along with U.S. Treasuries. Now EU-specific factors are driving euro yields higher. Investors are coming to the realization that the ECB may be behind the curve when it comes to raising rates in line with inflation. If true, inflation could shoot higher and erode into fixed income returns which explains why markets have correspondingly been adjusting yields higher. German bonds today closed at their highest level in more than a year, and French and Italian bonds are each at nearly 2 year highs. Spain and Austrian bonds also broke through 12 month highs. 10 year yields in Germany and France are 0.49% and 1.05% respectively. Italian bonds have also been rising on political risk as well up to 2.2% currently. The ECB still is imposing negative interest rates and purchasing assets each month. Data from December showed that consumer prices rose that month in every EU country except one, economic growth reached a five year high in December and unemployment is near a seven year low. This comes just a couple days after a hawkish ECB member from Germany suggested that it may be time to shift from such significant easing policies. Sabine Lautenschlager marks the first ECB official to suggest this shift and she said that inflationary pressures are building. Other monetary hawks from Germany are likely to echo those sentiments.

Thursday January 26

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