Tuesday January 31

Stock indices fell today however pared losses from earlier in the session. The S&P 500 fell 0.1% to 2,278 while the Dow Jones lost 0.5% to 19,864. The KBW Bank index lost 0.6%, transportation shares fell 1.5% while utilities gained 1.7% as investors sought safe assets. Earnings reports today showed that Under Armor missed expectations and shares fell more than 20% as a result. Earnings from Exxon Mobil, UPS, Harley-Davidson and Visa all missed expectations as well. Some analysts may be beginning to expect that if Trump continues such a devisive style of governing then he may have trouble passing stimulus bills on Congress which would not be good for stock prices. The two year Treasury yield rose 1bp to 1.21% ahead of the FOMC statement tomorrow. The ten year Treasury yield rose 2bp to 2.48%. Accordingly 2yr vs 10yr flattened 3bp to 1.25%. The dollar weakened on the day against peers after more currency talk from the Trump camp. An advisor to Trump singled out Germany as getting an advantage on trade given how weak the euro is. As a result USD fell 1% against EUR to $1.0794. USD fell 0.8% against JPY to Y112.93. USD fell 0.7% against GBP to $1.2578. The VIX rose slightly to 12.16 however still remains low by historical standards. Oil prices stopped their streak of losses. WTI rose 0.4% to $52.85 and Brent added 0.8% to $55.68.

The Bank of Japan met today and held current policies as is which was expected by investors. The BoJ is currently anchoring 10 year JGB yield at zero and paying -0.1% on commercial deposits held at the central bank. The yen appreciated against the dollar after the announcement but much of that could have been dollar weakness as opposed to yen strength. The BoJ expects inflation for the next year to be 1.5% and it increased its growth projection by 0.2% to 1.5%. In spite of that increase they still maintain a dovish stance and said that risks are skewed to the downside. Kuroda highlighted the risks of some of Trump’s policies affecting Japan’s economy. In particular he highlighted the risk that Trump could make an effort to weaken the dollar at the expense of the yen, and he also fears that protectionist trade policies could hurt Japanese manufacturers. A few weeks ago Trump made critical statements regarding Japan’s trade policies.

Given that yields are on the rise and traditional correlations with stocks have returned recently investors are once again looking to bonds as a hedge. Traditionally investors use government bonds as haven assets as a buffer against losses in equities. However as yields plummeted to record lows last summer Treasuries lost their appeal as a hedge against losses given that many thought they were overvalued and find it hard to imagine a scenario when yields could fall even further. In that case both equities and government bond prices moved in tandem. However given the return of volatility and inflation expectations, correlations have turned back towards historical norms. As a result investors could be once again looking towards government bonds as shock absorbers in portfolios of other assets such as equities.

High frequency trading firms have suffered a setback recently. One argument is that these companies are especially profitable in times of volatility and that when volatility is low that eats into their returns. Many of these companies are privately held so it is hard to gauge how well they are doing but earnings statements from publicly traded Virtu show that correlations between earnings and the VIX are quite high since it IPOd. Since the VIX has gone down over those years so have earnings and the company’s share price. This is also the case with other publicly traded HFT firms. Nevertheless these companies do remain profitable. A less optimistic view would be that increased competition into their markets has reduced profits for the original players which would be more of a lasting negative impact to their business models. Additionally efforts such as IEX and NYSE MKT and the potential for a regulatory “speed bump” could also stymie their business models. Capital Group which is an asset manager that manages $1.4tn recently approached regulators and spoke favorably about the IEX business model lobbied in favor of repealing reg NMS. He says that he is hopeful that changes will be made and that regulators are now more willing to hear what is going on. It is important to note that an advisor to Trump on regulatory matters voted against reg NMS when he was commissioner of the SEC. For the incoming chair of the SEC his views on the matter are not particularly known.

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Tuesday January 31

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