Wednesday February 8

Stock indices were mixed today as rates rallied and the dollar fell. The S&P 500 rose 0.1% to 2,294 and the Dow Jones fell 0.2% to 20,054. Financials fell 1% while utilities rose 1%. That reflects an expectation that rates may remain lower for longer than expected. Economic data today showed that crude oil inventories rose by 13.8 million last week compared to a 6.5 million increase last week. Concerns in Europe are back in focus now with political risks rising and fears of a Grexit coming back. Betting odds and opinion polls still suggest the odds of a Marine Le Pen victory in France’s elections are slim. The market for Fed funds futures is currently pricing in a 39% chance of a 25bp hike in May which is on a downward trend. Accordingly the two year Treasury yield fell 2bp to 1.15%. The ten year Treasury yield fell 5bp to 2.34%. 2yr vs 10yr bull flattened to 1.19%. The dollar was weaker on the day against peers and FX markets were seemingly undeterred by proceedings in the UK on exiting Article 50. USD fell 0.1% against EUR to $1.0691. USD fell 0.4% against JPY to Y112.01. USD fell 0.2% against GBP to $1.2535. Oil prices had a choppy session. WTI rose 0.4% to $52.39. Brent rose 0.2% to $55.16.

Rising interest rate expectations are pushing corporations with bank loans to refinance ahead of the anticipated higher rates. S&P expects that more than $100bn in bank loans were refinance last month which is the highest level by far in at least ten years. The second highest month was in the start of 2015 when around $50bn was refinanced. Doing so could save the companies that participated in refinancings billions of dollars in interest expenses per year. That could open up the door for money to be spent on other projects such as M&A activity and investments. Refinancings have been helped along by high demand for corporate loans in the present environment. Those loans are in demand because they offer a floating rate of return to investors and perform well when interest rates rise since they reprice faster than fixed rate debt. Since September floating rate mutual funds have experienced more than $17bn in inflows with the majority of that coming in the most recent months. As such these fund managers will be looking for new supply to allocate money towards. This is affecting the riskier corners of the debt market and high yield borrowers since they are typically recipients of leveraged floating rate loans.

European governments are still able to sell long dated debt even in spite of rising political risks in the region. Yields in some European countries have hit multi-year highs however there is still demand for long dated debt. Belgium issued 40 year bonds on Tuesday and bids for the 40 year tranche were higher than yields for the 10 year tranche. That follows last year when Belgium issued 100 and 50 year bonds among others. Italy and Spain last year issued 50 year bonds and Austria issued a 70 year bond. In the United States just last week Apple, AT&T, and Microsoft all issued large blocks of bonds that included 40 year tranches. Investors such as insurance companies and pension funds like those long dated products since it helps them match assets and liabilities. For these countries they are able to raise debt at low interest rates for a long period of time before interest rates are anticipated to rise. Belgium’s 40 year bond carried a yield of just 2.3%. Investors are still hungry for yield in a world when trillions of dollars of government debt yields negative. However longer maturities and durations lead to higher interest rate risk. Investors in long duration bonds are highly exposed to fluctuations in interest rates. That being said since 2012 the average maturity of all euro-denominated debt has risen from 7 years to 10.4 years last year. When the ECB scales back its quantitative easing program these bonds will likely suffer a selloff. Mounting political pressures in the region will also send prices lower. Investors have been undeterred by political risks in France as demand for 20, 30, and 50 year bonds this months has been solid.

High yield bonds have benefitted since Trump was elected and inaugurated. Given the search for yield that is driving longer dated debt issuances investors have also benefitted from tightening spreads. Since December high yield funds have experienced inflows of more than $10bn which has driven yields down to as low as 10% for the riskiest corners of the markets. That has pushed CCC rated firms to issue debt and lock in low costs while they can. Year to date junk rated companies have issued a total of $41bn in the United States. Since the start of last year spreads have tightened from as high as +900 to below +400 currently which is almost the lowest level going back to 2010. There is $2.2tn in debt outstanding in the US high yield market and some analysts are concerned that $1tn of that is due in the next five years. Rating agencies have been warning at the same time that credit qualities are deteriorating. That includes easing lending standards, rising delinquencies on credit cards and auto loans, and loan growth slowing in commercial and industrial sectors.

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Wednesday February 8

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