Friday February 10

Stocks rose today to close out the week on a strong note. The S&P 500 rose 0.4% to 2,316 and the Dow Jones rose 0.5% to 20,269. Over the course of the week the S&P 500 was 0.8% higher and the Dow Jones was 1% higher. Today the KBW Bank index rose 0.2% as Daniel Tarullo the Fed’s point man on regulation resigned and utilities rose 0.8%. Economic data today showed that import prices rose 0.4% which was higher than expected and export prices rose in line with estimates. The two year Treasury yield was unchanged at 1.19%. The ten year Treasury yield rose 1bp to 2.41%. Over the course of the week the week the 2yr was flat and the ten year was 6bp lower. The dollar was pretty flat on the day against peers as Trump meets with Shinzo Abe over the weekend. USD rose 0.1% against EUR to $1.0642. USD fell less than 0.1% against JPY to Y113.20. USD rose less than 0.1% against GBP to $1.2486. Oil prices were firmer on the day as compliance with the Opec cuts is higher than expected. WTI rose 1.6% to $53.85. Brent rose 1.8% to $56.61.

Many analysts take the view that record high demand from foreign investors pushed down yields in the United States to record low levels last year. However now that tide may be starting to shift as foreign countries and institutions either sell off their holdings of Treasuries or at the very least buy with lower demand than before. To a lesser extent Germany may also be facing a similar dynamic. Data recently released by the U.S. Treasury showed that foreign holdings of U.S. government debt was less than 30% which is the first time since 2009 when that was the case. Numbers have also been falling in the U.K. and Germany. As such international pension funds, sovereign wealth funds and central banks have been either purchasing less or selling government debt. This is yet another factor that could lead rates to drift higher in these developed markets. Along with higher inflationary pressures, monetary tightening, fiscal spending, and political risks less foreign demand is just another bearish factor for the market. Some analysts predict that this could create more volatility in Treasury markets. Nevertheless there is some level in Treasury rates when investors would step in and support prices and cap yields to prevent a huge selloff.

The ECB’s presence in the eurozone bond markets has left a big impact that will be felt for years to come. The central bank currently holds EUR 1.5tn in assets that span government bonds, corporate bonds, ABS, and other types of securities. While the amount of monthly purchases in March will fall from EUR 80bn to 60bn the central bank maintains a very accommodative stance and will continue to do so. Of the ECB’s holdings EUR 1.3tn of that, the vast majority, is made up of government bonds. Germany makes up more of that total than any other country, followed by France Italy and Spain. It’s significant holdings of German bunds forced the central bank to get rid of the requirement that the central bank not buy bonds that yield less than -40bps. The ECB holds more than EUR 200bn in covered bonds which are backed by pools of mortgages. That helps banks hedge their mortgage pipeline and enable them to originate more mortgages similar to the TBA market in the U.S. Given that it is a small market the ECB’s position takes up close to 30% of the market which has led some to complain about distortion. As a result market makers and asset managers have turned away from the space. The ECB holds EUR 60bn in corporate bonds and investors expect that as the ECB winds down QE corporate bond purchases will be the first to go. The central bank also has s small position in ABS market. The biggest complaints of distortion come from players in the repo market. The availability of collateral in repo markets has fallen significantly given that the ECB holds so many. That has pushed up demand for government bonds to be used as collateral, which pushes up the cost of borrowing those bonds.

Friday February 10

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