Wednesday February 22

Stock indices were mixed today as markets invested the release of the FOMC minutes. The S&P 500 fell 0.1% to 2,362 and the Dow Jones rose 0.2% to 20,775. Economic data was light today but the dollar and Treasury yields both fell even though the FOMC minutes showed that “many” members of the Fed thought it would be a appropriate to raise interest rates “fairly soon.” Even though this sounds relatively hawkish markets did not budge much which suggests that investors had priced in the information. Additionally the Fed appears ready to move in spite of lingering uncertainties relating to Trump’s policies. Nevertheless many analysts still don’t believe that the Fed will raise interest rates next month at the March meeting. The two year Treasury yield rose 2bp to 1.23% while the ten year fell 2bp to 2.41%. Accordingly 2yr vs 10yr flattened 4bp to 1.18% on rate hike expectations. USD fell 0.2% against EUR to $1.0562. USD fell 0.4% against JPY to Y113.25. USD rose 0.2% against GBP to $1.2452. In Europe markets are being driven by political risk particularly in France. The German 10 year bund fell 2bp to 0.28%. Oil prices were weaker on the day however they still remain range bound. WTI fell 1.1% to $53.73. Brent fell 1.2% to $56.01.

Problems in the commercial real estate market are not limited to apartment complexes. Developers and owners of commercial office spaces have reported that they are finding it difficult to increase rental rates on office space. Some commercial analysts have decreased their projections for rent increases going forward. They expect that a combination of supply growth in commercial real estate supply as well as slower employment growth will limit the ability for them to raise rental prices. Of course this varies depending on different cities. For the most part east coast cities such as New York, Boston, and Washington are facing the biggest problems. On the other hand in Los Angeles those problems don’t exist as much since there are new building supply constraints. New supply as a percentage of total U.S. office space has increased from 0.3% in 2012 to 1.2% in 2016. Developers rushed into the space as office-building valuations have risen dramatically since 2009 and have eclipsed their pre-crisis peak.

Pension benefits for pensioners of telecom company Avaya have been cut as the company is being restructured in Chapter 11 bankruptcy. Avaya was purchased by TPG and Silver Lake in an LBO in 2007. That deal ultimately failed as the financial crisis took its toll on deals around the country. Following the LBO Avaya is now burdened with $6bn in secured debt. Supplemental pension benefits are one of the first things on the chopping block in chapter 11 bankruptcy restructurings and they are not guaranteed by federal pension laws. For some pensioners that could make up as much as 40% or 50% of their benefits. As a consequence pensioners may have to reconsider their lifestyles or access their social security benefits at an earlier age. In some cases pensioners receive discounted benefits. In 2009 Reader’s Digest defaulted and unsecured creditors and pensioners were offered just 3.6 cents on the dollar.

The minutes from the January FOMC minutes show that officials are ready to lift interest rates “fairly soon.” However some analysts are of the belief that the number of officials that believe that aren’t in the majority and that the majority of the more influential members of the FOMC are going to take a dovish stance in March. Markets did not react much after the report was released suggesting that information released was priced in or expected by investors. The Fed appears that its going to act on the fiscal policies and economic conditions that it sees presently in existence as opposed to base policies on conditions and policies that may come in the future. The minutes also showed that for the most part officials agreed that it would be appropriate in the next few meetings to start discussing the size of the balance sheet and whether or not the Fed should keep reinvesting coupon and principal payments. Raising rates in March would help give some credibility back to the Fed as based on the stock market rally it doesn’t seem like investors believe that the FOMC will raise rates three times this year. Before they have to decide in March what to do with rates the Fed will be able to weigh the February NFP report in their decision.

CDS in French government bonds have been experiencing an increase in trading volumes as political risks in the country and region increase. Weekly CDS trading volumes last year averaged below $400mm for 2016 however this year they are running as high as $800mm. CDS spreads have risen from just below 40bps at the start of the year to nearly 70bps now. This also coincides with yields on French bonds rising compared to German bunds. There are two types of CDS that trade in the market. CDS contracts based on language written in 2003 are less likely to protect investors from a country leaving the euro. Contracts written on language set in 2014 will be more likely to protect investors of the Frexit. Accordingly the spread between the 2014 and 2013 CDS spreads has been increasing. The spread between the 2014 and 2003 CDS spread is currently 21bp compared to the end of January when it was just 3bp. That reflects the fact that the 2014 contract will be more valuable than the 2003 contract if France does decide to leave the euro currency. Nevertheless the legal protections and exact language laid out in each contract is up for debate and would likely be a messy argument in the event France did actually decide to leave.

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Wednesday February 22

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