Monday February 27

Stock prices rose marginally today ahead of Trump’s address to Congress tomorrow. The S&P 500 and the Dow Jones each rose less than 0.1% to 2,369 and 20,833 respectively. The KBW Bank index added 0.6% while utilties sank by that same amount. Economic data today showed that new durable goods orders rose 1.8% in line with consensus, however excluding transportation the number shrank 0.2% compared to a 0.5% anticipated gain. Robert Kaplan of the Boston Fed also said that the Fed should consider raising interest rates sooner rather than later which is in line with what other members of the FOMC have suggested. Other members of the FOMC including Janet Yellen and Stanley Fischer are also set to make statements this week. Also important was Trump saying that he will increase military spending by $54bn which would constitute fiscal stimulus. On that backdrop yields rose off of their lows hit on Friday. The two year Treasury yield rose 6bp to 1.21%. The ten year Treasury yield rose 5bp to 2.37%. Accordingly 2yr vs 10yr bear flattened to 1.16%. Data from Bloomberg currently reflects a 50% chance that the Fed will raise the Fed funds rate in March which is up from 40% odds on Friday. However the same figures put out by CME show just a 33% chance versus 27% on Friday. The dollar was mixed against peers. USD fell 0.3% against EUR to $1.0588 as concerns in France eased back slightly. USD rose 0.5% against JPY to Y112.75. USD rose 0.2% against GBP to $1.2441. Oil prices were for the most part flat on the day. WTI rose 0.1% to $54.06. Brent was unchanged at $55.99. Gold prices fell 0.5% as rates went higher.

Although a good portion of the Japanese government bond yield curve is negative right now international investors have still appeared to be willing to buy at those levels. Data from the Bank of Japan shows that foreign holdings of JGBs is at the highest level on record. Investors are especially piling into short term JGB bonds with the trading volume of those securities spiking at certain points last year and on a rising trend for the last several years. Foreign holdings have also been on the rise from around JPY 40tn in 2010 to around JPY 110tn currently. The reason why it is profitable for them to do this involves a cross currency swap. Investors swap their exposures from JPY back to USD once they buy a JGB. Given current market fundamentals the premium investors receive for swapping from JPY to USD in some cases exceeds the negative yield on the JGB which makes the trade profitable. For example an investor that buys a 3 year JGB earns a yield of -0.18%. The investor receives 0.78% to swap from JPY to USD which brings his total return on a virtually riskless trade to positive 0.6%. The reason for the positive cross currency basis is due to the demand that Japanese investors have for US assets right now. In a reversal of the trade just outlined right now Japanese investors are buying a lot of U.S. dollar assets and hedging their exposure back to JPY which is what is pushing the basis so far in favor of U.S. investors looking to do this trade. As a result a wide variety of investors are using this trade including hedge funds, mutual funds and FX reserve managers at central banks.

China’s regulator on foreign-exchange announced today that it will allow investors in China’s onshore bond market to use swaps and forwards to hedge their currency exposure of holding Chinese corporate bonds. This is a big step towards liberalizing the market in a country where historically regulators like to control the market. It comes as an effort to open up markets more for international investors as well as increase demand in Chinese corporate bonds. Yields in China have been on the rise and as private debt levels skyrocket some investors are concerned about a potential credit crisis in the country. With that in mind Chinese regulators may be looking to increase demand in their bonds in advance of any potential troubles. They did specify though that those contracts would only be available for investors looking to satisfy “real needs” which suggests that they aren’t yet ready to allow speculation with derivatives. Additionally investors looking to hedge are only able to do so with certain institutions. China’s bond market is a very sizeable $9tn and foreign holdings of that total have increased around 25% since the IMF named the yuan a reserve currency last October. One lingering source of concern is that China’s bonds aren’t yet included in aggregate indices that track the global world bond market. Goldman estimates that around $250bn of additional foreign capital would go towards China’s bond market if it were included in all three commonly used global bond indices.

Donald Trump is set to give an address tomorrow in front of Congress regarding the outline of his policy plans. Investors will be watching closely for any hints at deregulation, fiscal stimulus, and tax plans. Stock markets have rallied since his inauguration on hopes that there will be improvements in each of those three areas. If investor expectations aren’t met then equities could reprice lower. Already yields have been drifting down possibly on expectation growth may not be as high as previously anticipated. Trump will also provide an assessment of his view of the situation in the United States broadly speaking and talk about his legislative plans. Also of importance will be how Trump references trade deals and relationships with trading counterparties. Investors anticipate that Trump will come across with a negative tone about the country he inherited while coming across as very optimistic about the outlook. Currency policy and comments about the strength of the U.S. dollar will also be examined closely.

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Monday February 27

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