Tuesday March 14

Stocks fell today as oil prices dropped and investors look ahead to the FOMC statement tomorrow. The S&P 500 fell 0.3% to 2,365 and the Dow Jones fell 0.2% to 20,837. The KBW Bank index and the DJ Utility average both lost 0.1%. Economic data today showed that the producer price index rose 0.3% last month compared to estimates which called for just a 0.1% gain. That brings the yearly change to 2.2% which is the fastest pace in almost 5 years. Also driving sentiment was an Opec projection that showed non-Opec production rising this year by more than expected. To stabilize markets Saudi Arabia reiterated its efforts to maintain price stability in the oil market. Nevertheless oil prices slid below their 200 day moving average which is an important technical indicator. Ahead of the Fed’s meeting the market for Fed funds futures reflects a 93% chance that the FOMC will raise interest rates by 25bp tomorrow. On that backdrop the two year Treasury yield rose 1bp to 1.39%. The ten year Treasury yield fell 2bp to 2.60%. Accordingly 2yr vs 10yr bear flattened to 1.21% reversing some of the steepening from over the last week. The dollar was mostly stronger against peers with JPY bucking the trend. USD rose 0.5% against EUR to $1.0605 ahead of the Dutch elections tomorrow. USD fell 0.1% against JPY to Y114.74. USD rose 0.5% against GBP to $1.2155. On the Opec projections WTI fell 1% to $47.94. Brent lost 0.8% to $50.92.

Real rates are on the rise which is reflective of increased economic growth expectations. The yield on 10 year TIPS is at 0.60% and have risen significantly over the last two weeks. Real yields measure how much investors expect to hold net of inflation, and they are determined by deducting inflation expectations from nominal Treasury yields. Rising real yields are an indication that investors expect the economy to expand and as a result investors demand more in return. Typically rising real yields are a bullish market signal for the economy. On top of that with market based measures of inflation not too high that also presents a good picture for stocks. The Fed’s likely decision to raise interest rates tomorrow could also play into higher real yields. Investors are anticipating that nominal yields will push higher as well, as short positions on Treasuries have hit $93.9bn which is the highest level since the start of the year. This comes as economic data has come in that suggests higher growth on the horizon. The downside is that it could become more expensive for companies to finance themselves on a real basis and it could put upward pressure on USD which also is a drag on corporate earnings.

Alternative asset managers that focus on commercial real estate are turning their attention more towards debt investments as opposed to equity. Traditionally some real estate private equity firms might borrow $75mm and put $25mm of their own equity into the $100mm investment. However now that many industry experts anticipate a fall in commercial real estate values it is becoming more attractive to hold the debt portion as opposed to the equity portion of that deal since debt is comparatively safer. Blackstone, KKR, Och-Ziff, and other alternative asset managers last years raised $20.4bn for real estate debt funds which is up from $12.2bn in the prior year. While investment banks traditionally might have made those loans in the aftermath of the financial crisis and heavy regulations they have pulled back from those loans. As alternative asset managers pour into the lending space they have been attracted by high returns which could be anywhere between the high single digits and the mid teens, and returns can also be boosted by leverage. That would involve lending funds at a certain interest rate that were borrowed at a rate lower than the lending rate.

Junk bonds could come under threat if the Fed strikes a more hawkish tone in its meeting tomorrow. Junk bonds have been struggling over the last week due to concerns for oil prices combined with anticipation in front of the Fed meeting. High yield indices are 14% made up of energy names so there is high exposure to oil price fluctuations. High yield bonds have returned 2.9% year to date making them one of the best performing fixed income assets however that could shift. Year to date junk bond issuance has been elevated at more than $60bn, lagging only 2015 and 2012 going as far back as ten years. Yields for the most speculative grade bonds is also at the highest level since 2013 at around $5bn currently. If the Fed sticks to its guns and maintains that it is looking to raise interest rates three times this year that could spell trouble for both high yield and investment grade debt which could be overvalued according to some analysts. Yields and spreads are at notable lows so they could be due for some mean reversion. Investors haven’t reduced their appetite for risky debt. After returning 17.5% last year investors have poured $11bn into high yield bond funds total year to date, and funds have experienced inflows for 12 out of 14 weeks. Nevertheless strategists at GS have downgraded CCC debt to underweight as valuations have soared. Jeff Gundlach also doesn’t think the rally has much more room to run.

Tuesday March 14

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