Thursday March 23

Stocks fell on more political uncertainty. The S&P 500 lost 0.1% and the Dow Jones fell fractionally to 20,656. The KBW Bank index rebounded 0.4% and utilities fell 0.3%. Tension in Washington over the passing of a potential Supreme Court Justice as well as the delaying of the healthcare bill vote could be sources of concern for investors. The two year Treasury yield was unchanged at 1.24% and the ten year rose 1bp to 2.41%. Accordingly 2yr vs 10yr bear steepened to 1.17%. USD was mixed on the day against peers. USD rose 0.1% against EUR to $1.0789. USD fell 0.2% against JPY to Y111. USD fell 0.3% against GBP to $1.2523. The VIX continues to creep up rising to 13.07. WTI fell 0.7% to $47.70 and Brent fell 0.1% to $50.57.

Higher interest rates from the Fed could quickly lead to a decrease in consumption in products such as cars, lawn mowers, jewelry, furniture, and technology. Retailers and customers that buy these products have grown accustomed to 0% financing on their purchases. However that favorable financing is likely to change with the Fed on a tightening cycle. Typically retailers pay a bank a certain percentage of the purchase price of whatever their customers are buying. That effectively pays the financing cost for its customers which allows customers to effectively pay a 0% interest rate. The upfront fee that retailers pay to the banks or finance companies is tied to LIBOR which moves with the Fed funds rate. Six month LIBOR is up to 1.43% compared to 0.90% last year which makes 0% purchase programs more expensive for retailers. One possible consequence of this would be that retailers will offer shorter terms for 0% purchase programs. Whereas before they may have offered 0% spread out over three or four years, they now are likely to decrease the term to keep their up front costs low. However in spite of the increase in interest rates funding costs are still low and retailers are still offering 0% financing for 3-4 years. Automakers, technology companies, and furniture stores are among retailers that rely on 0% financing to attract customers. As interest rates rise and consumption decreases due to less attractive financing options retailers could suffer another big loss on top of already poor performance. Consumers are very sensitive to 0% financing according to observations from retailers.

The ECB’s policies are set to benefit bondholders. As part of its monetary easing program the ECB has a program that is called the Targeted Longer-Term Refinancing Operations. The TLTRO allows banks across the eurozone to access funds from the ECB at favorably low rates so that they can provide credit for companies and households. The banks put in bids for the amount of funds they request, and they then receive four year financing. The auction that just took place was the last TLTRO auction and demand was very high. Banks borrower EUR 233bn from the ECB which was more than double what the most optimistic estimate had called for. The reason for the spike in TLTRO funding was that since this was the last auction banks may have waited until the last possible time to lock in four year funding. TLTRO is most popular with banks in peripheral countries such as Italy and Spain. The banks are not likely to use all of the funding at once, and in the interim they will put it into sovereign bonds. Therefore short term bonds from Italy and Spain have benefited from this technical driver of the market.

Thursday March 23

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