Friday March 31

Stocks finished off the quarter on a weak note but still posted strong gains over the three month span. Yesterday the S&P 500 fell 0.2% to 2,362 and the Dow Jones fell 0.3% to 20,663. Over the course of the week those indices were 0.8% and 0.3% higher respectively. In the first quarter the S&P 500 rose 5% and the Dow rose 4.3%. Economic data today showed that the PCE index  rose to 2.1% which was in line with expectations. That brings the Fed’s preferred measure of inflation above the 2% target for the first time in this tightening cycle. The core number beat expectations by 0.1% rising to 1.8%. Data also showed that personal income rose 0.4% last month which was in line with expectations. In spite of the strong inflation data the two year Treasury yield fell 3bp to 1.25%. The ten year Treasury yield fell 3bp to 2.39%. Over the course of the week those numbers were 1bp and 3bp lower respectively. This week the probability of a rate hike in June rose from 50.2% to 56.7% following comments made by FOMC officials and the inflation data today. The dollar today rose 0.2% against EUR to $1.0652. USD fell 0.7% against GBP to $1.2550 as the pound has been little impacted by the Brexit. USD fell 0.5% against JPY to Y111.39. Oil prices continued to rise on hopes that Opec will extend its output cuts past June. WTI rose 1% to $50.85 and brent rose 0.9% to $53.62.

The yield curve has been flattening this year which could be a signal that investors and traders aren’t buying the economic growth and inflation narrative. The slope of the yield curve can be viewed as an indicator of economic growth and inflation expectations. As growth and inflation increase then the yield curve would steepen and the opposite dynamic would make the yield curve flatten. The spread between 2 and 10 year Treasury yields on Wednesday hit the lowest level since the election which could be indication that traders have reversed their stance on the Trump reflation bet. At the start of the year 2yr vs 10yr was as wide as 1.23% and widened to 1.30% in January however has since fallen to 1.13%. Also an indication of similar ideas, spreads on corporate bonds both high yield and investment grade have widened in recent weeks. The spread on IG CDX has widened from a low in February of 60bp to 66bp currently. Cash bonds have widened as well since February from 110bp to 114bp. Similar movements in the high yield market are evident as CDX have widened from around 308bp in early March to nearly 340bp currently. That suggests that investors are pricing in weaker economic fundamentals and credit conditions.

Emerging markets had a strong first quarter even as they were initially expected to suffer as a result of the Trump trade. These rallies were driven by the idea that possible protectionism from the US wouldn’t have as bad of an effect on global trade volumes as expected and valuations that are more attractive relative  to the US. According to the IIF emerging market assets experienced inflows of $30bn in March. Valuation metrics relative to developed market valuations are also attractive as EM equities trade at a 26% discount to their developed market counterparts compared to the ten year average of a 17% discount. That could be an attractive place to put money for the many investors in the US who see valuations as high given that P/E ratios are stretched relative to historic averages. Year to date the MSCI emerging market index has posted a gain of more than 11%. Bonds have also performed well as the US dollar hasn’t strengthened by as much as initially anticipated.

Political risk has been on the rise in South Africa which has created volatility for the South African rand this week. President Jacob Zuma in the country last night fired finance minister Pravin Gordhan after a period of arguments and tension between the two. Zuma is a proponent of big government spending and social spending whereas Gordhan is a fiscal hawk. Their plans naturally clashed and that conflict resulted in Gordhan being dismissed. On Monday Pravin Gordhan had been in Europe marketing a bond issuance to investors on a roadshow, however he was abruptly called home by Zuma with no explanation. That signal sent the pound down by as much as 4.4% at the start of this week. Gordhan has also faced charges over fraud allegations. The rand fell this week to SAR 13.4 against USD and some analysts believe that it could fall as low as SAR 14 or 15 against USD if its credit ratings are reduced as a result of the lack of Gordhan’s fiscal influence. South Africa’s bonds are also prone to more volatility due to political and FX reasons since 44% of the outstanding bonds are owned by international investors. The ten year bond yield also rose from 8.28% at the start of the week to 8.86% Friday.

Friday March 31

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