Thursday April 6

Stock markets rose today as investors will be paying attention to the meeting between Trump and Xi Jinping. The S&P 500 rose 0.2% to 2,357 and the Dow Jones rose 0.1% to 20,662. The KBW Bank index rose 0.8% while utilities fell 0.2%. Investors will be paying close attention to tomorrow’s NFP report which will provide more clarity as to what decisions the Fed may make later this year. Investors also noted that the Fed viewed equity prices as “quite high” which could also contribute to concern since the Fed doesn’t usually comment on that. Concerns about tax reform were also in mind as Paul Ryan said that the White House, Congress, and Senate were all far apart on tax reforms. Yields in the US inched higher after the FOMC minutes yesterday. The two year Treasury yield rose 1bp to 1.24%. The ten year Treasury yield rose 1bp to 2.34%. 2yr vs 10yr was unchanged at 1.10%. The dollar was stronger on the day against peers. USD rose 0.2% against EUR to $1.0642 after dovish comments from Mario Draghi. USD rose 0.1% against JPY to Y110.78. USD rose 0.2% against GBP to $1.2463. Oil prices rose. WTI added 1.1% to $51.70 and Brent gained 0.9% to $54.83.

The repo markets continue to be a source of trouble for the ECB. Given that the ECB has purchased so many government bonds over the last few years there is a shortage of high quality bonds. For repo markets that means there is a scarcity of collateral. Repo trades are essentially a short term loan collateralized by cash. The person receiving the loan typically pays a small interest rate on the short term loan which is called the repo rate. As demand for the collateral rises the repo rate falls. Given the demand for high quality collateral in the EU as well as the scarcity in supply, repo rates have gone negative in some cases. For example the spread between German general collateral and Italian GC has gone sharply negative at points recently and is currently around -1.30%. In order to prevent these dislocations from happening analysts argue that the ECB has four options. Increase the size of its repo facility, associate the rate at which securities are lent with its monetary policy deposit rates, allow non-banks access to ECB operations, or increase the amount of high quality assets in the European financial system by issuing an ECB bond. None of those options are ideal for the ECB and all have downsides. The most likely option is to open up repo facilities to non-bank institutions. However there are potential moral hazard problems associated with that since it would suggest that having a banking license doesn’t matter. It is apparent that the financial system is more focused on access to high quality collateral and liquidity there as opposed to liquidity from the central bank.

Unilever announced a restructuring plan in the aftermath of the Kraft Heinz bid. After Kraft Heinz bid $143bn for the company Unilever’s CEO was under pressure to return some value for investors, who may have liked the $143bn offer. After a strategic review Unilever hopes to sell its margarine and spreads business, raise its dividend, buy back shares, and increase the debt load all as a result of the Kraft Heinz merger. Unilever hopes to raise between $7.5bn and $8.5bn in a sale and said it would not sell for anything less. They could also be spun off separately as a publicly traded company. Already consumer brands such as French’s, Stonyfield, and Weetabix brands are on sale which are all in the same deal space and would attract similar buyers. It plans to increase its dividend by 12% and repurchase shares as part of a EUR 5bn program as a way to return money to shareholders. Additionally it will issue debt that will allow it to finance accretive acquisitions of EUR 1bn and EUR 3bn as well as deter any potential acquirers. At midday the company’s stock was up slightly more than 1% following the announcement.

Spotify is looking to IPO in a non-traditional manner which is significant on a few fronts. First the company is one of the privately held unicorns that is currently valued at $8.5bn in private markets based on the last financing round. The company hopes to achieve a public market valuation of around $10bn, and it could list as early as September some time this year. The company will issue by direct listing which is pretty different from the standard IPO process. Normally new investors buy shares from the company or from existing early stage investors that are priced the night before they start trading. That involves a long road show, underwriting, and valuation process on behalf of the banks and as a result they can command large fees. However by direct listing investors can purchase shares on the open market immediately after they are listed and the price is set based on supply and demand. The downsides to this method include volatility and unpredictability in pricing, as well as the stability that comes from placing the stock with large institutional investors. The company could benefit because they won’t pay high underwriting fees, they won’t have to deal with dilution in their shares, and investors won’t have to deal with lockup periods. Although they are considering this process they still may choose to go for the traditional route. This is bad for investment banks because they lose out on a lot of fee revenue. If the IPO goes well more companies could choose to go this route. Already IPO desks have been struggling as last year IPO revenue was the lowest in more than twenty years. This is similar to in 2004 when Google went public in a non-traditional method using the Dutch auction process.

Thursday April 6

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