Monday April 10

Stocks rose marginally today as investors investors look ahead to corporate earnings and geopolitical risk is fresh in mind. The S&P 500 and the Dow Jones each rose less than 0.1% to 2,357 and 20,658 respectively. The KBW Bank index fell 0.6% and utilities gained 0.2%. Investors look ahead this week to PPI and CPI data on Thursday and Friday as well as retail sales. Corporate earnings season is also about to kick off and analysts are calling for earnings increases from this time last year. Also on the geopolitical front the United States deployed an aircraft carrier off the coast of Korea and the government said it would act unilaterally on North Korea even as Trump met with Xi Jinping this weekend. One positive takeaway from that meeting was that there did not appear to be any hawkish comments on trade and both parties agreed for the need to balance trade. The VIX rose to 14.11 which is the highest level of the year. On that backdrop the 2 year US Treasury yield fell 2bp to 1.27% and the ten year US Treasury yield fell 1bp to 2.37%. 2yr vs 10yr finished at 1.09% which is very low by recent standards. The dollar was mostly flat in foreign exchange markets. USD fell less than 0.1% against EUR and JPY to $1.0592 and Y111.02 respectively. USD fell 0.2% against GBP to $1.2409. The South African rand continued its decline with a 1.3% drop to ZAR 13.9372. Oil prices continue to rise with the combination for geopolitical risk as well as hopes for an extension of the supply cut. WTI rose 1.6% to $53.09 and Brent rose 1.4% to $55.99.

In spite of falling interest rates borrowers have effectively been paying more on the mortgages based on the amount of money that banks make off of underwriting mortgages. Investors and financial markets finance mortgages and receive the majority of the interest payments borrowers make. A certain spread of each mortgage payment goes to the GSEs and the banks that underwrite the mortgages. Although mortgage rates have been falling, the bank’s share of what they take on interest payments have been rising. That is for a few reasons. First as mortgage volumes rise and banks get busier with back office and mortgage underwriting operations banks need more money in order to pay for those operations. That wasn’t happening before the financial crisis which is something that contributed to loose underwriting standards. A seconds reason for banks taking more fees from mortgage loans is the need to recapitalize their balance sheets after the financial crisis which makes the system safer. As funding costs have fallen as a result of quantitative easing banks have passed some of those savings on to consumers and saved some of those for themselves. It is also important to note that banks are quicker to save some of the savings for themselves when rates fall than they are hold on to some of the losses when interest rates rise. Also as the Fed starts unwinding the balance sheet that could lead to a disproportional rise in Treasury rates. Investors in MBS hedge negative convexity by selling Treasuries, but the Fed doesn’t need to hedge. As more of the MBS market is held by investors who hedge that could lead to increase demand to sell Treasuries.

Foxconn offered to buy Toshiba’s computer-chip business for $27bn which sent Toshiba’s shares up 6.47%. Foxconn is the largest manufacturer of electronics and contracts heavily with Apple to produce their products. Foxconn last year put in a very high bid for Sharp to outbid a investment fund backed by the Japanese government. This comes as Toshiba said it was exploring alternative strategies to boost capital after one of its subsidiaries filed for bankruptcy last week. This presents a challenge for the Japanese government who was looking to see either a Japanese company or a joint venture between a Japanese and American company take over the chip business at Toshiba. The Y3tn offer for the business is well above the analyst estimate of Y1.5 to Y2tn and it was the highest bid when Toshiba collected initial bids at the end of last month. That will help Toshiba plug a hole in its shareholders equity after the Westinghouse bankruptcy will lead the company to post a Y1tn loss this year. The Japanese government is skeptical of any mainland Chinese business due to national security concerns. Foxconn wouldn’t face antitrust concerns in this deal since they don’t have a flash memory unit however they are very closely involved in that supply chain. It would be a challenge for Foxconn since they would have to focus heavily on research and development and their current business is more focused on supply chain management.

Demand for credit has been strong as evidenced by the record amount of issuance in the first quarter. Emerging market sovereign and corporate issuance totaled $178.5bn in the first quarter which is the highest quarterly total on record. Investment grade issuance in the US was as high as $414.5bn which is also a record quarter. High yield US issuance was $79.6bn which is twice last year’s total. Mohamed El-Erian suggests that since the trade has worked well over the past few years it has a lot of momentum behind it and will continue to perform absent very convincing reasons for a turnaround. In spite of inflationary concerns which could eat into returns in the fixed income markets demand for bonds has still been high. In the weeks after the election those concerns resulted in more than $40bn outflowing from bond funds in the six weeks following the election. However since then inflows have made a sharp comeback in the first quarter with $112bn in inflows. Investors are taking more risks by buying emerging market bonds or high yield bonds. In the high yield market spreads are +393 on BAMLs index which is less than half of the spread last year.

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Monday April 10

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