Monday May 1

Stock indices were mixed today as economic data was slightly below expectations. The S&P 500 rose 0.2% to 2,388 and the Dow Jones fell 0.1% to 20,913. The KBW Bank index rose 0.9% even in spite of comments by Trump suggesting he is looking into bringing back Glass Steagall type reforms. Economic data today showed that personal income rose 0.2% over the last month and consumer spending was flat. Each of those measures missed expectations by a tenth of a percent. The core PCE index also fell 0.1% over the month missing expectations by the same margin. That brought the year on year change in PCE to 1.8%. The PMI manufacturing index came in at 52.8 which was in line with expectations however the ISM manufacturing index was 54.8 missing expectations. That was the first time in seven months that the ISM didn’t beat expectations. Construction spending also fell 0.2% on the month compared to the consensus which called for a 0.5% gain. Investors today might have drawn confidence over a bipartisan agreement on the budget which hopefully forebodes more political cooperation going forward. The agreement that was reached keeps the government in operation until September and it cuts increases to defense and spending which has implications for the wall. The 2 year Treasury yield was unchanged at 1.27%. In spite of the weaker economic data the 10 year Treasury yield rose 4bp to 2.32%. Accordingly 2yr vs 10yr bear steepened to 1.05%. The dollar was higher against peers. USD was unchanged against EUR at $1.0898. USD rose 0.2% against JPY to Y111.80. USD rose 0.5% against GBP to $1.2888. Oil prices were lower along with gold. WTI and Brent each fell 1.1% to $48.78 and $51.5 respectively. The VIX closed at 10.14 which is the lowest level since before the financial crisis.

Equities in Europe have rallied as investors shift their positions to reflect political risk as less of a theme in that region. Last week European equities experienced the highest inflows since 2015 with weekly inflows hitting $2.4bn. The DAX hit a record, the Euro Stoxx 50 index rose 3.5% in the week following the first round of the French presidential election. Year to date the Euro Stoxx 50 index has risen 12% outperforming US equities by around 6%. The clouds are clearing about the political situation at the same time as the corporate outlook is improving for European companies. Economic growth and inflation are slowly but steadily increasing in the region, which is contributing to a bullish outlook for corporate earnings for euro area companies. April’s inflation numbers came in at 1.9% which was slightly higher than expected. Following the release of that data the euro appreciated to $1.0897 and is up from around $1.07 before the presidential election in France. Shares of euro area equities and French bank stocks also jumped following the election. Investors could be caught on the wrong side of the trade of Marine Le Pen wins the final round of voting on May 7 however Macron is currently a heavy favorite to win. Following the Dutch election earlier in the year and the outcome there it may seem as if political risk in the region was overblown. Another country to keep an eye on is Italy. Euroskeptic parties have momentum there and the economic situation isn’t helping the matter. Nevertheless the political risk clouds dissipating are allowing investors to focus more on economic and corporate fundamentals in the region, which for now is bullish for equities. For the first time in a few years analysts seem to be more bullish on euro area earnings than US earnings.

Banks are hoping that operational risk capital requirements will be reduced in financial regulation that gets passed to either repeal or replace Dodd Frank. Dodd Frank requires banks to include operational risk in its risk weighted assets, and banks are required to hold a certain percentage of capital against risk weighted assets. Operational risk refers to losses that could incur from a bank’s own actions as opposed to market or economic conditions. Operational risk is typically calculated using hindsight based on a bank’s previous regulatory problems, fines, and other legal issues. Analysts at Barclays estimate that $236bn in capital is tied to operating risk across the four biggest US banks. Banks dislike the requirements, and Jamie Dimon and Citi CEO John Gerspach has criticized it as well. If that capital is freed up it could be used to finance dividends or share buybacks. Those in favor of operational risk capital requirements suggest that history tends to repeat itself in corporate misdeeds so it is appropriate to use prior regulatory issues. Of the five largest US banks 29% of RWAs is operational risk. As other types of RWAs have decreased since banks have cut back on riskier lines of business, operational RWAs as a percentage of total RWAs has fallen. This comes even as regulatory fines have decreased over the last year. Although no one is expecting operational risk capital requirements to be eliminated entirely even a modest decrease could have noticeable effects for banks.

Canadian banks have had a hectic few days. Last week Canada’s largest subprime mortgage lender announced allegations by regulators about misleading investors about mortgage fraud. In 2014 Home Capital group fired a significant portion of its mortgage brokers due to fraud involving mortgage applications, and those brokers generated 10% of company revenues. Regulators allege that HCG misled investors about the extent of that problem. Last week depositors at HCG fell by 72% down to CAD 391 million. Today HCG announced that it drew CAD 1bn on a CAD 2bn credit line. The stock price fell more than 50% last week and is down another 13% today. This also comes amid signs of stress in the Canadian housing market. Prices are on the rise in areas surrounding Toronto and are detached with economic fundamentals according to the national housing agency. Vancouver previously had a similar problem and imposed a 15% tax in foreigners buying homes. Additionally PrivateBancorp, a Chicago-based bank, was planning on buying Canadian Imperial Bank of Commerce. However that deal is being cast into doubt by the uncertainty surrounding Canadian banks. Private Bancorp still thinks it is a good idea to go through with the deal.

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Monday May 1

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