Tuesday May 9

The S&P 500 briefly traded above 2,400 and then dipped to finish slightly lower on the day. The S&P 500 fell 0.1% to 2,396 and the Dow Jones fell 0.2% to 20,975. The KBW Bank index lost 0.6% while the DJ Utility Average fell 0.9%. Robert Kaplan spoke today and said that three Fed rate hikes are still on the table for this year and said that the trajectory could be unaffected by balance sheet plans, both of which are somewhat hawkish comments. The JOLTS report showed that there are 5.7 million job openings which was in line with estimates and continues to be consistent with a tight labor market. The recent rally in risk assets has been driven by well-received corporate earnings as well as a decrease in political risk. The VIX finished slightly higher today but closed below 10 at 9.96. Rates globally have been moving higher as investors price in a more favorable growth outlook and the possibility of rising interest rates in the US. The two year Treasury yield was unchanged at 1.34%. The ten year Treasury yield was 1bp higher at 2.40%. Accordingly 2yr vs 10yr bear steeped to 1.06%. The dollar continued to strengthen against peers. USD rose 0.5% against EUR to $1.0875. USD rose 0.5% against JPY to Y113.86. USD rose less than 0.1% against GBP to $1.2936. Oil prices fell just one day after Saudi Arabia said it would do whatever it takes to support prices. WTI fell 0.8% to $46.04 and Brent fell 1% to $48.87.

Home Capital Group continues to struggle with the fallout of a regulator probe into the allegation that current and former executives misled investors on the extent of a mortgage fraud issue. Deposits at the company continue to fall, and are now down to CAD 146mm from CAD 2bn at the end of 2016. To plug capital holes HCG announced that it would sell CAD 1.5bn in mortgages to an unidentified buyer, and that there was a possibility that it could sell even more mortgages. As HCG does this it will continue to eat into the CAD 25.7bn in mortgages that it had at the end of the calendar year. It also accessed an emergency CAD 2bn line of credit with a Canadian pension plan that has since been syndicated to Credit Suisse, Goldman Sachs, Fortress, and an “unnamed North American financial institution.” These moves will make the company less profitable, however shares for HCG are up nearly 23% today which suggests investors like the deal.

Greek bonds have experienced an impressive rally over the last few years and the conditions for the rally to continue are preset. Since touching a high of close to 30% at the start of 2012 the 10 year government bond yield has since rallied to 5.49% currently. At the start of last year that number was in excess of 10%. Investors who bought Greek government debt in early 2016 would have since returned close to 60%. This comes as the government in Greece has been able to play nice with Euro area creditors and pass the reforms needed to unlock more bailout money. Some analysts are even calling attention to the possibility that Greece issues more debt as soon as the current bailout package expires in 2018. However that comes even as the economic picture in the country isn’t too positive. GDP fell 1.2% in 4Q 2016 and the unemployment rate currently exceeds 20%. The current spread between Greek bonds and German bunds implies a 40% chance of default in the next ten years assuming a zero percent recovery rate (assuming a recovery rate increases the chance of default). That is a higher level than other euro area countries that have similar if not worse situations than Greece, for example Portugal. Portugal has a higher debt service expenditure as a percentage of GDP than Greece does yet its spread to bunds implies just a 25% chance of default. If the reforms do start to have an effect on Greece’s economic fundamentals however that would be ideal for bond investors. The current expectation now among investors is that there will be restructuring of Greek bonds that affects “official sector” creditors and not investors. That restructuring effort would make it a more advantageous environment for credit in Greece which is good for investors. Additionally if the country starts to ingratiate itself with the ECB again that could drive down borrowing costs even further. The key risk with this idea is that there is a fallout between Greece, its creditors, and the euro area and as a result a Grexit occurs which would have unprecedented consequences that surely would not be good for credit.

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Tuesday May 9

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