Friday May 19

Stocks rose to finish off the week on a stable note after suffering a sharp selloff mid week. The S&P 500 and the Dow Jones each rose 0.7% to 2,381 and 20,804 respectively. Over the course of the week each of those indices were down 0.4%. Today the KBW Bank index rose 0.9% while utilities rose 0.4%. Optimism today could have in part been driven by higher oil prices on hopeful expectations for an Opec meeting next week. This week markets were rattled about reports of Trump potentially interfering with Comey’s investigation into Michael Flynn and some fringe onlookers calling for an impeachment. Investors are pricing in possibly a less effective tailwind from the fiscal side as a result of these political uncertainties, however some analysts still note that reasons for optimism remain. A less effective fiscal outlook could also have ramifications for the Fed’s tightening cycle, and James Bullard had dovish comments today regarding the Fed’s projected trajectory of interest rates. On that backdrop today the 2 year Treasury yield rose 2bp to 1.27%. The 10 year Treasury yield rose 2bp to 2.24%. Accordingly 2yr vs 10yr was unchanged at 0.97%. Over the course of the week those rates were 2 and 9bp lower respectively. The dollar was weaker on the day against both developed and emerging markets, possibly pricing in a more dovish Fed. USD fell 0.9% against EUR to $1.1207. USD fell 0.2% against JPY to Y111.26. USD fell 0.7% against GBP to $1.3037. Oil prices had a strong day. WTI rose 2.4% to $50.53. Brent rose 2.5% to $53.80.

One area that banks could make a comeback into as a result of deregulation is payday lending. Payday lending involves giving out very short term loans (typically two weeks or less) to what is typically low income borrowers who need to finance small purchases before they get their paycheck. The loans are typically small in size but carry very high rates of interest which sometimes come out to an annualized 300% or higher. Some payday lenders report average loan sizes of $300. Aspects of Dodd Frank and regulation from the CFPB either prevent or make it impossible for banks to be in this space. Instead smaller banks and smaller lenders occupy the space. That is difficult however since the costs of offering those loans in many cases make it not economic. The cost to originate a loan the size of an average payday loan is the same as the cost to originate a loan of thousands of dollars, so it doesn’t make sense for smaller banks to lend there. Bankers believe that it would make more sense for banks with a large platform that can spread out the costs and the losses, and apply a simple model on whether or not to originate the loans. Another benefit for allowing banks back into this space would be benefits for the consumer. The costs on payday loans are exorbitant and banks would be able to offer them for a lower cost. When banks did lend to this area they typically charged flat fees of 10%, and it would allow them to serve a wider variety of clients on a more broad platform. Banks such as Fifth Third, Wells Fargo, Regions, and U.S. Bancorp are looking to get back into this space and a proposal has been submitted to Steve Mnuchin by the American Bankers Association and the Consumer Bankers Association.

Political controversy is back at center stage in Brazil less than a year after President Dilma Rousseff was impeached for corruption. For the second time in recent years Brazil’s president is under formal investigation for corruption. Brazilian company JBS is one of the largest meatpacking companies in the world, and this week it admitted to paying tens of millions of dollars to Michel Temer, Dilma Rousseff, and Luiz Inácio Lula da Silva. That implicates each of Brazil’s leaders for the last 14 years. Dilma Rousseff was impeached following corruption involving oil company Petrobas, and that corruption implicated da Silva as well. Before these allegations Temer’s approval rating was just 9%, and if he loses the support of Congress his term could very well be cut short. The chairman of JBS under a plea deal said that he has paid $123mm in bribes to politicians in recent years including Temer and $30mm in an offshore bank account to Rousseff, and $50mm in an offshore bank account to da Silva. The Supreme Court released documents, videos, and recordings related to this probe. These payments were made in order to receive large favorable interest rate loans from Brazil’s state development bank BNDES which JBS used to finance international expansion and foreign acquisitions. This is very bad for Brazil’s financial markets. Investors had just now been warming to the country’s markets following the previous corruption probe, and were optimistic that Congress would be able to pass the necessary reforms to turn the economy around and fill the budget deficit. With this political risk now on the forefront investors may scale back those expectations since politicians will be less keen on passing reforms and more focused on the vacant presidency. As a result of that development the Brazilian real fell 8% on Thursday. That is not good for investors in the carry trade, and Brazil had been a popular destination for that. At the same time the yield on Brazilian government bonds denominated in real rose 2% after the news broke. That is a sharp reversal of recent trends when Brazil was an emerging market investor favorite due to optimism for economic reforms.

Companies have been looking to outside investors to specifically finance certain research and development initiatives. In theory companies probably shouldn’t need to do that, since they receive money from shareholders to invest into their business to finance projects and capital expenditures. However research has showed that stock markets tend to discount R&D in company stock prices, given that R&D intensive companies tend to outperform over a long period of time. That suggests that stock market prices don’t accurately reflect the possible payoffs associated with R&D. That could be a sign of short termism on behalf of investors. As a result some companies are taking the view that since investors don’t reward companies for R&D, it may be wiser to look for outside sources of funding if they still want to do it. The idea is that while investors may want exposure to the marketing and manufacturing of certain products but not the development. This practice has been used in the past for financing drug R&D but now it is shifting on into manufacturing as well. There are small funds that are dedicated to financing specific R&D projects. The Ontario Teachers’ Pension Plan and the Development Bank of Japan put up $50mm and $100mm respectively for the financing of General Electric’s GE9X engine. In return they will receive a share of future sales which is likely to be between 15 and 20% since the project has been successful.

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Friday May 19

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