Monday June 5

Stocks finished slightly lower today after a volatile day for oil. The S&P 500 fell 0.1% to 2,436 and the Dow Jones fell 0.1% to 21,184. The KBW Bank index was up 0.1% while utilities fell 0.5%. Economic data today showed that nonfarm productivity came in slightly higher than expected and unit labor costs rose 2.2% in the first quarter which was slightly below consensus. The PMI Services index was 53.6 which missed consensus. The ISM non-manufacturing index missed slightly as well however both continue to show solid expansion. Factory orders fell 0.2% on the month which was in line with expectations. Notable news this morning was that Saudi Arabia, the UAE, Bahrain, and Egypt cut diplomatic and some economic ties with Qatar since they say the country doesn’t do enough to stem extremism and terrorism. Immediately following that news oil prices rose 1% however they finished lower on the day. Qatar is the largest exporter of liquid natural gas in the world. Analysts estimate that this action does not have any immediate impact on the output cuts that are ongoing since Qatar is very much a willing participant in the cuts. Interest rates in the US rose as markets price in a 95% chance of a 25bp hike when the Fed meets in a few weeks. The two year Treasury yield rose 1bp to 1.31%. The ten year Treasury yield rose 2bp to 2.18%. Accordingly 2yr vs 10yr bear steepened 1bp to 0.87%. The dollar was slightly higher against peers. USD rose 0.2% against EUR to $1.1257. USD was fractionally changed against JPY to Y110.49. USD rose 0.1% against GBP to $1.2906. After a volatile day oil prices finished lower. WTI fell 0.6% to $47.36 and Brent fell 1% to $49.47.

President Trump this week is expected to get going on his pledges relating to infrastructure investment. Tax and healthcare reforms have been difficult for him to get through Congress, however since infrastructure is a less contentious issue hopefully he will be able to make some progress on this front. Among other things he plans to announce a program that will privatize air traffic control, a plan to improve infrastructure along the Ohio River, as well as a speech later in the week at the Transportation Department that could talk about plans for roads, bridges, tunnels, etc. During the campaign and after the election Trump talked about $1tn in infrastructure spending financed by private investors. It does remain to be seen the programs he plans to use to attract private investors, and how the government will finance projects that aren’t able to lure private investment. Private equity funds such as Blackstone, KKR, and Carlyle have been actively raising infrastructure funds, but for projects that won’t be profitable the government will have to finance those somehow. Among other things Gary Cohn has talked about improving the process by which infrastructure projects get approved since it currently can take up to 10 years and involve approvals from more than a dozen government agencies. In the time it takes for projects to get approved it becomes more costly. The administration is also hoping to reduce the federal government’s share of infrastructure spending by encouraging state and local governments to finance the projects. Hopefully this week and in the months ahead investors and the public get more information on project specifics, financing details, and timeline details. As more details are clarified it could have ramifications for equity and fixed income markets.

The recent regulatory crackdown in China and subsequent tightening of financial conditions is pushing borrowers and want to be lenders into the shadow banking sector. The PBoC in China over the last month has aggressively raised short term interest rates in order to shake out excess leverage in the financial system. That has sent corporate bond yields to two year highs in China. As a response the amount of funds raised for trust loans has increased to the highest level in four years. Trusts raise money from individuals and corporations and make loans in China to riskier areas of the economy. Typically they provide credit to companies who would not be able to get bank loans or issue bonds, however now more and more companies are looking to get funds from that informal banking sector as formal markets are increasingly tight. Banks and investors are increasingly reluctant to lend and trusts have soared in response. That presents a difficult challenge for regulators and further complicates the problems they are having there with excessive debt in the system. This grey area obscures how much debt is actually in the system and companies are able to disguise risky loans as investments. As a result regulators in China have reportedly held discussions on how they can tackle the debt issue without causing too much commotion in markets which pushes investors and borrowers into these risky areas.

Although weak economic data recently has caused some to question whether or not the Fed will raise rates in June, it seems that the Fed will still raise rates this month to avoid the hit to its credibility that it would face if it decided to hold off. Based on the most recent FOMC minutes and Fedspeak investors are generally anticipating a rate hike, and credibility of the FOMC could be damaged if it didn’t hike at this point. Nevertheless in the months ahead the Fed could adjust its stance from “full steam ahead” to a “wait and see” stance. To reflect the idea that the Fed will hike this month coupled with the longer term uncertainty with the economy, the yield curve has been flattening significantly in recent weeks. Regardless according to Bloomberg investors are anticipating a 90% chance that the Fed will raise rates when it meets this month. Supporting the argument in favor of the Fed raising rates this month is the fact that financial conditions are generally pretty accomodative right now and market conditions seem prime for a rate hike. Since markets are presenting the opportunity for the Fed to hike rates it seems justifiable for them to do so. The St. Louis Fed’s financial stress index which tracks financial credit conditions using equity markets, Treasury markets, and credit markets is at a three year low and is close to an all-time low. That has been driven in part by lower Treasury yields this year along with a weaker dollar. Prior Fed rate hikes also have not had a huge affect on financial market conditions in recent months so the opportunity seems right for the FOMC.

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Monday June 5

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