Wednesday July 5

Stock indices drifted higher today as investors returned from the July Fourth weekend. The S&P 500 rose 0.2% to 2,432 while the Dow Jones fell fractionally to 21,478. The KBW Bank index rose 0.3% while utilities fell by that same margin. Economic data today showed that factory orders fell by 0.8% last month compared to estimates which called for a 0.5% decline. Investors also paid attention to the release of the FOMC minutes from the June meeting, which showed that the Fed may begin unwinding the balance sheet in the next couple of months before raising interest rates again. The reasons for that would be benign inflation, calm financial market conditions, and Janet Yellen’s potentially ending term at the start of 2018. All of those things could encourage the Fed to adjust the sequence of monetary policy normalization between balance sheet reduction and interest rates. Investors today didn’t pay much attention to geopolitical tensions flaring up in North Korea, and indices stayed firm in spite of falling oil prices. Prices dropped today after data showed Opec production increased due to Libya and Nigeria, as well as a report that said Russia would not support further production cuts. On that backdrop the two year Treasury yield was unchanged at 1.41%. The 10 year Treasury yield fell 2bp to 2.33%. Accordingly 2yr vs 10yr bull flattened to 0.92%. The dollar was little moved on the day against peers, moving less than 0.1% against EUR, JPY, and GBP. EUR finished at $1.1345. JPY finished at Y113.21. GBP finished at $1.2928. WTI fell 4.4% to $45.01 while Brent lost 3.9% to $47.69.

Today marked the first day that Bond Connect opened, which connects fixed income investors in Shanghai with international investors based in Hong Kong. The trading link comes after China opened its bond markets last year to international investors with accounts inside of China, and Bond Connect was designed in a way that mimics the stock market connections between China and Hong Kong. All of these steps reflect an effort on behalf of China to liberalize their financial markets by making it easier for international investors to transact in Chinese securities. One of the key differentiating factors between the stock and bond market connections is that the stock market connection is two-way, meaning that investors in China and Hong Kong can both buy and sell stocks in the other market. However Bond Connect is only one way, as Chinese investors won’t be allow to buy bonds in Hong Kong due to the efforts of Chinese authorities to limit capital outflows. In spite of the celebrated opening in China, that was highlighted by a large bond issuance from one of China’s state sponsored banks, the bond market had a quiet day. The 10 year government bond yield only moved 4bp and the 1 year bond yield moved less than 1bp. International market makers such as Citi and HSBC also did their first transactions using Bond Connect. However in spite of these efforts many analysts don’t believe that opening up this platform will draw a significant amount of international investors, which currently make up less than 2% of the market in China. Several factors, including unreliable rating agencies, poor credit fundamentals, unpredictable policies by the PBoC, inconvenient settlement practice, and the inability to hedge foreign exchange risk are all keeping international investors. Therefore for the time being, in spite of China’s efforts to liberalize its markets, it seems as if it will take more reforms for the characteristics of its market to change.

Wednesday July 5

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