Stock prices fell after investors were made jittery by the release of the ECB minutes from the June meeting. The S&P 500 fell 0.9% while the Dow Jones lost 0.7%. The KBW Bank index fell 0.9% while utilities fell fractionally. The ADP employment report today showed that June private payrolls rose 158k compared to the consensus of 180k. That continues the trend of economic data missing expectations, and could foreshadow an underwhelming NFP report tomorrow. The PMI Services index came in at 54.2 which was higher than the consensus of 53.0. Similarly the ISM non-manufacturing index was higher than expectations at 57.4. Also on the economic calendar was the EIA Petroleum Status report which showed that crude oil inventories and gasoline inventories drew down by 6.3 and 3.7 million barrels last week which provided slight support for oil prices. Ahead of the June NFP report tomorrow, the 2 year Treasury yield fell 1bp to 1.40%. The 10 year Treasury yield rose 4bp to 2.37% as global yields continue to sell off. Accordingly 2yr vs 10yr bear steepened to 0.96%. The dollar was weaker on the day against peers, especially EUR after the ECB minutes. USD fell 0.6% against EUR to $1.1422. USD fell 0.1% against JPY to Y113.18. USD fell 0.3% against GBP to $1.2972. Oil prices found some support from the EIA report. WTI rose 0.5% to $45.34. Brent rose 0.3% to $47.91.
Central banks around the world over the last week caught investors off guard by suggesting they may be getting closer to winding down monetary stimulus. That has been the case over the last week in the UK and the eurozone, and as a result yields in those markets sold off and have continued to do so. As these central banks get closer to removing accommodation by purchasing less bonds each month, it could lead to volatility and uncertainty in markets. However Japan has in a way been able to remove accommodation without causing too much of a panic. Instead of targeting a certain amount of bonds to purchase each month, which is what the ECB, the BoE, and formerly the Fed did, the BoJ targets a certain yield on the 10 year JGB. That has allowed the BoJ to purchase a smaller amount of bonds each month without having to spook investors over a reduction of monetary stimulus. It also takes out a significant amount of volatility of fixed income markets. Since announcing the target on the 10 year yield, the JGB has fluctuated just between 0.05% and 0.10% while yields in Europe and the US have been much more volatile in part due to monetary policy uncertainty. This comes even as the BoJ has purchased a smaller amount of bonds each month going back to the summer of last year, which under other circumstances might increase volatility. This could serve as a lesson for other central bankers looking to provide QE in the future, as Japan’s policy seems to provide more flexibility.
Investors in Europe were once again jittery after the release of the minutes from the June ECB meeting. Investors seemed to focus in on comments from Draghi that said risks of deflation had “largely vanished.” That led to a selloff in eurozone government bonds. The 10 year German, French, and Italian yields rose 10, 10, and 12bp to 0.56%, 0.92%, and 2.26% respectively. In spite of those comments on deflationary risks going away, the minutes didn’t come acros as overly hawkish. Monetary policy officials continue to state that they are willing to step in with more stimulus if conditions materially worsen, and they have not yet discussed reduction of the current accommodation of EUR 60bn a month. They believe inflation is on track to hit the target of just under 2%, but only with significant help from monetary policy and as such they won’t begin to reduce stimulus until inflation is well on track to sustainably be at the target. Strategists at Pimco said they did not interpret the statement as overly hawkish, in spite of the immediate market response.
High yield markets in both the US and in Europe have reported strong returns year to date, however some analysts are skeptical about prospects for the second half of the year. US high yield bonds rose 4.8% in the first six months of the year while the European sector advanced 3.7%. While both of those numbers are strong, they both did dip slightly in the last two weeks of the quarter. US high yield was primarily affected by the selloff in oil prices. The dramatic price drop in oil was reminiscent of the start of 2016, which was a very bad period for high yield which could have turned away some investors. Deals by high yield issuers such as Charter Communications, Virgin Media, Hecla, and Berry Global all pulled deals from the high yield or leveraged loan markets. The nature of those deals allowed the issuers to be opportunistic, meaning that they did not necessarily have to issue the debt and they had flexibility. It remains to be seen what would happen if buyers pulled back on a deal that had to go through. US names in the high yield space issued equity at the start of 2016 to weather the storm, however they would be unable to do that this time around as they may have exhausted those sources of financing. As the second half of 2017 continues oil prices and the slowdown in retail will continue to be key risks for US high yield. The recent turnaround in European high yield can be attributed to the selloff in sovereign bonds across the region. The European index is made up of a higher portion of BB rated bonds compared to the US index. Those bonds, while they are still high yield, carry lower coupons and longer maturities than lower rated high yield bonds. That means that they have more duration, and their performance is more adversely affected in the event of a selloff in rates. Accordingly for the European high yield sector the outlook for ECB tapering will be a key risk for the remainder of the year.