Tuesday July 11

Stock prices were little changed for the second consecutive day as investors struggle to find direction this week. The S&P 500 fell less than 0.1% to 2,425 and the Dow Jones was unchanged at 21,409. The KBW bank index fell 0.6% while utilities fell marginally. The JOLTS report today showed that job openings came in below consensus at 5.66mm compared to estimates of 5.975 million openings. Job openings missed expectations while job hirings rose. Lael Brainard spoke and came across as dovish on rates, but said that the Fed could begin running off the balance sheet soon. Neel Kashkari also came across as somewhat dovish on rates, saying that he finds it hard to believe that the economy is at risk of overheating given low wage growth. Investors were somewhat skittish today after reports that Donald Trump Jr. accepted a meeting with a Russian lawyer with ties to the Russian government before the election. The S&P fell as much as 0.6% before recovering. In spite of that reaction, as well as reports from Citi and Pimco highlighting the political risks associated with this headline, it seems that it will take a report with real traction and clear wrongdoing on behalf of the administration to move the needle for investors. The 2 year Treasury yield fell 1bp to 1.38%. The 10 year Treasury yield fell 2bp to 2.36%. Accordingly 2yr vs 10yr bull flattened to 0.98%. The dollar was mixed on the day against peers. USD fell 0.4% against EUR to $1.1465. USD rose 0.4% against JPY to Y113.84. USD was little changed against GBP and finished at $1.2846. Oil prices rose for the second consecutive day which provided support for energy sector shares. WTI rose 1.6% to $45.10 and Brent rose 1.5% to $47.57.

Investors are looking to get their hands on bonds issued by Total Bankshares Corporation, which is a small lender based in Miamo that was a subsidiary of Banco Popular. When Banco Popular was acquired by Santander for EUR 1 a few weeks ago, Spanish regulators imposed losses on holders of hundreds of millions of euros in debt. Some legal analysts have questioned the legality of this move, and several investors including Pimco are seeking litigation strategies against Banco Popular in order to earn a return. The bonds issued by Total Bankshares Corporation are very small, believed to be less than $50mm, however they are attractive to investors because since they were issued under US laws they may give investors who hold them the benefit of US bankruptcy laws. That could entitle them to a higher payout after acquiring the bonds at deep discounts. The bonds are difficult to track down as they were placed into a CDO along with dozens of other series of bank debt. A secondary market has formed for the euro denominated bonds as well, with investors looking to make a legal play as well. Analysts note that traders have made purchases of euro denominated subordinated bonds issued by Banco Popular for 1 cent on the euro. At that price even a payout of 2 cents on the euro could mean a 100% return for investors. Also in the European credit space was Bain Capital Credit buying nearly EUR 1bn in NPLs from Spanish and Italian banks.

The Bank of Canada is expected to join the Fed tomorrow as central banks that are tightening monetary policy. Benchmark interest rates in Canada are currently 0.5%-0.75% and the majority of analysts believe that range will be increased when the central bank meets tomorrow. The market for OIS is showing a 90% chance of a rate hike tomorrow. Additionally in anticipation of the meeting tomorrow the Canadian dollar has appreciated over the last week and Canadian government bonds have sold off. Nine out of the ten primary dealers that cover Canadian government debt believe that the central bank will raise rates tomorrow. The only bank that believes the central bank will hold off, TD Securities, thinks it will wait until the fall. The impetus for raising rates now comes from soaring real estate prices that have led the government to impose official measures to slow speculation in the space. Additionally hiring data has been strong, and quarterly GDP growth annualized has been very strong over the last three quarters. At the same time the ratio of consumer debt to after-tax income has risen steadily over the last 5 years to nearly 170%. The only factor that may hold the Bank of Canada back is inflation. Inflation in May was just 1.3% on an annualized rate which is below the 2% target, and similar to in the US wage growth is persistently low. However analysts are willing to look past this and cite hawkish statements since June coming from the BoC as reasons why they believe the central bank will move tomorrow.

Pre-2008 home equity lines of credit are becoming less of a sore spot for banks. Helocs typically allow borrowers to only pay interest for the first 10 years, at which point a reset date occurs and then the borrowers have to pay down principal as well. In recent years that posed problems for banks, as borrowers who signed up for Helocs in the years leading up to the crisis struggled to pay after payments increased after the 10 year period. Between 2013 and 2016 more than 4% of the borrowers who had signed up for Helocs 10 years earlier were one to four months late on their payments. However for Helocs that were made at the start of 2007, delinquency rates have fallen to 3.8%, which could suggest that lending standards had started to tighten at that time as cracks in the housing bubble started to emerge. Another part of the reason why borrowers might be able to better pay off their loans is that less mortgages are considered to be seriously underwater than they were just 3 years ago. Currently only 9.7% of the mortgages outstanding are considered to be seriously underwater, which means the loan is 25% higher than the overall value of the home, compared to 17.5% in 2014. Improving employment markets may also be helping this trend for banks. Additionally banks have also been actively reaching out to customers who’s Helocs are about to reset and helping them find alternatives that are more affordable. For some that may be taking out a loan or applying for a new Heloc and qualifying for another 10 year period. That allows banks to “positively” close loans as opposed to having to deal with bad loans on their books.

Tuesday July 11

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