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.

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Tuesday July 11

Monday July 10

US stocks started out the week fractionally higher on follow through optimism after the NFP report and ahead of 2Q earnings releases later this week. The S&P 500 rose 0.1% to 2,427 and the Dow Jones fell fractionally to 21,408. The KBW Bank index and the DJ Utility Average each fell less than 0.1% to start the week. Economic data today was light, however it is a busy week for Fedspeak with comments forthcoming from Lael Brainard, Neel Kashkari, Janet Yellen, Esther George, Charles Evans, Robert Kaplan, and John Williams. Additionally Janet Yellen is going to testify in front of Congress where she will likely defend the manner in which the Fed conducts monetary policy. Also on the economic calendar this week is PPI, CPI, retail sales, and industrial production data. It was a quiet day in financial markets today, but the global bond selloff did recover somewhat. The 2 year Treasury yield fell 1bp to 1.39%. The 10 year Treasury yield fell 1bp as well to 2.38%. Accordingly 2yr vs 10yr finished at 0.99%. 10 year yields in Germany and the UK fell 4bp to 0.54% and 1.27% respectively. USD rose slightly against peers. USD rose marginally against EUR to $1.1397. USD rose 0.2% against JPY to Y114.05. USD rose 0.1% against GBP to $1.2880. Oil started the week tentatively higher. WTI rose 0.8% to $44.56. Brent rose 0.7% to $47.03.

Hedge funds are seeking to profit by “orphaning” outstanding CDS contracts against debt issued by Matalan. Matalan is a European retailer that currently is rated CCC, and its bonds trade at yields around 11%. Hedge funds sold CDS against outstanding Matalan bonds when CDS spreads were very high, believed to be around $4mm for every $10mm in notional principal, or 4000 basis points. Now those same hedge funds want to help Matalan refinance the debt that the funds are short. They hope Matalan will refinance the debt by issuing the bonds under a separate legal entity, which would not be covered under the CDS the hedge funds sold. That would make the CDS that they sold effectively worthless as the legal entity that formerly housed debt would have no debt anymore, and the CDS contracts that they sold would expire worthless. That process is known as “orphaning” the outstanding CDS. The key risk for the hedge funds here is that Matalan defaults on the refinancing issue in the event that the hedge funds retain the deal. There is also legal risk.  This type of activity was more common before the financial crisis when the single name CDS market was more liquid. In 2006 the SEC investigated an insider trading case involving a deal similar to this with a Dutch company, however it was dismissed in 2010.

Investor focus on what the next monetary policy move is shifting from the Fed towards the ECB. Over the last few years investors would hang on the Fed’s every word to determine how the Fed may adjust monetary policy, and interpretations from statements would drive global financial markets. Now that is shifting from the Fed to the ECB. The Fed is underway with a tightening cycle, and it has discussed plans to begin unwinding the balance sheet within the next few months. In the past such steps might have rattled markets, however this past month the rate hike and the announcement to unwind the balance sheet went smoothly in markets. In Europe on the other hand, investors are hanging on Mario Draghi’s every word and that is driving market activity in both the US and in Europe. The ECB currently buys EUR 60bn of bonds each month, which equates to around EUR 2bn per day. That has pushed down yields and increased asset prices. Financial markets in the US have benefitted as well as investors dissatisfied with depressed yields in the eurozone look to the US for higher returns. Since 2012 US corporate bonds held by foreign private investors have steadily increased from around $2.5tn to $3.5tn. US Treasuries held by foreign private investors have increased from $1tn to just under $2tn over that same time span. As the ECB looks to normalize policy in Europe, some international investors might take money out of the US and put it back to work in Europe as rates rise. If the ECB begins to raise rates, it could reduce pressure on the dollar as well. The dollar experienced upward pressure as a result of monetary policy divergence between the US and Europe, however as both countries shift towards a tightening bias it could take some pressure off the dollar.

As ETFs become a more mature and popular asset class there are still ways investors can use them more effectively. One of the easiest ways investors can do so is to time the purchase so that it does not coincide with the market open or market close. Typically ETF NAV’s tend to diverge from the value of the underlying assets at the market open and close due to a flurry of orders and heightened volatility. That means that investors can reduce transaction costs and more effectively track the portfolio they want exposure to by buying ETFs during times when the NAV most accurately tracks the assets. Another way investors can use ETFs more effectively is to understand the nature of funds that are marketed as “smart beta” or similar nomenclature. These funds use certain factors, other than market cap, to weight its holdings in order to achieve outperformance based on those factors. For example a dividend smart beta fund might hold stocks that pay high dividends with a higher capitalization than they are held in a cap weighted index. A problem with those types of funds is that specific factors go in and out of style with respect to how they perform against the market. As one factor gets overplayed, the price of the stocks will get expensive leading to underperformance. In that way smart beta funds may not be the best strategy for a longer term investment horizon. Investors should also be cognizant of funds that use complex beta strategies or combine multiple factors. Some complex ETFs use as many as 15 or 20 factors in its strategy. Regardless investors should be well aware of how each ETF in their portfolio will perform in certain market environments.

Monday July 10

Friday June 7

Stock prices finished the week on a strong note after the release of the June NFP report. The S&P 500 rose 0.6% to 2,425 and the Dow Jones rose 0.4% to 21,414. Over the course of the week those indices were 0.07% and 0.3% higher respectively. The KBW Bank index today advanced 0.6% and utilities rose 0.2%. The June NFP report showed that payrolls rose by 222k in June which was higher than estimates of 170k. However the trend of strong payrolls and weak wage growth continues as earnings rose just 0.2% on the month. The report seemed to land in a sweet spot for investors based on the market reaction. The “risk-friendly” report sent indices higher in spite of a renewed sharp selloff in oil prices. On that backdrop the 2 year Treasury yield was unchanged again at 1.40%. The 10 year Treasury yield rose 2bp to 2.39%. Accordingly 2yr vs 10yr bear steepened to 0.99%. Over the course of the week the 2 and 10 year were 1 and 9bp higher respectively. The dollar also found strength from the NFP report. USD rose 0.2% against EUR to $1.1406. USD rose 0.6% against JPY to Y113.91. USd rose 0.7% against GBP to $1.2884. WTI fell 2.7% to $44.30 while Brent also fell 2.7% to $46.80. 

Data today showed that nonfarm payrolls rose by 222k in June, which exceeded analyst estimates which called for a 170k gain. The prior month was also revised upwards by 14k. The monthly trend for nonfarm payrolls continues to look positive for 2017. The unemployment rate ticked up one tenth of a percentage point to 4.4% however that could be attributed to a slightly higher participation rate. In spite of the very strong reading on payrolls, wage growth continues to disappoint. Average hourly earnings rose just 0.2% on the month compared to estimates which called for a 0.3% gain. That amounts to an annualized pace of 2.5% which is somewhat stagnant. This is a recurring trend over the last year, as the Fed maintains that low unemployment will eventually drive wage growth. Stock markets rally as this is somewhat of a goldilocks scenario for investors. The economy is healthy as reflected by the continually low unemployment and strong payrolls. However wage growth and inflation is not high enough to the point when it could cause the Fed to raise rates. That ideal scenario for investors has send the S&P 500 forward P/E ratio to 17.5x which is elevated by historical standards. 

Richard Koo at Nomura writes about the potential market effects of the Fed unwinding its balance sheet. He believes that it potentially could lead to a big increase in interest rates. When the Fed is reinvesting principal payments of maturing securities, normally the Treasury will issue refunding bonds to private investors, and pay the Fed with the proceeds of the refunding bond. As the Fed continues to reinvest principal and interest payments, all of the money stays in the fixed income market. However once the Fed stops reinvesting, the proceeds of the refunding bonds will be paid to the Fed and at that point they will effectively disappear and be removed from the market. Koo believes that this should have the same effect as a massive increase in the fiscal deficit which would normally lead to a selloff in rates. Koo believes that over the next four years private savings will have to increase by 300, 600, 600, and 450 billion in order to make up for this gap. However based on his conversations with clients, he believes that many investors are surprised and unaware of this fact, and that as a result Treasury yields may still be supported. He likens the situation to Greece before the European sovereign debt crisis. At that point Greek bond yields traded close to Germany because Koo argues investors prioritized the belief that the government was observing the Maastricht Treaty’s cap on deficits over Greece’s actual deficit. The report states that value is a social construct, meaning that if investors don’t notice that interest rates should be higher, they may not ever increase. 

Funding from investors has allowed oil companies to weather the storm and continue opening new wells. Oil prices have fallen 13% since April, and in that time frame US producers have put 100 rigs online. Oil production is on track to hit a record high of 10 million barrels a day in the United States as more oil companies expand their drilling initiatives. However to some it seems to be an inefficient allocation of capital. Investors are rewarding producers who are able to report production growth, as opposed to those who are able to tighten their belts and get by at the current levels. Around current price levels oil companies spend more money than they earn back through revenues. Last year when oil prices averaged $43 oil companies spend $1.58 for every $1 in revenue. Over the next six months oil companies are on track to spend $20bn in excess of their revenues. Part of the reason for this could be that oil executive compensation is oftentimes tied to production growth as opposed to profitability. At the same time investors are rewarding companies for growth as opposed to earnings, which is reminiscent of how they will pay a high multiple for a loss making tech company as long as it is reporting growth. Investors have been a lifeline for oil companies, which have raised capital in high yield and equity markets since oil prices took a turn for the worst. Last year oil companies issued a record amount of equity. However times may be turning if oil companies continue to shoot themselves in the foot by increasing production at all costs. After a busy 2016, capital raisings from the energy sector have trailed off in 2017 which could suggest that investor appetite is full. 

Friday June 7

Thursday July 6

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.
Thursday July 6

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

Friday June 30

Stocks rose modestly today to finish the first half of 2017 on a strong note. The S&P 500 rose 0.2% to 2,423 and the Dow Jones rose 0.3% to 21,350. Over the course of the week those indices were 0.6% and 0.2% lower respectively. The KBW Bank index and utilities both finished fractionally lower today. Economic data today showed that personal income rose 0.4% last month which was 0.1% higher than expected. Consumer spending rose 0.1% in line with expectations. The PCE Price Index both headline and core both rose 1.4% compared to expectations of 1.5%. That shows that inflation remains muted in the US which takes gives some ammunition for the doves in the FOMC. If the trend persists it could also be bearish for the dollar as inflation is picking up in other economies where central bankers are looking to raise rates. Data also showed that consumer sentiment was stronger than expectations. The theme of the week was rising yields globally. The 10 year German bund yield was up 21bp on the week and finished at 0.47% and the same maturity gilt rose 22bp to 1.26%. In the US today the 2 year Treasury yield rose 3bp to 1.39%. The 10 year Treasury yield rose 3bp to 2.30%. Accordingly 2yr vs 10yr finished at 0.91%. This week marked the first week since the start of May that the yield curve steepened over the 5 day span. Over the course of the week the 2 and 10 year were 5 and 12bp higher respectively. The dollar rose today against EUR and JPY in spite of the weak inflation data. USD rose 0.2% against EUR to $1.1423. USD rose 0.3% against JPY to Y112.49. USD fell 0.1% against GBP to $1.3024. Oil prices posted another strong day which could be reassuring for investors who feared another selloff similar to the start of 2016. WTI rose 2.9% to $46.21 and Brent rose 1% to $47.90.

Stock markets around the world have posted very broad gains in the first half of this year, which leaves investors wondering what might be in store next. Of the 30 largest stock indices around the world, 26 are in positive territory for the year and around half of those are at or near record highs. In the last 20 years there have been only four times when markets have been this broadly bouyant. Two times, in 1999 and 2007 the rally preceded a sharp downturn. The other two times in 2003 and 2009 preceded a multiyear rally. The rally this year has been driven by accommodative central banks, and in Europe decreasing political risk as anti EU movements has supported sentiment as well. The rally across different sectors has been fairly broad as well, as most sectors have risen with the exception of oil. One reason for concern could be that defensive shares have outperformed cyclical shares which could suggest that investors are turning bearish based on their positioning. Another big question mark is how central banks will unwind their accommodation. In many ways central banking policies are responsible for the impressive rally that has been experienced, and it remains to be seen how they will remove their presence from the market without leading to a selloff.

Bank shares have put in a strong performance this week as several factors turned in their favor. At the start of the week financials were supported by news out of Italy that the government was orchestrating a EUR 17bn bailout of two struggling Italian banks. Similarly there was consolidation in the financial sector in Spain which also suggests that the system is getting stronger. On Wednesday bank investors were pleased when all 34 of the banks passed the Fed’s stress tests which will allow them to return capital to shareholders. Between the five large US banks alone analysts anticipate that they will return around $100bn to shareholders, amounting to more than 100% of net income for this year on average. Also contributing to positive sentiment was the global bond selloff towards the end of the week driven by central bankers in the UK, Europe, and Canada catching investors off guard by suggesting they may soon shift their monetary policy stance. That led investors to believe that higher interest rates in those economies may not be too far on the horizon, which benefits bank earnings. Banks put in a strong week of performance, even as they have underperformed the broader market for much of 2017. However over the last couple of weeks that trend has reversed and banks have led the way as hot sectors, such as technology, have retreated. A lingering downside for banks is that economic growth, and therefore loan growth remains sluggish.

FT Alphaville published an article outlining some facts about shifts in the retail sector as it relates to employment and the macro economy in general. There has been a narrative  out there that excessive losses of jobs in the retail are a threat to the economy. However thus far job losses in the retail sector have been minuscule compared to the total number of people employed in the industry. From the macro level it appears that the shift from brick and mortar retail to e-commerce will benefit the economy through innovation and increased efficiency. On average it takes more than 8 employees in a department store to generate $1mm in sales per year. For e-commerce that figure is just 0.7 people so it makes sense that more effort is being allocated there. That could help explain why retail store closings this year could hit a record high. The jobs created in e-commerce also aren’t showing up in the data as clearly as the direct number of layoffs is. Economist Michael Mandel argues that the jobs created through e-commerce exceeds the losses in jobs from retail. On top of that e-commerce jobs tend to pay better than traditional jobs at both the entry and manager level. Over the long term that will be beneficial for the economy, however on the societal level its unlikely the people competing for e-commerce jobs will be the same people displaced from traditional retail jobs.

 

 

 

 

Friday June 30

Thursday June 29

Stocks fell today as volatility across markets driven by monetary policy comments continues. The S&P 500 fell 0.9% to 2,419 and the Dow Jones fell 0.8% to 21,287. The KBW Bank index rose 1.3% as interest rates continues to rise and utilities lost 0.8% for that same reason. James Bullard spoke today and said that he supported the current trajectory of interest rates which calls for one more hike in 2017. In Europe investors focused on similar comments from officials as well as data in Germany which showed that inflation is picking up. The 10 year bund yield rose 8bp to 0.45% and the 10 year gilt yield rose 9bp to 1.25%. In the US weak performances from the technology sector weighed on sentiment and drove prices lower, along with the concerns about higher rates. The 2 year Treasury yield was unchanged at 1.36%. The 10 year Treasury yield rose 5bp to 2.27%. Accordingly 2yr vs 10yr bear steepened 4bp to 0.91%. The dollar continues to weaken against peers. USD fell 0.5% against EUR to $1.1442. USD fell 0.2% against JPY to Y112.10. USD fell 0.6% against GBP to $1.3007 breaking the $1.30 technical level. Oil prices rose for the third consecutive day. WTI rose 0.3% to $44.87. Brent rose 0.2% to $47.39.

The selloff in government bonds continued for the third consecutive day following hawkish comments made this week by officials at the BoE, the ECB, and the Bank of Canada. Government bond yields in the US, Europe, and the UK have risen and for the most part those currencies have strengthened against the dollar. The comment that triggered the selloff earlier this week came on Tuesday from Mario Draghi who commented on the “strengthening and broadening” economic recovery in Europe. This is a quick reversal of sentiment from just Monday of this week when the 10 year Treasury yield fell to 2.13% on the expectation that rates would stay low for longer. Across financial markets rising government bond yields will have implications for equities particularly utilities and financials, currencies, as well as riskier fixed income investments. Some analysts point to certain structural factors at play in the market that will prevent yields from rising too much too quickly. With aging populations around the world, pension funds have to be putting money to work and insurance companies as well for life insurance portfolios. That along with the global search for yields leads analysts to believe that there are many large institutional investors out there with money to put to work and ready to buy the dip. Regardless in the near term this could lead to some volatility in fixed income and currency markets. That is a welcome development for funds and traders since it provides them with more investment opportunities compared to a not volatile market.

The World Bank is offering pandemic bonds for the first time, which resemble an insurance linked security that is intended to combat the spread of illnesses around the world. The idea for these bonds came from the spread of the Ebola outbreak a few years ago in which 11,000 people mostly in West Africa died. $7bn in donations were made to fight the disease, however analysts believe that if there was more funding earlier in the fight agains Ebola many of those lives would have been saved. Investors will purchase the bonds and in return they will receive a healthy rate of return. If there is a pandemic that meets certain criteria, some of their coupon payments or capital will be diverted from them to fight the outbreak of the disease. The bond raised $322mm and the World Bank also offered $100mm in swaps that offer protection from pandemics, which perhaps gives the investors a way to hedge their risks. They issued two types of bonds. One of the bonds covers pandemic influenza and coronaviruses which priced at 6.5% over Libor. The other bond covers filoviruses and yields 11.1% over Libor. Triggers determined by the World Health Organization related to the number of cases and deaths, growth rate of the disease, and geographical spread will determine whether or not the bonds redirect money from investors towards an outbreak. The World Bank in the past has been active in been issuing insurance linked securities designed to address natural disasters and other catastrophe bonds. Swiss Re, Munich Re, and GC Securities worked on the deal which was 2x oversubscribed but still priced below the original estimate.

 

Thursday June 29