Wednesday June 28

Stock prices rose today approaching record highs after a busy day for central bankers in Europe, the UK, and Canada. The S&P 500 rose 0.9% to 2,440 while the Dow Jones added 0.7% to 21,454. The KBW Bank index rose rose 1.7% while utilities lost 1%. The EIA Petroleum Status report showed that crude oil inventories today rose 100k barrels last week compared to estimates which have called for a decline. However traders looked bullishly on data that showed that gasoline inventories drew down by far more than expected. Members of the ECB tried to backtrack after comments made yesterday led investors to believe that the ECB may soon shift to a tightening bias. In the UK Mark Carney said that if business sentiment and economic indicators continue to improve then he would vote to tighten policy. That puts him closer in line with Andy Haldane last week with his hawkish comments. In Canada as well the head of the central bank also made hawkish comments. In spite of that the 2 year Treasury yield fell 1bp to 1.36%. The 10 year Treasury yield rose 1bp to 2.22%. 2yr vs 10yr steepened to 0.87%. The dollar was weaker against peers as investors digested the central bank comments. USD fell 0.3% against EUR to $1.1379. USD fell less than 0.1% against JPY to Y112.27. USD fell 0.9% against GBP to $1.2929. Oil prices rose after the EIA data. WTI rose 1.3% to $44.83. Brent rose 1.6% to $47.41. That coupled with gains in financial in technology shares could have been driving sentiment in the equity market today.

The shift from active to passive investing has contributed to the stock market rally that has been seen this year. ETFs have been big buyers of US stocks as more and more investors put their money into passive investments. ETFs bought $98bn in stocks in the first quarter as other types of investors and market participants stepped away. Corporate share buybacks, which were common in recent years, have decreased and active managers have reported outflows in order to meet redemptions. Data from the Fed shows that ETFs own around 6% of the US stock market which is the highest portion on record. ETFs own nearly 6% of Microsoft shares and around 5.5% of the shares outstanding for Apple and Amazon. That is up from around 4% in 2012 for all three names. That could also be contributing to the recent trend of low volatility. As a larger and larger portion of stocks is held by ETFs, which do not frequently trade their holdings, volatility and quick price movements could be suppressed. The risk that some analysts cite is that ETF investors will all rush for the exits at the same time when volatility picks up, however that remains to be seen aside from some isolated cases.

Investors have reversed course somewhat after the initial reaction from Mario Draghi’s speech yesterday. The ECB’s vice president spoke in an interview with CNBC that was posted on the ECB’s website. In the interview the vice president said that he doesn’t see much difference between the speech yesterday that markets reacted to and the prior two speeches that Draghi has made. That had the effect of confusing investors and some of the movements in currency and fixed income markets reversed. The euro fell slightly as did government bond yields. This highlights a difference between the ECB and the Fed. The Fed seems to do a better job of painting a clear picture and making sure that its intentions are accurately telegraphed. The ECB on the other hand tends to leave investors confused and unsure more often which could hurt the transmission of monetary policy. As yields rose in Europe this morning however there was definitely a definitive cap to how high rates would go. Traders noted the presence of international institutional investors, particularly insurance companies in France and Japan who were waiting to buy the dip. That will put a cap on long term yields in spite of the uncertainty surrounding the future monetary policy.

For the first time since stress tests began in 2011 the Fed has approved of all 34 banks plans to return capital to shareholders. This marks a major turning point for the financial industry just as regulations are set to get less stringent in some ways. Already the tests were made easier for some banks, as only the largest and most complex financial firms were subjected to the qualitative portion of the test this year. The move is a welcome development for bank shareholders, as they will be able to receive payouts in the form of dividends and share buybacks. This year the expected capital payouts come out to close to 100% of expected earnings for the 12 month period, and for some firms such as Citi it is as high as 130% of expected earnings. For the group as a whole the payout as a percentage of earnings is up from around 65% last year. Banks have underperformed the broader market this year with an around 3% increase for the KBW Bank index compared to an 8% increase for the market broadly. That comes as political concerns and Washington as well as a flattening yield curve have weighed on share prices. Goldman Sachs and Morgan Stanley just barely passed the tests by a few tenths of a percentage point which suggests they are getting better at preparing for the tests.

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Wednesday June 28

Tuesday June 27

Stocks fell today following hawkish comments from Mario Draghi as well as further political deadlock in Washington. The S&P 500 fell 0.8% to 2,419 and the Dow Jones fell 0.5% to 21,310. The KBW Bank index rose 0.8% and utilities lost 1.4% as rates went higher. John Williams of the San Francisco Fed spoke and mentioned low growth in developed economies around the world. Patrick Harker spoke and came across as hawkish saying that the Fed should have its balance sheet normalization policy on “autopilot” and coming across as hawkish on rates in spite of low inflation. Investors today also focused on comments made by Mario Draghi that were bullish on the European economic recovery and investors took that as a sign that tapering may be forthcoming. Some analysts are expecting an announcement of tapering as soon as September. Also driving downward sentiment today was news out of Washington that a vote on healthcare would be delayed until after July 4. On that backdrop the 2 year Treasury yield rose 4bp to 1.37%. The 10 year Treasury yield rose 7bp to 2.21%. Accordingly 2yr vs 10yr bear steepened to 0.83%. USD was weaker for the most part on the day. USD fell 1.5% against EUR to $1.1343. USD rose 0.4% against JPY to Y112.34. USD fell 0.8% against GBP to $1.2823. The weaker dollar supported oil prices for the second consecutive day. WTI rose 1% to $43.82. Brent also rose 1% to $46.27.

Across markets investors are wanting to hedge their exposure given uncertainty and the lingering feeling that markets may be due for a turnaround. Movements in equity, fixed income, and currency markets all reflect some investor concern. In equities while the VIX has drifted lower, the ratio of the VVIX to the VIX has increased to an all time high which suggests anticipation for a spike in volatility in the near future. Additionally the put-call ratio spiked up in June close to the highest level of 2017 which is indicative of investor bearishness. Additionally utilities have rallied this year which is normally a defensive sector. In the rates market the Treasury yield curve between 2s and 10s has flattened and is approaching the lowest level since 2007. That could suggest markets pricing in a monetary policy mistake, such as the Fed raising rates too much too soon which subsequently dampens inflation and hurts the economy. In FX markets haven currencies such as the Japanese yen and the Swiss franc have both rallied this year.

Much of the low volatility in financial markets can be attributed to low volatility in underlying economic conditions. The three year rolling standard deviation of the annualized quarterly change in GDP has reached its lowest level ever at just 1.5% in the United States. Part of that reason is that GDP has been low, and a smaller number tends to move around less on absolute terms. Other economic data points however have been less volatile as well. Some have attributed part of this shift to better technology, as for certain economic data figures better technology allows companies to better assess their inventory or capital goods needs and not overstock themselves. Globally this has been the trend of low economic volatility. It is resulting in low financial volatility as in the second quarter the average daily move in the S&P 500 has been 0.3% which is the lowest in more than 50 years. Another part of the reason for low volatility has been central bank activity which has been a safety net for economies around the world. The risk is that investors like low volatility in the economy and to some extent in markets, they could be get too complacent with calm conditions and be caught off guard once things change.

Mario Draghi’s speech today seemed to catch investors off guard based on the response in currency and government bond markets. Draghi came across as hawkish, speaking bullishly about the European economic recovery which has shown growth for 16 consecutive quarters. Inflation is picking up and is currently around 1.3%. Draghi said that if the ECB continues its current track of monetary policy coupled with the strengthening economy, that would effectively be an increase in stimulus. Coupled with comments made earlier this month at a policy meeting about not lowering interest rates any further, it seems as if the ECB is setting the groundwork to take a hawkish stance at the start of 2018. The ECB’s QE program in which it buys EUR 60bn a month is set to expire in December. Analysts after today expect that to be reduced to EUR 40bn in January of 2018 followed by another reduction to EUR 20bn in the second half of next year. That is a relatively slow pace of tightening. Another factor that may be encouraging the ECB to reduce accommodation is a decrease in political risk. As the political uncertainty fades companies may be more likely to expand and make investments which is stimulative for the economy. That would be a major shift in global financial markets, and it would put two of the world’s largest central banks in a tightening bias together for the first time in this recovery since the financial crisis.

Tuesday June 27

Monday June 26

Stock prices rose fractionally today as rates rallied. The S&P 500 and the Dow Jones each rose less than 0.1% to 2,439 and 21,409 respectively. Economic data today showed that durable goods orders fell 1.1% last month compared to estimates which called for just a 0.6% decline. This continues the recurring pattern of poor economic data that is missing expectations, which hurts the chances that the Fed will continue to hike rates as hawkishly as expected. In Europe shares benefitted from an EUR 17bn bailout of Italian banks on behalf of the Italian government. The 2 year Treasury yield fell 2bp to 1.33%. The 10 year Treasury yield was unchanged at 2.14%. Accordingly 2yr vs 10yr bull steepened to 0.81%. USD rose 0.1% against EUR to $1.1180. USD rose 0.5% against JPY to Y111.85. Oil prices rose today after a heavy selloff last week. Brent crude oil rose 0.6% to $45.83 while WTI finished up at $43.43.

The bank rescue in Italy is raising some questions on the relationship between the government and private sector. Veneto Banca and Banca Popolare di Vicenza are being liquidated instead of going through Europe’s normal resolution process. The big winner in this deal is Italian bank Intesa. Intesa will assume ownership of the good assets of the two failing banks along with an EUR 4.8bn cash subsidy. That subsidy will go towards making sure the capital ratio is unchanged by the acquisition as well as other costs associated with the process. Intesa also received billions of dollars in guarantees that will go towards backing potential legal and other risks. The reason these bankruptcies didn’t go through the normal resolution process was because it was deemed the failure wouldn’t be a threat to financial stability. However many analysts and industry participants thought that going through the resolution process itself would have posed a risk to financial stability since losses on senior bondholders would have been imposed, which could have sparked a broader selloff. Rules state that in order for a bank to go through the resolution process losses have to be imposed on 8% of liabilities, which in the case of the failing banks would have meant some senior bondholders. Now investors can use that threshold and precedent set here to better estimate how other bank failures in Italy might go.

The bank stress testing process is set to get less stringent for banks. There are currently two portions of the annual stress tests. The quantitative element which determines whether a bank would be able to follow through with its proposed capital plans and withstand a severe economic downturn without having its capital dip below key levels. The qualitative portion of the tests have proved to be trickier for banks. Banks such as Citi, Deutsche Bank, and Santander have failed the qualitative element of the tests in recent years, which is embarrassing from an investor and public relations standpoint. Only one company since the financial crisis has missed the test for quantitative reasons. The fact that regulators also call out failing firms publicly seems a bit ironic. The whole point of stress tests is to ensure financial stability. If regulators publicly censure banks that miss stress tests, it could hypothetically create panic for that bank if the situation was bad enough. Going forward the tests might only probe the quantitative portion of the test, which would mean a lot more transparency and clarity for bank managers and investors as well. Stress testing is also set to ease for smaller banks, as there is a risk that those firms could overinvest and overspend to meet requirements.

Recent events in bond markets are suggesting that investor demand for debt from Chinese issuers may be getting close to full. As interest rates in China have risen this year and interest rates in the US have fallen, companies in China have issued an increasing amount of bonds denominated in dollars. Year to date Chinese issuers have already sold around $90bn in debt, which is close to the entire total for last year and already eclipses the 2015 year total. The largest Chinese property developer China Evergrande which carries a single B rating last week issued $6.6bn in bonds which is the largest ever high yield issuance from a Chinese company. The bonds carried a coupon of 8.75%, and they are already trading below face value which is abnormal so soon after issuance. That suggests that investors who were allocated bonds have been selling shortly after receiving them. That could be a sign of them receiving more bonds than they wanted. For this particular issuance the company increased the size significantly on the last minute, which could have resulted in investors receiving far more bonds than they wanted given that investors oftentimes bid for more bonds than they want since they rarely receive full allocations. There is also signs of investor concerns that Chinese issuers are simply issuing as much debt as markets can absorb in the current environment irrespective of need or credit conditions. That would be bearish for Chinese high yield corporate bonds.

Monday June 26

Wednesday June 21

Stock prices fell slightly today as the selloff in oil prices continues to weigh on sentiment. The S&P 500 fell less than 0.1% to 2,435 and the Dow Jones fell 0.3% to 21,410. The KBW Bank index lost 0.8% while utilities fell 0.7%. The EIA Petroleum Status report today failed to convince oil market participants that the supply glut was dissipating. Data showed that inventories fell 2.5 million barrels which is 1.8% above last year’s level. Gasoline inventories were up a similar amount from last year. That sent oil prices selling off for the second consecutive day. After the MSCI decided to include China’s A-shares into its emerging market equity index, shares in Shanghai rose 0.5%. By contrast shares in Argentina fell after the country’s shares were not included in the index. In the UK investors paid attention to a statement made by a typically quieter, more dovish member of the MPC that said that he is in favor of a rate hike and even a policy normalization which contradicts what Carney said yesterday. The US 2 year yield was unchanged at 1.35%. The ten year yield rose 2bp to 1.17%. Accordingly 2yr vs 10yr bear steepened to 0.82%. USD was weaker on the day against peers. USD fell 0.2% against EUR to $1.1162. USD fell 0.3% against GBP to $1.2665. USD fell 0.1% against JPY to Y111.34. Oil prices suffered another selloff following the EIA data which sent energy shares down another 1.6% which lagged on S&P 500 performance. Brent fell 2.6% to $44.82. WTI fell 2.2% to $42.54.

Wednesday June 21

Tuesday June 20

Stock prices retreated today after posting record highs yesterday. The S&P 500 fell 0.7% to 2,437 and the Dow Jones fell 0.3% to 21,467. The KBW Bank index lost 1% while utilities were unchanged. Stanley Fischer spoke today and expressed concern about rising home prices, which could suggest that he is more likely to take a hawkish stance. Eric Rosengren also spoke about the concerns about keeping interest rates too slow for too long. Robert Kaplan of the Dallas Fed capped off the day for Fedspeak, and he seemed to be a little more dovish saying that he is keeping an “open mind” to future rate hikes as opposed to some members who are full steam ahead for one more in 2017. Sentiment today was negatively affected by falling oil prices, which officially entered a bear market down from its peak reached in February. The two year Treasury yield fell 1bp to 1.35%. The ten year Treasury yield fell 4bp to 2.15%. Accordingly 2yr vs 10yr bull flattened to 0.80%, which makes sense given the big drop in commodity prices. The dollar was mixed on the day against peers. USD rose 0.2% against EUR to $1.1132. USD fell 0.2% against JPY to Y111.46. USD fell 0.1% against GBP to $1.2629 after BoE governor Mark Carney showed that he didn’t agree with the hawks on the BoE who last week were in favor of a rate hike. WTI fell 2% to $43.34 and Brent fell 1.9% to $46.01.

After a few years of underperformance compared to peers investors are looking for Citi to change this trend. Since 2012 Citigroup shares have produced a total return of just under 80% which has underperformed peers including Goldman Sachs, Bank of America, and Morgan Stanley which have returned 94%, 165% and 176% respectively. Over that time period the KBW Bank index and the S&P 500 have both returned 87%. The first way investors will look for Citi to turnaround its performance is through returning capital to shareholders in the form of dividends and share buybacks. Citigroup’s annual capital returns have increased significantly from close to zero in 2012 to more than $12bn in 2016. This year investors are hoping that Citi will return capital in excess of earnings which means that its dividend payout rate would be more than 100%, allowing Citi to draw down on its capital instead of building it up. Investors are also looking on CEO Michael Corbat to offer reasons why Citi’s valuation should increase, as the bank trades at 85% of book value which gives it the lowest valuation compared to its peers. The company is trying to focus its efforts on increasing profitability in credit cards and retail banking. The corporate and investment bank has been either at or near targets in recent quarters, but retail banking has lagged targets by several percentage points. It has been refocusing its efforts on the corporate side by decreasing the number of clients it serves from 30,000 to 14,000. On the retail side it is investing into promising markets, highlighted by a $1bn into retail banking in Mexico. It is also focusing retail efforts on its card business following a purchase of $10bn in card loans from Costco and making investments into its own card offerings. Over the past several quarters it has been in the investment phase on each of those endeavors, and soon is the time for those investments to start paying off.

Argentina’s century bond issuance is reflective of some of the trends that country and emerging markets are seeing and investor demand more broadly. Argentina issued $2.75bn in debt with a 100 year maturity at a yield of 7.9%. According to someone at one of the underwriting banks, this type of issuance is typically a “reverse inquiry” in which a large investors approaches the issuer with terms for a deal that would work for both parties. This would be one way for an investor to take a levered view on Argentina’s economic recovery. A traditional money manager may not be able to take out leverage, so buying a very long duration product would be one way to amplify returns. In spite of all the debt the country has issued since emerging from bankruptcy just last year, analysts still put Argentina’s debt level at a sustainable level assuming the country is able to reduce its deficit and meet its fiscal target. Analysts note that if yields on this issuance were to fall by around 150bp it would produce returns in the double digits for investors. It seems as if enough investors bought into the recovery story as the deal attracted offers of $9.75bn. Yields in the country have decreased over the last year while the country’s stock market has rallied as well. That comes as investors generally have been bullish on emerging markets which have reported billions of dollars in net inflows. The risks to this deal are obvious however. Argentina has defaulted eight times since its independence in 1816, so for it to not default at all over the next hundred years would be a significant break from the historical trend. Additionally as the Fed raises interest the risk of another taper tantrum is out there, and there high duration bonds would be the first hit. However for now it seems that the search for yield is overpowering those risks.

KKR is making an aggressive push into the leveraged lending arena through its capital markets business. In just the first five weeks of 2017 KKR underwrote more leveraged loans than it did throughout all of last year. It has pushed its way in the league tables to eleventh which markets ahead of more established UBS, Nomura, and HSBC compared to 229th last year. Historically large banks have dominated this business however as regulators have increasingly scrutinized these deals done by banks, unregulated lenders such as KKR have stepped in. To reflect this earlier in the year the UFC wanted to refinance some if its debt however Goldman Sachs had to turn down the deal because of regulatory scrutiny, and KKR stepped in its place. KKR is able to both sponsor deals by providing capital and using its balance sheet, as well as broker deals by using its relationships with sovereign wealth funds and pension funds to sell loans if needed. That is a powerful combination, coupled with KKR’s stellar reputation in the private equity space. Some banks have complained that the regulatory environment gives KKR an advantage through an uneven playing field, and that if the tables were fair they wouldn’t be as competitive. Already the Treasury’s report released last week calls for some changes to the way banks are regulated when making leveraged loans, which would give KKR less of an advantage in this space. In Europe however the regulations that benefit KKR and similar lenders are still going strong.

Tuesday June 20

Monday June 19

Stocks rose to record highs today to start the week off on a strong note. The S&P 500 rose 0.8% to 2,453 and the Dow Jones rose 0.7% to 21,528. The KBW Bank index rose 0/9% while utilities fell 0.4%. Bill Dudley of the New York Fed spoke today and came across as bullish on the US recovery and on the inflation outlook. Gains today were led by financials and technology, and there was optimism in Europe after Emmanuel Macron won a strong parliamentary majority that will allow him to enact his reforms. There was generally a risk on attitude across markets today which sent yields higher, but surprisingly the dollar fell after rising initially. The 2 year Treasury yield rose 4bp to 1.36%. The 10 year Treasury yield rose 4bp to 2.19%. Accordingly 2yr vs 10yr was unchanged at 0.83%. USD fell 0.2% against EUR to $1.1151. USD fell 0.2% against JPY to Y111.55. USD fell 0.1% against GBP to $1.2735 even as Brexit negotiations officially began today. Oil prices also started the week off on weaker ground. WTI fell 1.4% to $44.13. Brent fell 1% to $46.89.

Oil companies and countries that are reliant on oil exports are learning to cope with low prices. Oil prices have plummeted from a peak of around $110 in the summer of 2014 and they are currently trading in the $40s. At the same time analyst expectations for oil prices have continually been downgraded over the last year. At this time last year analysts expected oil prices to be $64 and $72 in 2018 and 2019 respectively. Since that time forecasts have continually been downgraded and now analysts are expecting prices around $57 for both 2018 and 2019. The theme in oil markets right now is “lower for longer” and producers are learning to adapt to that environment. They are doing this by reducing their costs by more closely managing contracts with suppliers and servicers, abandoning more expensive projects, as well as focusing on their most profitable oil fields. For US producers as well they have benefitted from Opec’s output cut. Immediately after Opec announced the 1.2m barrel/ day cut oil production in the US started to increase again. Countries such as Saudi Arabia have been forced to cut or abandon social spending programs that were subsidized with oil revenues.¬† At the start of last year low oil prices sent the industry into a widespread panic, however¬† since then companies have recovered. Profits at Shell, BP, Exxon, and Chevron over the last 3 quarters have all started to resume a modest upward trend, reflecting the idea that they may be able to operate in the $50-60 range. Already it seems that they are able to maintain dividends to shareholders with oil at those levels. Oil producing countries including Libya, Saudi Arabia, Iraq, Iran, and the UAE and others have all lowered their fiscal breakeven prices as well. In spite of this turnaround story there remains concerns since prices are currently below $50 and US production shows no signs of relenting. That could result in the need for more efficiency or more consolidation in the sector.

Trump’s appointee to head the FDIC continues the trend of financial deregulation. Jeff Clinger is a former aide to Jeb Hensarling, who authored the Financial Choice Act that passed the House of Representatives last week. While there are few clues as to Clinger’s own personal views based on speeches and writings, analysts believe that he will take a sharply deregulatory stance and that it is a positive development for banks. Bankers are beginning to wind down their hopes that regulation to unwind Dodd Frank will pass in Congress, however it seems that the focus now is shifting towards a much more relaxed interpretation of existing regulations by Trump’s appointees. To reflect this Gary Cohn earlier this year said “personnel is policy.” Lobbyists for banks are pleased with this move to appoint Clinger. Given the timing of financial deregulation moves over the last week critics of the administration say that Trump and republicans are trying to roll out deregulation sneakily. The FCA passed the day of the Comey testimony, the Treasury’s regulatory suggestions were released last week without publicity, and the decision to appoint Clinger was announced on Friday afternoon. If Clinger is approved he will assume office in November. Also on the calendar for banks is the review process by the Fed to determine the amount of dividends they will be allowed to pay this year. Analysts at Goldman Sachs believe that banks have amassed large buffers of excess capital that allow them to pass the Fed’s tests on even the most severe economic downturn over the next nine quarters. If that is the case and regulators look favorably on the bank’s plans and capital levels, some banks may be entitled to return more than 100% of their earnings to shareholders through dividends and share buybacks. Goldman forecasts that more than twelve of the thirty four banks that are tested requested for dividends in excess of profits. This would be beneficial for bank shareholders and comes at a time when Trump appointees are looking to reshape the way these tests are conducted. The Treasury last week announced an effort to soften the tests and make them less cumbersome, which is supported by banking executives.

There is an early stage debate going on in monetary policy circles surrounding the potential increase in the inflation target. The debate surrounds the opinion that central banks, particularly the Fed as the most influential, should consider raising their inflation target. As economies have proved to be very much reliant on low interest rates and are stuck in a low growth cycle, some central bankers and economists have expressed concern that there may not be much room to cut interest rates to accommodate if the economy enters a downturn. A higher inflation target would give the Fed more room to cut interest rates in the event of a downturn according to some. Janet Yellen has acknowledged this debate which is the most high profile recognition of the debate. She has said that the Fed would reconsider the issue in the future. Inflation in the US, Europe, Japan, and Canada all are at below target 2% and are trending downwards. Only the UK is showing above target inflation approaching 3%. 22 economists and former officials have submitted a proposal asking the Fed to officially get to work on determining whether or not they should raise the target. The potential downsides of higher inflation could be a reduced quality of life for consumers if wage increases don’t keep pace with inflation. That seems to be a concern even now, as wage gains have been sluggish even as labor markets have tightened. Given political uncertainty at the Fed involving uncertainty as to whether or not Yellen will be in charge next year, it seems unlikely that there will be any dramatic changes in policy. Several FOMC members in the past including Eric Rosengren and John Williams have in the past advocated for a higher inflation target. In Europe the debate is further complicated by different cultural attitudes towards inflation, especially in Germany where there is a cultural disapproval for any inflation at all. There is also credibility concerns surrounding this whole debate, because if central bankers around the world are unable to hit their inflation targets at 2% it doesn’t seem likely they would able to maintain or achieve a higher target.

Monday June 19

Friday June 16

Stock prices rose slightly to finish off the week. The S&P 500 rose fractionally to 2,433 and the Dow Jones rose 0.1% to 21,384. Over the course of the week those indices were 0.05% and 0.5% higher respectively. Today the KBW Bank index fell 0.2% as the flattening yield curve continues to weigh on financials. The DJ Utility average rose 0.4%. Economic data today showed that both housing starts and permits missed expectations continuing the trend of weaker than expected economic data. Robert Kaplan of the Dallas Fed spoke today and came across as relatively dovish, expressing that the Fed should be cautious going forward when it raises interest rates. Investors seemed to second guess the Fed at towards the end of the week as the dollar eased back after rising Wednesday following the statement. On that backdrop the 2 year Treasury yield fell 4bp to 1.32%. The 10 year Treasury yield fell 1bp to 2.15%. Accordingly 2yr vs 10yr bull steepened to 0.83%. Over the course of the week those yields were 3 and 5bp lower respectively. The dollar was mixed against peers and lower broadly. USD fell 0.4% against EUR to $1.1198. USD rose 0.3% against JPY to Y110.88. USD fell 0.1% against GBP to $1.2778. Oil prices rose modestly following a two day decrease. WTI rose 0.5% to $44.69. Brent rose 0.8% to $47.30.

Hedge funds that use quantitative and systematic methods to make investments have been lagging the market this year. Year to date these types of funds have returned around 1.6%, compared to a 3.5% overall return for hedge funds more broadly and more than 8% for the S&P 500. This comes as the statistical models and strategies they have been using in recent years don’t appear to be weathering these markets as well. Last year those funds had very strong performance and many investors looked to put money to work in those quantitative strategies. Even in spite of weak performance this year investors have still increased their allocations this year in spite of outflows from more traditional hedge fund strategies. One popular strategy that those funds use includes investing based off momentum, and that strategy hasn’t fared very well this year as several trends from the last few years have reversed. It also remains to e seen whether those funds can maintain strong performance when correlations are low and markets are more unpredictable. For investors they may not be dissuaded by poor performance this year as long as the funds aren’t correlated to the overall market.

Investors are beginning to consider whether or not the Fed is raising rates prematurely. To reflect their concerns with the economic outlook, the spread between the 2 and 10 year Treasury has decreased to the lowest level since October and is approaching levels not seen since 2007. That spread has fallen significantly nearly 50bps since the start of the year. While some analysts have pointed out that in the past such a decline could be a harbinger for a material economic decline, one recent suggestion is that might not be as accurate of an indicator anymore given cross border capital flows distorting the picture. Also related to the Fed going full steam ahead on interest rates, the 10 year breakeven rate which is indicative of inflation expectations dropped significantly following the meeting and is now approaching 1.6% which is the lowest since the middle of last year. Expectations can change quickly however, as can be seen from shortly after the presidential election. If Trump is able to garner support for some of his policies then these trends could reverse very quickly.

Central bank officials in Switzerland continue to assert that the Swiss franc is overvalued and they maintain an easing bias in an attempt to weaken the currency. It is debated whether or not the Swiss franc is overvalued. The currency is very strong and is viewed as a haven asset for international investors. With Switzerland being one of the biggest net creditor nations when Swiss investors pull their money back in times of uncertainty it also has the effect of strengthening the currency. However given the country’s strong trade balance of 6% of GDP, a high current account surplus which is more than 6% of GDP, and promising growth outlook some analysts are of the view that the currency’s strength is justified given those fundamentals. Economic growth has remained around 1.5% in recent quarters and is expected to stay around that level, while inflation continues to be muted. At the policy meeting of the SNB this week officials indicated that they would leave short term interest rates at -0.75% in order to make investments in the country less attractive and they would intervene in currency markets as needed to prevent the franc from becoming too strong.

Friday June 16