Week ending October 2, 2015
A weekly newsletter
providing a synopsis of the latest market and economic
news and releases and a recap
of the securities markets. Find commentary for a wide range of
sectors: US equities, US Treasury, corporate, mortgage,
municipal and high-yield bonds,
global bonds and currencies, and emerging-market bonds.
|1 Yr Ago
|MSCI EM Index
|US$ / Euro
|US$ / British
|Yen / US$
as of 7:22 a.m. PDT
to Date (12/31/14 -10/2/15)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/14 -10/1/15)
High Yield Index
Morgan EMBI Global Diversified
||(JN) Industrial Production YoY
||In Japan, industrial production fell for a second month in a row.
||(EC) Unemployment Rate
||Eurozone unemployment stayed flat at its lowest level since February 2012.
||(US) Change in Nonfarm Payrolls
||The jobs report disappointed with a low number and downward revisions (-59k) of previous months; the unemployment rate was stable at 5.1%.
Nonfarm payroll (NFP) employment appears to have slowed in the last couple months. In September, 142,000 jobs were added to payrolls, while August saw just 136,000 net new jobs created. Newspaper headlines and market watchers seized on the "terrible" and "weak" data as evidence of a material deterioration in the US labor market. One popular economic commentator went so far as to assert that "we cannot dismiss the notion that a new recession may be starting." We do not think this is appropriate. Here's why.
First, the noticeably weaker August and September jobs reports arrived on the heels of a rather remarkable string of payroll reports over the last couple of years. We saw 17 reports over with NFP growth above 200,000 during that two-year period. Job growth hadn't been that strong on a sustained basis since the 1990s cycle. Historically, as the unemployment rate has dipped below 5% (closer to the so-called "full employment" level), NFP growth decelerates from its mid-cycle rate of growth. While we are reluctant to declare a new trend, a deceleration in the pace of job growth wouldn't be all that unusual as labor market slack declines.
Second, the NFP number can be erratic on a monthly basis, varying from lows of just +119,000 in March 2015 to highs of +423,000 in the fall of 2014. Did economic bears throw in the towel in the fall of 2014 on the +400k number? Of course, not. Nor should the bears celebrate on a +34,000 print--or a +142,000 report. And yet that is precisely what we have seen after September's jobs report.
Third, some weakening was to be expected due to slower global economic activity and a stronger US dollar. Global trade rose just 0.8% from a year ago and global PMIs point to a contraction in global manufacturing activity. While the US labor market has suffered, it's hard to call the recent global economic tremors a smoking gun. Mining & logging employment fell by about 100,000 jobs in the last 12 months as oil prices tanked, while manufacturing employment is nearly unchanged from a year ago.
In light of the global headwinds, today's jobs report isn't bad, even if it was less good than the trend we've seen over the past two years. What is more, other indicators of broader US economic health still look positive. Though flatter, the US yield curve (10s - fed funds) remains steep at just under 200 basis points. Historically this yield curve spread turns negative before a recession. No sign of that.
Elsewhere, the US leading economic index continues to improve. The index of 10 major economic indicators rose 4% since last year. Finally, if we look at an academic model built to estimate the probability of a recession, there is no sign the US economy is on the chopping block. Economic activity may end up being slower in Q3 than Q2's strong report, but a recession? Unlikely.
While the August-September period will be seized upon by pessimists as evidence of a weakening labor market, it's probably too soon to call it a new trend. Central bankers shouldn't be making policy decisions based on a single report anyway. We will probably have to wait until next week for an update from Fed speakers, as Fed Vice Chair Stanley Fischer's published remarks from a speech this afternoon in Boston centered on financial stability questions and gave no hints of new thinking on the US economy.
The 10-year note came within half a basis point of the 2% level before Friday's employment data. A soft tone in equities and jittery market conditions led corporations to bring less issues to market, undershooting the street's estimates of $30 billion in supply this week. The employment data for September was very poor with the headline number missing significantly, wages undershooting estimates, participation rate falling and revisions down. This led to buying and short covering across the curve.
The 5-year point touched the lowest yield level since early February as the belly outperformed the long-end on the week. Risk sentiment decayed throughout the week with equities unable to hold morning gains and weaker than expected manufacturing data adding to the momentum. Even as Fed officials have taken a more hawkish tone in recent speeches, the market refuses to believe the committee would hike in turbulent markets. The probability of a December rate hike as implied by Fed Fund futures is now 30%, down from 45% pre-payroll number. We have only seen one bank change their official rate call yet though.
The Treasury announced a supply package worth approximately $58 billion in 10-year note equivalent duration across 3-years, 10-years and 30-years for next week while short T-bill issuance has dropped to multi-year lows at around 2/3rd of the historical average.
The U.S. Equity Market closed the week unchanged despite the unexpected weak U.S. labor report. The slowing pace of U.S. jobs growth further weakened investor confidence, which continues to mend post the FOMC meeting. The fragility of the equity markets was apparent as price action swung around a wide trading range on increased price volatility.
However, the broad equity market showed resilience after managing to snap back from lows last seen in August. The S&P 500 index, along with the Dow Jones Industrial Average, ended the week little change, while the tech focused NASDAQ Composite slid 0.8%. Large-cap stocks outperformed the higher beta small-cap stocks. In terms of style, large-cap value stocks outperformed large-cap growth stocks. The best performing sectors for the week were materials and energy, while the worst performing sectors were financials and telecom.
This week primary market issuance fell below expectations, with $18 billion issued versus an expected $20-25 billion. The majority of deals came on Wednesday when nearly $15 billion was issued across nine tranches in a Hewlett Packard Enterprises deal. The deal was notably cheap for a high BBB/low single-A rated name, with the two-year starting price talk at a spread of 200 basis points over Treasuries, and ultimately pricing 15 basis points tighter at +185.
It was a rough week in the secondary market with automakers (especially Volkswagen) continuing to struggle under enhanced scrutiny and commodities suffering yet again. Glencore, one of the large metals and mining names in the corporate space, came under fire and saw their equity take a nosedive only to partially recover by midweek based on more thorough analysis. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +171, nine wider on the week. Overall, Metals/Mining were 50 wider; energy was 25 wider. Senior financials were 11 wider and subs were 12 wider. Industrials were 10 wider and utilities were wider by four.
Agency mortgage securities struggled versus Treasuries as yields fell on weaker-than-expected economic reports. The decision by the Federal Reserve to pass on an interest rate hike has soured the mood for credit sensitive assets. Agency mortgages were the beneficiaries of a Fed on hold but recently joined other spread product in the 'dog house' as yields drifted lower to levels that may ignite a refinance response.
With the volatility higher and mortgage origination robust, pass-through spreads widened 5-7 basis points across the coupon stack. In the programs, Ginnie Mae mortgages continued to march lower versus their Fannie Mae and Freddie Mac conventional cousins on waning appetite from overseas investors. 30-year and lower coupons bested 15-year and higher coupons as the yield curve flattened.
For the week, the 30-year current coupon spread versus the 10-year Treasury widened by 3 basis points to 76 basis points. According to Freddie Mac, the primary thirty-year mortgage rate fell to 3.85%.
Comparing the BAML ABS index to the BAML 1-3 year Treasury index (similar durations), ABS continues to add value, returning 0.42% on the month versus 0.30% for the Treasury index. Year-to-date is even better with ABS returning 1.57% versus 0.98% for Treasuries.
Despite the recent volatility and headline news, the fundamental collateral performance of ABS remains solid. The market's appetite for auto ABS will be tested next week as BMW, GM Financial, World Omni, DriveTime, Westlake and Nissan are in the queue.
Corporate volatility is finding its way into the CLO marketplace with greater scrutiny regarding oil and gas exposure as well as the metals and mining sectors. CLO manager tiering is also playing a greater role. These factors are magnified further down the capital stack, especially in non-investment grade and equity. BBBs are on the cusp and may be the next domino to tip.
The municipal market traded to lower yields this week with a flattening bias against a backdrop of troubling signs of slower economic growth both domestically and overseas with stronger Treasury markets. At mid-week, the 10-year AAA benchmark municipal yield registered in at 2.03% and nearly 99% of its Treasury counterpart. The municipal to Treasury yield is even more attractive farther out the yield curve on a relative value basis as 30-year municipal yields are 106% of their Treasury counterpart.
New issue supply this week saw a bump higher at $7.0 billion compared to $5.5 billion last week. The 2015 weekly average is about $8.0 billion. The largest deal on this week's calendar is $840 million State of Connecticut special tax bonds (Aa3/AA/AA). New issue supply is higher than last year due to increased refunding volume. Most new issues priced at historically traditional spreads due to the attractiveness of municipals relative to treasuries offset by modest mutual fund outflows. Next week's supply builds to $7.4 billion. The largest deals include $2 billion Port Authority of New York and New Jersey (Aa3/AA-/AA-) with bonds maturing between 2016 and 2065 including taxable and AMT series as well as $1.9 billion Chicago O'Hare International Airport (NR/A/A-).
Competitive deals saw decent sales while most negotiated new issues were priced attractively in order to garner buyer's attention amidst a low interest rate environment. The secondary market experienced reasonable bidding with most trading in-line with the overall market's improved tone. Dealer's bids are opportunistic under current market conditions as the market experienced average bid wanted activity in front of quarter-end. The 30 day visible supply is $13.1 billion, somewhat elevated to averages for the year. Longer term, municipal bonds should outperform other fixed markets as relationships are attractive relative to Treasuries.
High-yield traded lower and wider again this week as investors sought to shed risk. The BofA Merrill Lynch BB/B cash pay constrained index was down 1.35% this week as spreads widened by forty-six basis points to an option-adjusted-spread of 561 basis points. The BofA Merrill Lynch BB/B index that excludes utilities and energy was down 1.18% for an OAS of 512 as that spread widened by forty-eight basis points. The BofA Merrill Lynch Euro BB/B constrained index was down 0.62% as the spread of that index widened by twenty-nine basis points for an OAS of 488.
High-yield was heavy this week with the bulk of the selling pressure felt on Monday and Tuesday. Wednesday brought a bit of a relief rally as equities finished higher on the day, but the rising tide did not lift all boats as high-yield bonds finished mixed. The macro fears of China, the Fed and the slowing global economy that investors have been worried about for weeks combined with more idiosyncratic trepidations related to specific sectors and credits all weighed heavily on prices and pushed spreads wider. The downgrade of Sprint Corp two weeks ago pushed spreads wider in telecom, and the purchase of Cablevision Systems by Altice and the subsequent new issuance last Friday to fund the purchase had the same affect in the cable and satellite sector. The previously unscathed healthcare sector was wider as well as pharmaceutical credits traded wider on worries over more regulatory scrutiny.
No new issues priced this week and this will leave the total new issuance for September at $19.6 billion after just $10.2 billion was priced in August. September's total is less than half of the $40.2 billion that priced in September of 2014. Year-to-date new issuance volume is lagging last year's pace by 9.4% as $225.5 billion has priced year-to-date versus $248.8 billion at this time last year. Fund flows for the week were a negative $2.15 billion with ETF's reporting an outflow of $925 million and actively-managed reporting an outflow of $1.25 billion. The negative fund flow for the week is the first in four weeks for high-yield.
Global Bonds and Currencies
Non-US sovereign bonds benefitted from the pervading risk off sentiment in a week that saw financial markets dominated by a sharp drop in the share price of commodity company Glencore. Although the worries over Glencore faded as the week progressed, market participants remained concerned about the state of the global economy. Friday's weak US payrolls report added to these concerns, suggesting to some market participants that the Federal Reserve was vindicated in its decision to keep rates on hold in September.
Global government bond yields dropped in sympathy. The 10-year German Bund yield fell by 7 basis points on the week, as did the 10-year UK Gilt yield. Peripheral Euro-zone spreads to German Bunds were tighter, with Spanish bond spreads tightening the most since February 2015 as the Catalonia regional election results indicated an even split between pro-separatists and unionists.
In currency markets, the USD started the week on a firm note but dropped against all of the major crosses after Friday's disappointing US payroll numbers. The Yen fluctuated within a narrow range as the Japanese economy fell back into deflation territory, and Governor Kuroda reiterated his commitment to work alongside the government to boost inflation. Sterling saw a moderate rise against the greenback on the back of strong construction PMI, but finished the week lower against the Euro and Japanese Yen.
Emerging market dollar-pay spreads widened 16 basis points to 430 basis points over US Treasuries, while local debt yields narrowed to 7.04%. EM currency performance was mixed against the dollar, with the Colombian peso (+ 1.9%) and the Turkish lira (+1.8%) outperforming. The Russian ruble (-1.4%) and the Thai baht (-0.9%) led declines.
In Colombia, the central bank surprised expectations and delivered a 25 basis point hike, leaving the policy rate at 4.75%. Consensus had called for the central bank to remain on hold. Despite slowing growth, the decision reflected the board's concern about rising inflation expectations.
India's central bank (RBI) cut rates by 50 basis points to 6.75%; analysts had been calling for a more modest 25 basis points in easing. In its decision, the RBI cited weak global activity and contained inflation dynamics, particularly among food prices. In China, the official manufacturing PMI, a gauge of factory output, improved modestly to 49.8 in September versus 49.7 in August. The new orders sub-index, at 50.2, increased by 0.5 percentage points relative to last month.
In Africa, Moody's cut Zambia's long-term foreign currency rating to B2 from B1 but left the country's outlook stable. Moody's highlighted the deterioration in the country's fiscal metrics amidst a backdrop of lower commodity prices.
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||(JN) Real Cash Earnings YoY
||(EC) Retail Sales YoY
||(US) Markit US Composite PMI
||(US) ISM Non-Manf. Composite
||(US) Labor Market Conditions Index Change
||(RU) CPI YoY
||(UK) Industrial Production YoY
||(UK) Manufacturing Production YoY
||(UK) Bank of England Bank Rate
||(CA) Housing Starts
||(US) Initial Jobless Claims
||(CA) Unemployment Rate
||(US) Wholesale Inventories MoM