Week ending January 23, 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 7:30 a.m. PDT
to Date (12/31/14 -1/23/15)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/14 -1/22/15)
High Yield Index
Morgan EMBI Global Diversified
||(UK) ILO Unemployment Rate 3Mths
||The labor market in the UK continued to heal, falling 0.2%, beating expectations. That said, employment growth slowed considerably in November, dropping from +115k to +37k
||(US) Housing Starts
||Housing starts rose 4.4% on the month, as single family unit starts picked up 7.2%. Multi-family home sales were weaker, falling 0.8%
||(CA) Bank of Canada Rate Decision
||The Bank of Canada, much to the surprise of market, cut their policy interest rate. The reasoning for the decision was the sharp decline in oil prices, even as core inflation remains right at 2% year-over-year
||(EC) ECB Main Refinancing Rate
||(UK) Retail Sales Ex Auto YoY
||UK retail sales picked up in December, rising 0.2% on the month. Analysts pointed to increased importance of "black Friday" in the UK as part of the reason for strength
||(US) Existing Home Sales MoM
||Existing home sales picked up on the month as single-family home sales bounced 3.5% in December. Distressed sales accounted for 8% of sales and all cash purchases accounted for 26%
||(US) Leading Index
||The US leading indicator index rose in line with expectations as contributions form interest rate spreads and the leading credit index were positive
The ECB is doing QE to cause inflation. But QE doesn't cause inflation.
The above is, in our opinion, the most important takeaway from Thursday's news. The ECB announced its much anticipated asset purchased program, dubbed "QE" by the marketplace. In March, the ECB will begin buying EUR60 billion bonds per month through September 2016. If things go as planned, that sums to EUR 1.1 trillion in fixed income securities over the next 18 months.
During introductory remarks, ECB President Mario Draghi explicitly linked the asset purchase plan to the central bank's inflation objective. Asset purchases, he guided, would continue until "we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term." At present euro area wide core inflation is growing at just 0.7% year-over-year. In the aftermath of Thursday's ECB meeting we've seen headlines suggesting the ECB unveiled its "bazooka" and that the "ECB exceeded expectations." But we wonder: what does this have to do with inflation?
Didn't we learn QE doesn't cause inflation? In the last six years we have witnessed the closest thing to a laboratory experiment we will see in macroeconomics. Despite bond-buying campaigns by major central banks across the globe, consumer prices have not increased at a faster rate. Anywhere you look—the US, the UK, Japan, China, Switzerland, Europe—inflation is below 2%. Why should this QE program be any different?
The treasury curve flattened this week with much of the move being led by other sovereign bond markets across the globe. The European Central Bank announced a comprehensive bond buying program of EUR60 billion per month until September 2016 causing European government bond curves to flatten on net supply and the treasury curve to follow suit as global investors reached for yield.
Even with the 30-year Treasury at 2.38%, global investors see the yield as attractive compared to the German 30-year at 1.06% and the Japanese 30-year at 1.20%. US Treasuries underperformed European government bonds with the spread between the US Treasury 10-year and the 10-year German Bund moving from 130 to 146. Reported flows were heavily driven by reinitiating flatteners and staying in flattening positions by both domestic and foreign managers.
Treasury supply this week was $15 billion in new 10-year TIPS with auction statistics coming stronger than expected on recent strengthening of inflation breakevens off their recent lows.
The U.S. Equity Market rallied for the first time in four weeks as the focus was squarely on Thursday's European Central Bank (ECB) meeting. Equities, along with most risk assets, surged higher after the ECB officially announced quantitative easing. The S&P 500 index climbed approximately 2% for this holiday shortened week, while the NASDAQ Composite rose 2.7%. Large-cap stocks outperformed small-cap stocks. In terms of style, large-cap growth stocks outperformed large-cap value stocks. All sectors were posted a gain for the week. The best performing sectors were energy and info tech, while the worst performing sectors were telecom and consumer staples.
Earnings season continued this week with 50 companies in the S&P 500 index reporting quarterly results. A few notable earnings beats include Goldman Sachs, IBM, General Electric and eBay. A few notable misses include Morgan Stanley, American Express, Kinder Morgan and McDonald's.
In fund flow news, Lipper reported that U.S. based equity mutual funds saw redemptions of $995 million for the week ending January 21, 2015.
Investment grade primary issuance was upwards of $20 billion, at the upper range of estimates of $15-$20 billion for the week. Ten issuers tapped the market starting on Tuesday, and we saw financial supply accounting for roughly 41% of this week's supply. The big surprise came from Southwestern Energy (SWN) who completed another round of their Chesapeake Energy asset financing by issuing $2.2 billion across the curve. It was the first E&P deal of the year so initial price talk was nebulous at best. On average, the deal was over four times oversubscribed and tightened 35 basis points from preliminary guidance to final launch. All three tranches tightened 12 basis points after it launched and are currently trading 33 basis points tighter since issuance.
Investment grade corporate spreads tightened slightly this holiday-shortened week. The drop in oil, nearly $3 from last Friday's close, led to another haphazard session with the S&P down 10 points, then up 16 points to finally close up 10 points in the first half of the week. The ECB delivered on its pledge, unveiling a slightly better-than-expected €60 billion per month asset purchase program that led to a "risk on" environment, in which spreads tightened. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +136, two tighter on the week. Overall, Senior Financials were 10 tighter, Sub Financials tightened by 15. Metals/Mining tightened by 25 and energy tightened by 15. Industrials were three tighter and Utilities were unchanged.
Mortgages bested Treasuries in a reversal of fortune as rates stabilized at the low end of the recent trading range. Since the start of 2015, lower mortgage rates have driven volatility higher and spreads wider. The refinance index has doubled negatively altering dealer forecasts on prepayments and return expectations. This week, the market snapped back with the current coupon basis tightening by five-to-seven basis points as investors plowed money back in the asset class. The Federal Reserve continues to support the market with reinvestment of principal and interest proceeds.
Major lenders have been slow to drop mortgage rates below the key 3.50% threshold. That's given the market a little breathing space and time to manage shortening durations, faster prepayments, and a pickup in gross supply. In the programs, Ginnie Mae mortgages bounced off recent price lows compared to conventionals. As stated in previously, Obama's announcement of insurance premium cuts poured cold water over GNMA investors and led to a 1/2 point haircut in GNMA/FNMA swap prices.
For the week, the thirty-year current coupon versus the ten-year Treasury held steady at 74 bps. According to Freddie Mac, the primary thirty-year mortgage rate fell slightly to 3.63% from 3.66%.
New issue supply was the theme of the week in ABS land. Top-tier names like Honda lead the way, with execution through initial price talk, while subordinated classes and infrequent issuers had to widen spreads to clear their deals. The wide variety of deals probably didn't help as investor focus was pulled in all directions, as the street desperately worked to clear these deals in a MLK shortened week.
Collateral types included a whole business deal from Dunkin Brands, timeshare, equipment, rental car, railcar, and refinanced private student loans from Social Finance (SoFi), a peer-to-peer lender just to name a few. SoFi is an interesting and developing story from a number of aspects. First, it is a peer-to-peer lender, and it is growing up really fast, issuing four deals in a little over a year. Their initial niche is to refinance student loans for borrowers with jobs, primarily graduate school degreed, from the who's who of top academic institutions.
The holiday shortened week saw a heavy supply calendar and a strong market tone. Even after a stellar year of performance, municipals - along with other fixed income classes - have enjoyed a remarkable run so far in 2015, especially on the longer end of the yield curve where 30-year AAA benchmark yields rallied twenty five basis points, keeping right up with Treasuries despite the rapid pace of yield decline. The muni-treasury ratio stayed solidly high as a result, touching 106% by mid-week, with munis persistently cheaper than treasuries.
The short and intermediate parts of the curve also followed suit, but with a more cautionary tone, as those are perceived to be the more vulnerable maturity ranges, as they are subject to fickle cross-over sentiment.
As rates grind lower, muni issuers are loading up sizeable refunding volume, which would certainly reverse quarter-on-quarter supply trends from last year. If an aggressive calendar starts building on the foreground of lower rates, we are likely to see corrections in five year and longer parts of the curve where dealer inventory is heavy and cross-over appetite volatile. Retail demand would follow the herd and slow fund flows, further exacerbating any market weakness. Thus, though munis are on strong footing now, it is a tenuous equilibrium that depends on several market players moving slowly, cautiously, and in a coordinated fashion, which of course is the exact opposite of what we know to be typical market behavior.
The Merrill Lynch BB/B cash pay constrained high-yield index was up 0.20% as spreads tightened by sixteen basis points to an option-adjusted-spread of 445 basis points. The high-yield market continues to be bifurcated as much of the energy sector remains out of favor while the non-energy portion of the market has traded in a tight range with little volatility. Activity in this holiday-shortened week has been somewhat muted as investors awaited the ECB's policy decision regarding quantitative easing on Thursday. Fund flows were negative this week with AMG reporting a $241 million outflow, but higher than average account cash balances and light new issuance have combined to keep the non-energy sector well bid.
Just $11.50 billion has priced so far in this month as compared to $26 billion for the full month of January 2015. The issues that have come to market have for the most part been well-received as the demand for paper allowed deals to both increase in size, and price at the tight end of guidance.
The largest deal of this week was issued by Endo Finance LLC. The Ireland-based pharmaceutical company brought an upsized $1.20 billion B1/B+ 10-year note priced to yield 6.00%, at a spread of 431 basis points over treasuries. The original price talk was 6.50%, but the demand was strong enough to cinch pricing tighter by 50 basis points. The new bonds moved up three-quarters of a point and tightened twelve basis-points when freed to trade.
Global Bonds and Currencies
The major non-US sovereign bond markets surged this week, largely driven by the European Central Bank's (ECB's) asset purchasing programme announcement on Thursday. The week was off to a quiet start with some profit-taking on Tuesday and Wednesday ahead of the ECB policy meeting. However, after ECB President Draghi announced plans for a €60 billion per month asset purchases Quantitative Easing package, government bonds rallied across Europe.
The asset purchasing programme, which will amount to €1.1 trillion over 18 months starting in March this year, will include government and private-sector bonds, and will see national central banks assuming most of the risk on their national debt. The 10-year German Bund yield finished the week 7 basis points lower, touching a record low on Thursday. Peripheral government bonds also rallied on the news and spreads to German bunds tightened on the week. In the UK, sovereign bond markets shrugged of better than expected unemployment and wage growth numbers and focused on the Bank of England's latest policy meeting minutes. The policy makers' unanimous vote in favour of keeping interest rates at the current level indicated a dovish outlook and 10-year Gilt yields fell by about 5 basis points this week.
In the currency markets, the US Dollar continued to rise against all major currencies, supported by positive interest rate differentials. The euro touched its lowest level against the US Dollar in 11 years on news of the ECB's Quantitative Easing programme. Uncertainty about the outcome of the Greek presidential elections on Sunday additionally weighed on the single currency. The sterling sold off after the latest policy meeting minutes were published. The Australian dollar fell to its lowest level against the US Dollar since 2009 as expectations of an interest rate cut increased, while the Canadian dollar touched a record low on Thursday after the Bank of Canada lowered interest rates by 25 basis points to 0.75%.
Emerging market dollar-pay spreads widened 24 basis points to 397 over US Treasuries, while local yields fell 12 basis points to 6.19%. Emerging market currencies showed mixed performance versus the US dollar; the Russian ruble (-7.7%) and Hungarian forint (-3.3%) led declines, while the Indian rupee (+1.0%) and Indonesian rupiah (+1.0%) gained.
The Reserve Bank of India surprised markets by lowering rates 25 basis points to 7.75% in an unscheduled policy meeting. The central bank indicated that the disinflation path has guided inflation expectations lower, creating space for monetary easing. However, further easing will hinge upon the quality of fiscal consolidation announced by the government in the forthcoming 2015 budget. Bank Indonesia (BI) held rates at 7.75% matching consensus expectations. In the accompanying note, BI indicated that inflation likely peaked in December after the government removed energy subsidies in November.
The National Bank of Poland held rates at 2.0%, and Governor Belka struck a dovish tone given persistent deflation pressures. Still, the central bank may adopt a wait-and-see approach before cutting policy rates as zloty depreciation could push inflation higher.
In Latin America, Peru unexpectedly cut rates 25 basis points, to 3.25%. Officials see the country at a weak point in the economic cycle and expect inflation to fall more quickly towards the 2% mid-point target. Chilean policymakers held the benchmark rate at 3% as they attempt to contain elevated inflation amid soft growth.
On the political front, Croatia held elections and Kolinda Grabar-Kitarovic became the country's first female president winning 50.4% of the vote. The election outcome is mildly positive as Kitarovic is viewed as reform oriented. Markets will see if the new administration can lift Croatia from a 7 year recession which is putting pressure on the sovereign's debt trajectory.
Sri Lanka held presidential elections which resulted in a victory for opposition candidate Maithripala Sirisena. The opposition was able to coalesce to fight against corruption and nepotism, which marked the previous Mahinda Rajapaksa administration. Parliamentary elections, likely to be held in April, will be important as the opposition's coalition would like to gain two-thirds majority to pass constitutional reforms.
Emerging market bonds experienced outflows of $1.1 billion, skewed toward hard currency funds.
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||(UK) GDP YoY
||(US) Durable Goods Orders
||(US) S&P/CS Composite-20 YoY
||(US) New Home Sales
||(US) FOMC Rate Decision (Upper Bound)
||(US) FOMC Rate Decision (Lower Bound)
||(GE) Unemployment Rate
||(EC) M3 Money Supply YoY
||(JN) Natl CPI YoY
||(JN) Natl CPI Ex Food, Energy YoY
||(JN) Industrial Production YoY
||(EC) Unemployment Rate
||(US) GDP Annualized QoQ