Week ending July 31, 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 7:12 a.m. PDT
to Date (12/31/14 -7/31/15)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/14 -7/30/15)
High Yield Index
Morgan EMBI Global Diversified
||(UK) GDP YoY
||GDP grew for the 10th consecutive quarter, the third longest duration of consecutive growth on record.
||(US) GDP Annualized QoQ
||Consumer spending was the main driver of growth while Q1 GDP was revised up to 0.6%.
||(JN) Natl CPI Ex Fresh Food YoY
||Japan is nowhere close to its 2% target and continues to face very low inflation.
||(EC) Unemployment Rate
||Eurozone unemployment persisted with Greece and Spain showing the highest levels.
||(US) Employment Cost Index
||Wages and salaries increased at their slowest pace since 1982.
The much anticipated July FOMC meeting came and went with little new information divulged by the Fed. Investors scoured the six paragraph policy statement for hints of an imminent departure from the zero bound. None appeared. Unlike the 2004 hiking cycle, when policymakers gave advance warning of the first rate hike, members of the FOMC including Chair Yellen have suggested time and again that no such notice will come in 2015.
From the first paragraph of the statement we gleaned that policymakers had upgraded their assessment of the recent string of economic data The second paragraph expressed the FOMC's view that the balance of risks to economic growth were "nearly balanced." However, it was one word in the third paragraph which caught investors' eyes: "some." The June FOMC statement reported that the Fed required "further improvement in the labor market" before proceeding with the first rate hike. Today that changed to "some further improvement." The difference between "some further improvement" and "further improvement" is a bit like the progress bar on your computer screen when you download a music or movie file. At first you need further progress to finish the download, but as you near completion of the download you need just "some" further progress.
Our view is that we are closer today to a rate hike--but without an explicit progress bar it is difficult to say with any reasonable certainty when the criteria will be met. With no dissenters at the meeting, it seems that there was consensus to wait and see how the data evolves.
This week we got our first hints on the data front. Thursday saw the release of Q2 US gross domestic product (GDP) and revisions to prior GDP reports. The takeaway: nothing in this report will change the Fed's mind about the state of the US economy. Q2 growth registered at a solid 2.3% annualized rate and Q1 GDP was revised higher to 0.6% at a quarterly annualized rate, erasing the negative print that has haunted bond investors. That said, revisions to previous years' growth estimates were lowered. Also, on Friday, the Bureau of Labor Statistics' Employment Cost Index report showed weak gains in wage growth (up only 2.1% since last year).
For next week, we expect to see slightly higher inflation readings, evidence of wage growth in average hourly earnings, as well as another solid month of payroll growth in the July jobs report (released Friday, August 7). If we are right about the data, the bar for "lift-off" will be lower. September is still on the table.
The Treasury curve was on track for a fourth week of flattening on second quarter GDP estimates and the market giving a higher probability that the Fed could start to raise interest rates in September before the employment cost numbers on Friday.
Treasuries bull steepened with the 5-year note leading after quarterly increases in U.S. wages came in the smallest on record dating back to 1982 putting a bit more doubt on a September lift off if the Fed needs to feel "reasonably confident" inflation measures will return to target.
Trading volumes were subdued as summer trading conditions are in full affect running approximately 60-70% of the recent 20-day average. The July FOMC statement re-emphasized data dependency and left the door open for a rate hike this year but overall moves in the market were muted. Dealer desks reported better buying in the long end of the curve as an early month end extension trade and some flattener unwinds post-employment cost numbers on Friday. The market was able to digest the approximately $41 billion 10-year note equivalent Treasury supply in the front end with solid non-dealer demand for 2-years and 5-years and average demand for 7-years. Corporate issuance is expected to be around $60-70 billion for the month of August, front loaded in the first two weeks, which could put some pressure on the rates market.
The U.S. Equity Market rallied for the week despite disappointing economic data and mixed corporate earnings results. The broad equity market managed to recover most of last week's losses as the recent risk-off sentiment dissipated after the market got past the uncertainties from the FOMC meeting and the Q2 GDP report.
Investors have shown a lack of directional bias for most of the year as the S&P 500 index continues to trade in a narrow range over the last five months. The S&P 500 index closed the week up approximately +1.7%, while the NASDAQ Composite and Dow Jones Industrials both ended the week up +1.2%. Large-cap stocks outperformed small-cap stocks. In terms of style, large-cap growth stocks performed in line with large-cap value stocks. All sectors posted a gain this week. The best performing sectors were utilities and industrials, while financials and info tech were the laggards.
In earnings news, the current reporting season is winding down with 353 S&P 500 companies having reported quarterly results. Corporate results have been better than expected with 74% topping earnings estimates, while 50% have beaten sales estimates. In fund flow news, domestic equity mutual funds continued its year-long trend after Lipper reported $1.86 billion was redeemed from U.S. based equity mutual funds, while non-domestic equity mutual funds took in $1.15 billion.
Investment grade primary issuance was a bit below expectations at roughly $19 billion versus an anticipated $20-25 billion. This week's supply came from several different issuers whose largest deal was $3.5 billion.
One notable deal was brought by Janus (JNS), which had just one tranche of $300 million in the 10-year space. The bonds' initial price talk was at a spread of 225, but widened 50 basis points to a spread of 275 at final pricing. This is rare; typically deals tighten 10-20 basis points from initial price talk to final pricing. The bonds tightened one basis point on the break and are now 12 basis points tighter.
Commodities hit a new low on Monday, and corporates impacted by commodity inputs widened in line. Metals/Mining were 51 wider; energy widened by 14. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +153, five wider on the week. Senior financials were two wider and subs were wider by four. Industrials widened by seven and utilities were two basis points wider.
Mortgages outperformed as Treasury yields edged lower on weaker economic reports and a dovish Federal Reserve outlook on monetary policy. Volatility declined as headline and Global headline risk abated. Pass through spreads compressed across the coupon stack by three-to-five basis points.
Housing market activity was a topic this week, posting mixed results as existing home sales accelerated while new and pending home activity failed to meet expectations. The Case Shiller home price appreciation report disappointed with a several markets, led by San Francisco, posting negative monthly results. It remains a renters/landlord market as the homeownership rate declined to its lowest level since the 1960s at 63.4% of households.
In commercial MBS, spreads stabilized after widening throughout July due to supply concerns. Spreads to swaps for new issue AAA-rated CMBS range between 48 basis points to 105 basis points, depending on the maturity point. As for the agency thirty-year mortgage, the thirty-year current coupon spread compressed three basis points to 71 basis points. According to Freddie Mac, the thirty-year mortgage rate fell below 4.0% to 3.98% for the first time since mid-June.
As typical for the last week of the month, new issuance volume was muted with only four new ABS deals being marketed. Of those, half were of the peer-to-peer variety with Citi Held for Asset Issuance (CHAI 2015-PM1) utilizing Prosper collateral and another student loan deal from Social Finance (SOFI 2015-C). A New York tax lien deal and a subprime auto loan deal from Flagship rounded out the week. Next week should be active with GM Financial, CarMax, Marriott and Solar City in the visible queue.
Credit has not been an issue in both the ABS and CLO space, but FFELP student loans have found their way into the news due to slower than expected prepayment rates. This has caused a number of senior triple-A rated classes to be put on negative watch due to the possibility of principal remaining outstanding at the legal final maturity. In addition to the elevated levels of deferment and forbearance, a rising number of borrowers are using income-based repayment (IBR) plans. This has been a very popular political stance in doing good for the consumer, but it is creating havoc for issuers and investors.
The municipal market saw mostly unchanged yields this week against a backdrop of a Federal Reserve inching toward a rate increase. At mid-week, the ten year AAA benchmark municipal yield registered in at 2.23% and nearly 98% of its Treasury counterpart. The municipal to Treasury yield is even more attractive farther out the yield curve on a relative value basis as thirty year municipal yields are 105% of their Treasury counterpart.
New issue supply this week was somewhat lower at $7 billion compared to $9.5 billion last week. The 2015 weekly average is over $5 billion. The largest deals of the week included $990 million State Building Authority of the State of Michigan and $750 million New York City. 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 lackluster mutual fund flows. Next week's calendar includes $723 million Central Puget Sound Regional Transit Authority.
Competitive deals saw lingering balances and most negotiated new issues were priced attractively in order to garner buyer's attention amidst a robust calendar. New York deals dominated the new issue slate. The secondary market was orderly with most trading in-line with the overall market. Dealer's bids are reasonable under current market conditions. The 30 day visible supply is $10.7 billion, somewhat elevated for the year. Longer term, municipal bonds should outperform other fixed markets as relationships are attractive relative to Treasuries. Market participants are paying close attention to the Commonwealth of Puerto Rico's anticipated default on the August 1st debt service payment and its implications for the health of the overall municipal market.
US high-yield was higher this week despite broad-based negative fund flows. The BofA Merrill Lynch BB/B cash pay constrained index was up 0.44% this week as spreads tightened by ten basis points to an option-adjusted-spread of 426 basis points. The BofA Merrill Lynch BB/B index which excludes utilities and energy was up 0.35% for an OAS of 394 as that spread also tightened by eight basis points. The BofA Merrill Lynch Euro BB/B constrained index gave back some of last week's outperformance versus its US counterparties this week as it was down 0.26% as the spread of that index widened by eight basis points for an OAS of 368.
High-yield started off the week with a soft tone as concerns continued over weakness in Chinese stocks and lower oil prices. Metals, mining and energy were under pressure again and a busy week of earnings announcements kept investors playing defense. The tone of the market improved as the week wore on, and a combination of short-covering and real money buying pushed the market higher as beaten-down, higher-beta credits outperformed. The benign FOMC release, mostly solid corporate earnings, and a lack of new issue supply also helped to support the positive market tone. The forward calendar for high-yield new issue currently stands at $4.5 billion as just $1.935 billion has priced this week.
High-yield bond funds reported an outflow of $1.7 billion as actively managed funds had outflows of $1.1 billion and ETF's saw negative flows totaling $645 million. Year-to-date fund flows now stand at a positive $449 million for ETF's and a negative flow of $1.3 billion for actively-managed funds.
Global Bonds and Currencies
An eventful week for global financial markets began with Chinese stocks registering their biggest one day drop since 2007. The related weakness in commodities and increased risk aversion led to a rally in developed market sovereign bonds. Weakness in commodities extended through the week even as the Chinese market stabilized. This put downwards pressure on medium term inflation expectations and as a result sovereign yields closed the week lower. The yield on the 10-year German bund finished the week 4 basis points lower, while European peripheral spreads to German bunds tightened.
UK Gilts performed in line with German bunds with the yield on the 10-year note falling by 5 basis points on the week. On the data front, second quarter GDP supported the case for an interest rate increase sooner rather than later.
In a week that saw a fairly heavy US data calendar, including in particular the FOMC statement and the release of US Q2 GDP numbers, the US dollar ended lower against the major crosses after Friday's US employment cost numbers failed to meet consensus expectations. Sterling firmed against the greenback as investors brought forward their expectations of the first UK interest rate hike. The Australian dollar softened slightly on the back of commodity price weakness and growing concerns in Chinese growth but regained its lost ground against the US dollar after Friday's employment cost data.
Emerging market dollar-pay spreads widened four basis points to 364 basis points over US Treasuries, while local debt yields increased six basis points to 6.77%. Currencies were weaker against the US dollar, led by the Russian ruble (-3.1%), Chilean peso (-2.6%) and Brazilian real (-2.6%).
Brazil remained in focus as S&P revised the outlook on the country's BBB- credit rating to negative, putting Brazil on the precipice of losing one of its investment grade ratings. In addition to the government's downward budget revision last week, the rating agency expects a challenging policy environment in the fallout from the broadening Lava Jato corruption scandal.
Meanwhile, Brazil's central bank increased the policy rate 50 basis points to 14.25% as it deals with elevated inflation. However, the statement accompanying the hike indicated that the bank's aggressive tightening cycle may have ended.
In Mexico, Banxico chose to maintain the policy rate at 3% as officials perceive muted demand side inflation pressures. Separately, in light of the Mexican peso's sharp depreciation in recent weeks, the Foreign Exchange Commission, comprised of members of the central bank and finance ministry, announced it would intervene more heavily in the currency market to promote financial market stability.
The Central Bank of Russia moderated the pace of its rate cutting cycle, easing by 50 basis points to 11%. While policymakers are concerned about slower growth prospects, they remain wary of inflationary pressures, particularly as the ruble has resumed depreciation along with the new decline in oil prices.
The Bank of Israel maintained the base rate at 0.1%. Policymakers have paused after cutting to a record low policy rate, weighing reasonable growth momentum against negative inflation rates and a strengthening currency that has hampered the large export sector.
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