Week ending July 25, 2014
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 7:45 a.m. PDT
to Date (12/31/13 -7/25/14)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/13 -7/24/14)
High Yield Index
Morgan EMBI Global Diversified
||(US) CPI YoY
||US consumer prices slowed their acceleration from last month, denting some hawkish inflation talk that imagined prices heading steadily higher this year. Core CPI was 1.9% YoY
||(UK) Retail Sales Ex Auto YoY
||Retail sales disappointed expectations, growing only 0.1% on the month, including auto fuel. Core retail sales fell -0.1% since last month
||(US) New Home Sales
||New home sales cratered -8.1% MoM, with sales declining in all regions of the United States. Months' supply (inventory) rose to 5.8
||(JN) Natl CPI YoY
||Excluding the effects of the VAT hike, core inflation rose only 1.3% YoY, a decrease from May's yearly rate of increase of 1.4%
||(EC) M3 Money Supply YoY
||Broad money growth elevated, as a pickup in household bank deposits and currency lead the aggregate. Lending to the private sector continues to contract at -1.1%
||(UK) GDP YoY
||A minor slowing in construction was offset by growth in services, driving GDP growth higher in the UK
||(US) Durable Goods Orders
||Durable goods orders printed in line with expectations, but the more revealing core capital goods component came in at 1.4% MoM versus 2% expected monthly growth
Janet Yellen is a dove.
Of that investors and the commentariat seem assured. So why does the yield curve disagree? Since the start of 2014, the yield curve has flattened by 68 basis points. A flatter yield curve (i.e., lower long-term yields relative to short-term yields) suggests one or two things. First, that inflation will not become a major problem and thus eat away at a fixed-income investors' coupon income in the years ahead. Second, it may suggest that the Fed will hike interest rates sooner (in part to curtail future inflation).
But if Yellen is so dovish, why would she move to preempt a pick-up in inflation? Would not a true dove embrace inflation as a means to stimulate the economy (or at least welcome it as a sign of the economy heating up)? Recent Fed commentary, and published Fed forecasts, suggest that they envision a pick-up in inflation over the rest of the year. Again, if Yellen were so dovish, and the Fed so sanguine on inflation, 10-year yields should be moving higher. But they are not.
So what gives?
Our reading of the yield curve suggests that the current market bet of a flatter yield curve depends on Yellen pivoting to a more hawkish stance. If the Fed hikes interest rates sooner, then they clamp down on any incipient inflation pressure and should cap longer yields at lower levels.
We do not see the Fed pivoting, or Janet Yellen suddenly going "full hawk." In our view, US economic growth is moderate and will remain that way. We have counseled investors to ignore Q1 GDP, and eagerly await revisions. Q2 GDP will be released next week and will be a lot better than Q1 (perhaps growing at around 3% annualized). Payroll growth also looks better than it has for more than a decade.
But, despite all the positive signs, nominal wage growth registers at just 2% year-over-year. Underwhelming housing data, and the ever elusive jump in and business investment have dented optimism for strong 2014 growth. In our view, this suggests low rates will be with us a while still.
The Treasury market was mixed over the past week with the long end better on relatively tame CPI data and weaker than expected durable goods data. The front-end came under pressure on Thursday after initial jobless claims came in at the lowest level in 8 years. The 10-year Treasury yield is currently at 2.48% and the flattening trend continued with the 2/10 curve at sub 200 basis point level. Ten-year and 30-year securities are testing 12-month lows in yield which has been exacerbated by the short base in the market.
The U.S. Equity Market closed unchanged for the week as the ongoing geopolitical tension in Eastern Europe and mixed corporate earnings weighed on investor sentiment. Light trading volumes on historically low intra-day volatility reflect a sense of complacency in investors' risk appetite. Despite setting a new all-time intra-day high on Thursday, the S&P 500 index haas stubbornly traded in a tight range over the last four weeks after meeting each new high with some resistance. The index closed the week largely unchanged. A mixed week of performances amongst broad equity indices after the NASDAQ Composite climbed 0.2%, while the Dow Jones Industrial Average fell 0.9%. Large-cap stocks outperformed the higher beta small-cap stocks. In terms of style, large-cap growth stocks modesty outperformed large-cap value stocks. The best performing sectors were energy and health care, while the worst performing sectors were consumer discretionary and industrials.
We are now approximately half way through earnings season as 145 companies from the S&P 500 index reported quarterly results this week. So far, quarterly results have been better than expected with 78% of the companies that have reported topping street earnings estimates, while 66% have beaten sales estimates. â€¢ In fund flow news, Lipper reported that U.S. based equity mutual funds took in $380 million for the week.
Anticipated investment grade primary issuance this week was $12-15 billion, and as of Wednesday $12 billion has been issued. July has been a very slow new issue month with around $30 billion pricing thus far, in sharp relief against June's $105 billion issuance. Despite very positive earnings announcements in the financial sector (31 of 38 have surprised to the upside), new issue activity in the space has been limited. One notable deal this week was issued by Ebay (EBAY), who issued for the first time in two years. The deal totaled $3.5 billion across multiple floating and fixed tranches in the 3, 5, 7 and 10 year space and was nearly two times oversubscribed. From price talk to final pricing, the 10 year tranche tightened 15 basis points to T+100.
Credit has changed little over the week, with rates remaining tight after the geopolitical news of last week. In terms of spreads, most sectors are currently at their 3 month average. Corporate Index Option-Adjusted Spread (OAS) finished the week at +99, up one basis point on the week. Financials remained unchanged (banks -0, insurance +1); industrial spreads increased by a few basis points (basic materials +2, capital goods -0, telecom +3, consumer cyclical +1, consumer non-cyclical -0, energy +3); and utilities remained unchanged.
The mortgage market lagged again on a pickup in supply and refinance activity as rates consolidated at the low end of the range. Pass-through spreads widened three-to-five basis points as investors balked at lower yields and the yield curve flattened. Within the market, Ginnie Mae mortgages were under pressure compared to their conventional cousins on dollar price fatigue. Fifteen-year compared to 30-year discounts are languishing with limited sponsorship from domestic financial institutions. Lower rates from this point on complicate the carry benefits of agency MBS.
In commercial MBS, issuance was benign compared to previous weeks. Spreads have survived widening in the other market as deals come in at the tightest spreads since the financial crisis. Long-cash flow AAA-rated CMBS bonds are trafficking in the 75-to-80 basis points range. A new single-family rental issuer, Silver Bay Properties (SBY), is in the market with a $313 million offering. This deal represents half of the properties held in their portfolio for the fourth largest player in the CMBS-RMBS subtype.
The current coupon yield versus the 10-year Treasury stands at 73 basis points. According to Freddie Mac, the 30-year mortgage rate fell to 4.10% but some smaller originators are quoting below 4.0%.
In a word, diversity characterized the new issue ABS market this week. Ford auto lease highlighted the on-the-run market and it quickly went off-the-run with UAC, an infrequent subprime auto loan issuer and OneMain, a Citibank spinoff, who specializes in subprime personal loans. This was their second issuance. Yield still rules the day and all deals were able to clear the marketplace.
SeaCo brought a sea shipping container deal and Mississippi Higher Ed brought a state agency FFELP student loan deal. Finally, Solar City brought their second securitization in a rapidly developing industry. Next week is looking like more off-the-run issuance.
The municipal market has chewed through this week's $6 billion new issue calendar with ease. The calendar featured $1.2 billion State of Maryland, $383 million Beaverton, OR, and $300 million Houston, TX. Maryland came competitively and priced at lower yields than the AAA benchmark and serials in the Houston, TX deal were 10 times over-subscribed, validating the supply/demand imbalance that has dominated the municipal market as of late.
Municipal bond funds saw net inflows of $157 million with high yield funds shedding $60 million due to continued Puerto Rico selling. The selling continues as the Puerto Rico Electric Power Authority (PREPA) approaches 7/31 and 8/14 payment dates on some of its credit lines. Volatility is expected to continue. Meanwhile, Puerto Rico GOs seem to have rebounded over the past week and are trading at"pre-restructuring law" levels.
The overall municipal market outperformed Treasuries once again over the past week. The 5,10, and 30 year AAA muni spots outperformed comparable Treasuries by 2, 6, and 3 basis points, respectively.
The high-yield market was modestly higher this week as the sector began to stabilize after two weeks of outflows. The Merrill Lynch BB/B high-yield index was up 0.05% for the week as spreads tightened by 2 basis points, and is now up 5.13% for 2014. The bulk of the outflows over the prior two weeks have been concentrated in high-yield ETFs and one particular actively-managed mutual fund. The pace of the outflows moderated this week as the week wore on, which gave way to more balanced trading and shifted towards better buying by accounts looking to opportunistically pick up credits that had underperformed over the past two weeks. The flood of BWIC's (bid-wanted-in-competition) from ETFs that helped to depress high-yield bond prices early in the week slowed to a trickle as a steady stream of OWIC's (offer-wanted-in completion) took their place.
The slowdown in the pace of new issuance was another factor lending a supporting bid to high-yield as the anticipated active forward calendar moved temporarily to the sidelines in the face of the recent spread widening. Investors are being more selective and discerning on what new credits they are adding, and the deals that did price this past week reflected the pushback on pricing from high-yield accounts as final pricing was at or through the wide end of initial price guidance. Over $5.5 billion of new bonds were priced for the period with most seeing positive price action when freed to trade. Issuers that issued bonds this week included the petroleum refiner/gas station owner CITGO, which issued $650 million of bonds.
Global Bonds and Currencies
Major non-US sovereign bond markets finished the week with minor losses, as better global economic data and optimism on US corporate earnings counteracted the lingering concerns over current geopolitical tensions. Ten-year German Bund yields ended 2 basis points higher following the better than expected composite PMI data, while in the UK, 10-year Gilt yields were up by about 3 basis points, despite the softer than expected UK retail sales data. Bank of England Governor, Mark Carney's comments on the need for a gradual rise in interest rates and the International Monetary Fund's prediction that the UK will grow more than the other G7 economies in 2014 encouraged yields to rise on the week. Peripheral sovereign government bond spreads over Bunds finished tighter.
In currency markets, the US dollar was generally strong against the major crosses. The euro came under slight pressure on concerns that the Ukraine crisis will depress the region's economy and cause additional easing by the European Central Bank. Sterling was down following the worse than expected retail sales data, while the yen also finished lower against the US dollar on disappointing trade deficit figures. The Australian dollar rose on better Chinese economic data and higher inflation.
Emerging market dollar-pay spreads tightened to 259 basis points (bps) over US Treasuries, while local yields were flat at 6.47%. Currencies broadly appreciated against the US dollar, led by the Turkish Lira (+2.3%) and the South African Rand (+2.2%). By contrast, the Czech Koruna weakened by -0.6%.
In EM Asia, the spotlight remained on Indonesia, where the election commission officially announced former Jakarta Governor and PDIP candidate Joko Widodo as the winner of the Presidential elections held earlier this month. While this is a market friendly outcome, some uncertainties linger as the losing candidate Prabowo Subianto will be challenging the outcome with the constitutional court. In Thailand, the junta announced an interim constitution that will give the military oversight of the legislative assembly. The military is expected to choose a 220 member legislature, which in turn will appoint a prime minister and cabinet.
In Europe, Hungary's central bank lowered the base rate by 20 bps to 2.1% against consensus expectations of 2.2%. The central bank hinted that the end of the long easing cycle is imminent. The bank also noted that low rates will be maintained in the foreseeable future, possibly until 2015 absent any latent inflation surprise. Central Bank of Russia (CBR) unexpectedly hiked the policy rate by 50 bps to 8.0%. CBR noted that while inflation is easing and growth momentum continues to lose steam, rising geopolitical tensions warranted policy action.
Tension between Russia and the West escalated in the aftermath of the Malaysian Airlines crash in rebel-controlled Ukraine. Following the US, the EU is expected to broaden sanctions against Russia which will include individuals as well as entities. Domestic politics in Ukraine also turned volatile with the resignation of Prime Minister Arseniy Yatsenyuk, following a break-up in the coalition, which will likely to lead to early elections.
Emerging market debt funds received $0.3 billion of inflows for the week.
Visit the Weekly Market Update archives page to browse past editions of the publication.
||(US) Pending Home Sales YoY
||(UK) M4 Money Supply YoY
||(US) S&P/CS Composite-20 YoY
||(US) ADP Employment Change
||(US) GDP Annualized QoQ
||(US) Fed QE3 Pace
||(US) FOMC Rate Decision
||(GE) Unemployment Rate
||(EC) Unemployment Rate
||(US) Change in Nonfarm Payrolls
||(US) Unemployment Rate
||(US) Average Hourly Earnings YoY
||(US) PCE Core YoY
||(US) ISM Manufacturing