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Payden & Rygel: Weekly Market Update
Weekly Market Update

Week ending August 29, 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.

  Friday* Last Week Dec. 31
2013
1 Yr Ago
Dow Jones Ind. Avg. 17,088 17,001 16,577 14,841
S&P 500 1,997 1,988 1,848 1,638
Nasdaq 100 4,570 4,539 4,177 3,620
The Russell 2000 1,166 1,160 1,164 1,027
DJ STOXX Europe 341 337 328 300
Nikkei Index 15,425 15,539 16,291 13,460
MSCI EM Index 456 455 415 383
Fed Funds Target 0-0.25% 0-0.25% 0-0.25% 0-0.25%
2-Year US Treasury Yield 0.50% 0.49% 0.38% 0.40%
10-Year US Treasury Yield 2.34% 2.40% 3.03% 2.76%
US$ / Euro 1.32 1.32 1.37 1.32
US$ / British Pound 1.66 1.66 1.66 1.55
Yen / US$ 103.97 103.95 105.31 98.35
Gold ($/oz) $1,285.93 $1,280.08 $1,205.65 $1,407.75
Oil $94.55 $96.05 $98.42 $108.80
*Levels as of 6:40 a.m. PDT


Year to Date (12/31/13 -8/29/14)
Dow Jones Industrial Avg 3.08%  
S&P 500 8.03%  
NASDAQ 9.43%  
Russell 2000 0.20%  
MSCI World Index 5.01%  
DJ STOXX Europe 600 (euro) 3.94%  
MSCI EM Index 9.83%  
Year to Date (12/31/13 -8/28/14)
90 Day T-Bill 0.05%  
2-Year Treasury 0.53%  
10-Year Treasury 8.32%  
ML High Yield Index 5.70%  
JP Morgan EMBI Global Diversified 10.04%  
JP Morgan Global Hedged 5.79%  

 


Date Report Survey Actual Prior Details
8/25 (US) New Home Sales 430K 412K 406K New home sales fell -2.4% on the month. Supply has lifted, currently at 6 months' worth of sales, the highest level in four years
8/26 (US) Durable Goods Orders 8.00% 22.60% 0.70% A massive increase in civilian aircraft orders (318% MoM) drove the headline higher. Core capital goods orders actually disappointed, but core capital goods shipments (a direct GDP input) rose 1.5% MoM
  (US) S&P/CS Composite-20 YoY 8.30% 8.10% 9.34% Case-Shiller home prices fell by 0.2% MoM, the second straight month of decline. From a broader perspective, the year-over-year gain of 8.1% was the lowest in the past 1.5 years
8/28 (US) GDP Annualized QoQ 3.90% 4.20% 4.00% Upward revisions to business investment and a smaller drag from net exports helped push the second estimate of second quarter US GDP higher
  (JN) Natl CPI YoY 3.40% 3.40% 3.60% Measures of Japanese inflation remain weak. The Bank of Japan, after subtracting the 2% boost from the April consumption tax hike, is currently looking at core inflation of 1.3% YoY, below their 2% target
8/29 (EC) Unemployment Rate 11.50% 11.50% 11.50% See below
  (US) PCE Core YoY 1.50% 1.50% 1.50% Slow inflation continued in the US as core PCE inflation held steady. Headline prices rose 1.6% YoY

 



After calls that the European Central Bank (ECB) was "behind the curve," a massive roll-out of negative interest rates and conditional balance sheet expansion in June 2014 seemed to placate investors. But only for a time. Since the ECB announced its pseudo-QE in June, data have showed flat second quarter growth, dismal inflation, and labor markets only slowly healing. In a speech given last week, Mario Draghi addressed the persistent weakness in the euro area economy and hinted that further ECB action could come if inflation expectations continue to fall.

At the Kansas City Federal Reserve's annual Jackson Hole meeting, Mario Draghi gave a speech entitled, "Unemployment in the Euro Area." The speech was a meditation on the extraordinary levels of joblessness across peripheral countries in the monetary union. If the double digit levels of unemployment in Spain (24.5%), Greece (27.2%), Portugal (14%) and Ireland (11.5%) weren't bad enough, Draghi lamented that a full 6% of the total euro area labor force had been unemployed for one year or longer. In the United States, that number stands at only 2%. Despite the ECB's best efforts, labor market health has scarcely improved.

Draghi also cited low government bond yields and the prospect of declining inflation expectations as causes for concern. Highlighting the difficulty of coordinating fiscal and monetary policy across an 18 country group, Draghi referenced "ECB staff estimates of the 'credit gap' for stressed countries -- the difference between the actual and normal volumes of credit in the absence of crisis effects -- [which] suggest that that credit supply conditions are exerting a significant drag on economic activity." As we have suggested before, the ECB has struggled to fix the "transmission mechanism" of monetary policy--ensuring that lower policy rates affect all countries in the euro area. Thus far, the ECB's efforts have been in vain, as borrowing costs for small and medium sized businesses in the hardest hit countries remain elevated.

As a result of the low growth, high unemployment, and uneven credit growth, little surprise should come from falling inflation expectations. In particular, Draghi worried explicitly about the market pricing in Japan-like deflation: "the 5year/5year swap rate declined by 15 basis points to just below 2% - this is the metric that we usually use for defining medium term inflation." Falling prices in stagnating economies is not a pleasant sight for a central bank which just introduced its newest easing program.

If current inflation (running below 0.5% year-over-year) and inflation expectations continue to fall, we expect further action from the ECB. Whether in the form of open-ended asset purchases or targeted lending programs meant to ameliorate small business credit, the central bank still has options for easing monetary policy further. However, previous policy initiatives have yet to stimulate credit creation, inflation, or growth. While we hope for the best for the future of the euro area economy, a slow and jerky recovery may prove the unfortunate outcome.


Treasury Bonds

The Treasury market staged a rally this week led by continued geopolitical headlines and European sovereign debt markets as Spanish, German and Italian 10-year notes hit record lows in yield. The curve continued to flatten as the market cleared front-end supply and managers setup for the relatively large 0.13 year index extension. The 30-year note continues its move towards 3.00% as the long-end has outperformed. Volume remained light with many market participants out for the last week of summer.

Large-Cap Equities

The U.S. Equity Market rallied for the fourth consecutive week as investors head into the long Labor Day weekend. Despite the ongoing geopolitical tension in Eastern Ukraine and Russia, U.S. economic data released this week was better than expected offsetting some of the negative headlines. Growing expectations that global central bankers outside of the U.S. will soon announce new stimulus programs to spark global expansion have also spurred a positive investor sentiment towards risky assets. The S&P 500 index closed above the psychology 2000 mark for the first time ever as seasonally low trading volumes and minimal intra-day volatility provided little resistance for the index to levitate to new record highs. The S&P 500, NASDAQ Composite and Dow Jones Industrial Average indices all closed the week up approximately 0.4%. Large-cap stocks performed in-line with the higher beta small-cap stocks. In terms of style, large-cap value stocks outperformed large-cap growth stocks. All sectors finished higher for the week with the exception of industrials. The best performing sectors were health care and utilities, while info tech joined industrials as the worst performing sectors.

Corporate Bonds

Investment grade primary issuance was non-existent this week as the upcoming Labor Day holiday had most desks at half-staff. Volatility related to geopolitical apprehension kept issuers at bay most of August, which likely pushed some supply into September. There was a glimmer of hope early in the week that some issuers would have looked at the success of the Bank of America deal from last week and decide to tap the market but as of mid-week, it appears everyone will wait for next month. Interest rates, especially in the long-end, have created a surprising opportunity for issuers to lock in attractive total yields. Issuance is expected to pick up immensely in September, averaging over $25 billion per week.

Investment grade corporate spreads were slightly tighter this week as credit held in despite summer trading and anticipation of a marked pickup in the primary calendar. Corporate Index Option-Adjusted Spread (OAS) finished the week at +101, two tighter on the week. Overall, financials tightened by one (banks -1, insurance -1); industrials tightened two (basic materials -3, capital goods -2, telecom -1, consumer cyclical -1, consumer non-cyclical -2, energy -3); and utilities remained flat.

Mortgage-Backed Securities

Agency mortgages posted mixed performance versus Treasuries as rates declined on escalating global political tensions. Mortgage fixed-rate pass-through spreads (MBS) were one-to-three basis points wider on current and premium coupons as asset flows moved down in coupon (DIC) to participate in the bull-flattener in the yield curve. Although secondary mortgage prices have risen to their highest levels since the spring of 2013, primary mortgage rates remain ‘sticky' hovering near 4.0%. Restrictive lending and refinance burnout have fueled investor complacency over future prepayments. Demand for agency MBS from foreign and domestic financial institutions has offset tepid interest from money managers and reduced buying by the Federal Reserve. With the supply/demand equation in balance, the impact of the Federal Reserve's exit from quantitative easing should be limited without a pickup in volatility and/or material decline in primary mortgage rates to spark another refinance wave.

In the agency mortgage products, Ginnie Mae mortgages trailed their conventional cousins as investors anticipate faster GNMA prepayment experiences, backed by Federal Housing and Veteran Administration loans, compared to Fannie Mae and Freddie Mac eligible conforming mortgage loans.

For the week, the 30-year coupon mortgage edged higher by one basis points to 76 basis points versus the 10-year Treasury. According to Freddie Mac, the 30-year mortgage primary mortgage rate held steady at 4.10%.

Asset-Backed Securities

The SEC released their final Regulation AB II this week in an attempt to create more transparency in structured products by providing more extensive loan level disclosure. In a perfect world, it would prevent a replay of the subprime residential and CDO disaster. The major affected areas are public, SEC registered non-agency RMBS, CMBS and auto loan and lease ABS. The one glaring omission is private 144a securities. The obvious market response will be more 144a issuance since there is little to no difference in pricing between public and 144a, at least for regular and frequent issuers. We advise accounts to review their current guidelines regarding 144a.

The implementation date is 60 days plus two years after the rules are published in the Federal Register. Loan level information will be publically available on EDGAR. In this day and age of hacking and phishing, public loan level information can get scary. Privacy issues were clearly front and center between issuers and the SEC. Names and addresses will NOT be included, but FICO scores and enough information to back into an income figure are included. For autos, state information will be included, and for residential, 2-digit zip codes will be used. There are 99 unique 2-digit zip codes so this is more conservative than state information.

Municipal Bonds

The last week of summer was marked by a scramble for bonds in the secondary market as the primary did not furnish any additional volume at $2.5 billion. The majority of this week's new issues were priced Wednesday, adjusting the benchmark AAA scale down a few basis points in yield in the intermediate maturities. Yields on shorter maturities inside of seven years remained stubbornly rigid. Though this compression in yields is consistent with Treasury movements in the same maturity range, municipal yields are more reflective of market technicals that are currently defined by insatiable demand and extremely limited supply. The ratios on the shorter end of the curve have reached historically low levels, the 3 and 5yr at 57% and 67% respectively being well below their five year averages. This suggests that this part of the curve is the most vulnerable to a correction should the Fed decide to act sooner than later in raising short term interest rates.

Paradoxically, the unprecedented municipal rally is taking place on the foreground of multiple credit events that may - upon their resolution - redefine the perception of bondholder risk with respect to obligation strength, the role of bond insurers, issuer exposure, and the manner in which repayment disputes are adjudicated. Though there may be precedent setting outcomes in all of the current cases of distress/bankruptcy, the more illustrative conclusions will be those out of Detroit and Puerto Rico as the parties involved determine the ultimate "winners" and "losers" of the restructuring processes.

High-Yield Bonds

The high-yield market inched higher this week in light trading. The Merrill Lynch BB/B cash pay constrained high-yield index was up 0.15% for the week as the option-adjusted spread widened by 2 basis points and is now 22 basis points tighter for the month of August. Positive flows into high-yield mutual funds continued as inflows of $672 million were reported on the week. The new issue market will remain closed until after the Labor Day weekend and as expected no new issue was priced this week. The inflows and lack of new supply have helped to replenish cash balances and have provided a firm bid to the market.

While the robust inflows into the high-yield market has helped to drive the high-yield market higher and tighter this week, many accounts have let their cash levels build in anticipation of the $40 billion in new issue expected in September. Investment banks are being tight-lipped about what deals are slated to price in September, but one possibility is the funding of Burger King Worldwide's recently announced merger with Tim Hortons. The debt financing for the transaction is expected to consist of a $6.75 billion term loan along with a $500 million revolving credit facility. There will also be $2.25 billion in senior secured second-lien notes as well as $3 billion of preferred equity financing being provided by Berkshire Hathaway.


Global Bonds and Currencies

Major non-US sovereign bond markets ended flat to slightly firmer in the past week, as the worsening conflict between Russia and Ukraine overshadowed a better-than expected Q2 US GDP reading and encouraged a renewed flight to quality. In Europe bonds were also supported by declines in French manufacturing confidence and German consumer sentiment and by slowing euro-area inflation and high unemployment figures. Ten-year Bund yields were about 5 basis points lower on the week while Gilts finished almost unchanged, set back in relative terms by an improvement in UK consumer confidence in August. Peripheral sovereign bond spreads over Bunds were stable as low inflation numbers increased expectations of further monetary stimulus action by the European Central Bank (ECB).

In currency markets, the US dollar was mixed against the major crosses. It rose against the euro, as euro remained under downward pressure from the worsening regional economic data and prospects on additional ECB action. The dollar was almost unchanged against Sterling, as the improving UK confidence data underscored the case for the Bank of England to raise interest rates soon. However, the greenback was down against the Australian dollar following better than expected Australian private capital expenditure data.

Emerging-Market Bonds

Emerging market dollar-pay spreads were flat at 281 basis points over US Treasuries, while local yields fell to 6.52%. Currencies were mixed against the US dollar; the Brazilian real (+1.2%) and Turkish lira (+0.9%) gained, while the Chilean peso (-2.0%) and Russian ruble (-1.8%) fell.

Markets focused on a meeting between Russian President Putin and Ukrainian President Poroshenko, along with regional mediators, geared at de-escalation of the military conflict in Eastern Ukraine. While each side publicly stated the desire to reach a ceasefire, it appeared few substantive agreements were reached. The day following the meeting, Poroshenko made fresh accusations that Russian troops were fighting along with rebels in Ukrainian territory.

In Turkey, the central bank held its policy rate steady at 8.25%, against expectations of a 25 basis point cut. However, officials lowered the overnight lending rate by 0.75% to 11.25%, indicating a continued easing bias. The National Bank of Hungary broke a streak of 24 consecutive monthly rate cuts by holding the base rate at 2.1%, while noting expectations for low inflation and excess capacity. In Israel, monetary authorities surprised markets with a 0.25% cut, bringing the policy rate to a record low of 0.25%. Officials are concerned that a strong domestic currency has eroded export competitiveness, while growth has been weak.

The Philippines reported second quarter GDP growth at 6.4% year-over-year, above expectations and higher than the 5.6% growth rate in the first quarter. Manufacturing and exports were the strongest contributors to the faster pace of expansion.

Emerging market debt funds saw inflows of $0.5 billion, skewed towards local currency funds.



Date Report Consensus Last
9/2 (US) ISM Manufacturing 57 57.1
9/3 (EC) Retail Sales YoY 0.90% 2.40%
  (CA) Bank of Canada Rate Decision 1.00% 1.00%
  (US) U.S. Federal Reserve Releases Beige Book -- --
  (JN) BOJ 2014 Monetary Base Target -- ¥270T
  (US) Total Vehicle Sales 16.50M 16.40M
9/4 (UK) Bank of England Bank Rate 0.50% 0.50%
  (EC) ECB Main Refinancing Rate 0.15% 0.15%
  (EC) ECB Deposit Facility Rate -0.10% -0.10%
  (US) ADP Employment Change 215K 218K
  (US) Initial Jobless Claims 298K 298K
  (US) ISM Non-Manf. Composite 57.2 58.7
  (GE) Industrial Production WDA YoY 0.60% -0.50%
9/5 (EC) GDP SA YoY 0.70% 0.70%
  (US) Change in Nonfarm Payrolls 220K 209K
  (US) Unemployment Rate 6.10% 6.20%



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