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Payden & Rygel: Weekly Market Update
Weekly Market Update

Week ending October 24, 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
1 Yr Ago
Dow Jones Ind. Avg. 16,676 16,380 16,577 15,509
S&P 500 1,953 1,887 1,848 1,752
Nasdaq 100 4,451 4,258 4,177 3,929
The Russell 2000 1,117 1,082 1,164 1,119
DJ STOXX Europe 327 319 328 320
Nikkei Index 15,292 14,533 16,291 14,486
MSCI EM Index 427 424 415 416
Fed Funds Target 0-0.25% 0-0.25% 0-0.25% 0-0.25%
2-Year US Treasury Yield 0.38% 0.37% 0.38% 0.31%
10-Year US Treasury Yield 2.25% 2.19% 3.03% 2.52%
US$ / Euro 1.27 1.28 1.37 1.38
US$ / British Pound 1.61 1.61 1.66 1.62
Yen / US$ 107.91 106.88 105.31 97.28
Gold ($/oz) $1,233.16 $1,238.32 $1,205.65 $1,346.78
Oil $83.02 $82.75 $98.42 $96.71
*Levels as of 7:10 a.m. PDT

Year to Date (12/31/13 -10/24/14)
Dow Jones Industrial Avg 0.60%  
S&P 500 5.63%  
NASDAQ 6.57%  
Russell 2000 -4.02%  
MSCI World Index -0.07%  
DJ STOXX Europe 600 (euro) -0.39%  
MSCI EM Index 2.85%  
Year to Date (12/31/13 -10/23/14)
90 Day T-Bill 0.05%  
2-Year Treasury 0.89%  
10-Year Treasury 9.26%  
ML High Yield Index 4.65%  
JP Morgan EMBI Global Diversified 9.35%  
JP Morgan Global Hedged 6.21%  


Date Report Survey Actual Prior Details
10/21 (US) Existing Home Sales MoM 1.00% 2.40% -1.80% Existing home sales rebounded on the month as the share of purchases by first-time buyers was 29%, the share of all-cash buyers was 24%, and the share of investor purchases was 14%
10/22 (US) CPI YoY 1.60% 1.70% 1.70% See below
10/23 (UK) Retail Sales Ex Auto YoY 3.40% 3.10% 4.50% Retail sales fell marginally on the month as clothing stores saw sales fall 7.7%. Others pointed to poor weather as a dampening effect. However, positive sales growth year-over-year is a positive
  (US) Leading Index 0.70% 0.80% 0.20% The index of leading indicators rose on the month, beating the consensus. In particular, a steep yield curve, low jobless claims, and strong ISM contributed to the gain
10/24 (UK) GDP YoY 3.00% 3.00% 3.20% Economic output in the United Kingdom rose in line with expectations. Service output contributed the most to monthly improvement
  (US) New Home Sales MoM -6.80% 0.20% 18.00% New home sales held stable on the month, despite downward revisions to prior months. Month's supply was unchanged at 5.3 months


"What should I be for Halloween?" The text message question flashed on my smart phone while I sat in a meeting earlier this week.

"Go as inflation expectations."

My brother, a high school teacher with little to no interest in financial markets, shot back: "Huh?"

So I explained: "Falling inflation expectations always seem to be enough to frighten the world's most powerful central bankers into action. Try it out on your students and colleagues."

Needless to say, he ignored my advice and chose another costume.

But the point stands: as what we at Payden like to call "the Halloween FOMC meeting" approaches next week, disinflation haunts central bankers.

In the US this week we learned that core inflation dipped to 1.7% on a year-over-year basis in September. Since this measure produced by the Bureau of Labor Statistics tends to overstate inflation in the Fed's preferred gauge by 50 basis points, we expect central bankers to raise a few eye brows. Add to that the fact that the only major component of the index that is really "inflating" is the housing component. CPI ex food, ex energy and ex housing is up just 0.9% over the last year. Further, we don't think rising monthly rents and disinflating everything else will be the inflation mix the Fed was hoping for.

Importantly, this is not a US story. Of the 46 countries with "inflation targets" 30 are experiencing below target inflation. The vast majority of countries on Earth have inflation below 3%. But it isn't just inflation today that is low. Expectations of future inflation--a key determinant of future inflation in macro models employed by the world's macro technocrats--have also declined significantly since the summer. A quick look at inflation expectations out of the US and euro area provide plenty of "boo" for policymakers. US CPI swaps fell from 2.9% at the beginning of August to 2.6% today. Euro area CPI swaps fell from 2.1% to 1.8% over the same time period.

Cautiously, some of our traders tell us, "Well it's just oil pushing inflation expectations lower," or "the stronger dollar only pushes inflation lower today, not in the future." To which we hastily reply: "It matters less what's behind the move than the move itself." Once ingrained, lower inflation expectations prove mighty difficult to dislodge. Japanese policymakers have wrestled with this fact for nearly two decades. But, now, it's no longer isolated to an island nation in the Pacific.

More important for investors, though, falling inflation expectations often precede monetary policy shifts by spooked central bankers. In the summer of 2010, falling inflation expectations prompted talk of QE2, which eventually arrived at the Halloween FOMC meeting. In the summer of 2011, right after QE2 ended, the Fed unveiled Operation Twist as the economy stalled, jobs disappointed and, yes, inflation expectations tumbled. In 2012, a fall in inflation expectations presaged QE3's launch and the adoption of the famous Evan's Rule (interest rates stay at zero at least until we see 6.5% unemployment, and so long as inflation stays below 2.5%).

So what's different in 2014? In our view the US economy in particular is in much better shape. We've experienced nearly four years of steady job growth. That said, global growth, trade, and inflation look worse. Perhaps the data are not enough to drag down the US economy but the impact on US inflation is worth noting. As the world's foremost inflation-targeting central bank, global disinflation and falling inflation expectations will not go unnoticed by the Fed: whether they choose to acknowledge the backdrop at the meeting next week or prefer to skip by and hope for a revival (inflation expectations have actually bounced up a bit this week, for example) by the December meeting is another question.

Long telegraphed to end at the October meeting, prolonging QE3 is perhaps a low risk, easy commitment that would prove the central bank really is data dependent and worried about both sides of the dual mandate. At the very least, acknowledgement of persistently low US and global inflation could jump off the page in the 900+ word post-meeting policy statement. Any hints of an imminent move toward tighter policy should be absent--an important departure from market expectations/worries of just a few weeks ago.

As we approach the "Halloween FOMC meeting," watch out for central bankers frightened by inflation expectations.


Treasury Bonds

The US rates market finished the week higher in yield after risk assets staged a rebound from the large risk-off move seen last week. Initially there was a lack of selling despite big moves higher in stock markets and much of the selling was catch up after the CPI data was behind us. The 10-year note is currently yielding 2.26% or about 40 basis points higher than the intraday lows from last week. Repo rates were wider this week possibly suggesting that some market shorts have been squeezed out.

The Stone & McCarthy investor survey showed asset managers are still short but less so on the week with the duration-weighted benchmark at 98.8% vs. 98.5% prior (longest since August 2013). Liquidity remains thin with the willingness of dealers to warehouse off-the-run issues decreasing as we approach year end. The Treasury auctioned $7 billion re-opened 30-year TIPS (approximately $22 billion in 10-year note equivalent duration) at a less than 1.00% real rate. Although the auction tailed, the demand from indirect bidders was high despite declining inflation expectations here and in Europe.

Large-Cap Equities

The U.S. Equity Market rallied for the first time in five weeks on strong corporate earnings and better investor sentiment. Despite headlines dominated by Ebola fears, the S&P 500 index continued to recover from its month-long sell-off which saw the index fall nearly 10% from its highs. The recovery has been quick and unabated as the index has surged a little more than 7% in the last eight trading sessions. The S&P 500 index climbed approximately 3.6% for the week, while the Dow Jones Industrial Average added 2.1%. The NASDAQ Composite bested its peers after jumping 4.8% for the week. Large-cap stocks outperformed small-cap stocks. In terms of style, large-cap growth stocks outperformed large-cap value stocks. All sectors closed higher for the week led by health care and info tech. The worst performing sectors were telecom and energy.

In earnings news, companies in the S&P 500 index continued to post better than expected quarterly results. Out of 208 companies that have reported so far, 79% have topped earnings estimates while 61% have topped sales estimates. One notable company that reported this week was Apple, the world's most valuable listed company. The company surprised to the upside after reporting 4th quarter earnings of $1.42 per share and revenue of $42.1 billion, which beat estimates of $1.31 per share and $39.85 billion respectively. The company attributed the strong quarter to better than expected iPhone and Mac sales. In fund flow news, Lipper reported that U.S. based equity mutual funds took in $1.05 billion for the week, bouncing back from last week's $1.51 billion in redemptions.

Corporate Bonds

Investment grade primary issuance met expectations of $20-25 billion for the week, with roughly $25 billion tapping the market. Volatility in the market is still very high, with more days than not this week experiencing an equity swing of greater than 1%. Equities are finally seeing gains after large losses in the first half of October, supported by recent favorable international data and generally positive earnings reports. One notable deal this week came from Verizon, which issued a total of $6.5 billion across seven, ten and twenty year tranches. Although the deal initially planned to include a five year tranche as well, the issuer decided to pull it, despite heavy demand for it. In total, the deal was three times oversubscribed and each tranche tightened by 15 basis points from initial price talk, only to widen five basis points on the break, now trading flat on average to where they priced.

Investment grade corporate spreads saw some movement this week when the ECB suggested purchasing corporate bonds to add to their balance sheet, resulting in several basis points of spread tightening. This reversed when the market realized that there was no actual plan behind these words, losing some (but not all) of the gains taken on the news. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +117, three tighter on the week. Overall, Senior financials were four tighter, Sub financials six tighter, Metals/Mining tighter by five, Media names are four wider on the back of the Verzion deal which caused clients to sell names that have outperformed lately possibly making room for potential issuance. Industrials tightened by two, Tech and Healthcare were both three tighter.

Mortgage-Backed Securities

Calmer heads prevailed as rates drifted higher in orderly trading. Mortgages outperformed across the coupon stack with spreads firmer by two-to-four basis points. Last week's 'flash' rally didn't last long enough to drop mortgage rates below key thresholds. The mortgage refinance index, however, posted a 22% increase with activity levels back to November 2013. Still, a pickup in activity should be short lived as primary mortgage rates remain 'sticky' hovering near four percent. In the programs, Ginnie Mae mortgages rebounded versus conventionals on strong appetite from foreign money managers. The 30-year current coupon narrowed three basis points to 69 basis points versus the 10-year Treasury.

In commercial MBS, another quiet supply week with one conduit transaction in the market boasting 10-year AAA-rated bond at swaps +89 basis points. Agency CMBS settled in at 5 bps wider for the month (on a low base) to 25-to-35 bps versus comparable Treasuries. Blackstone/Invitation Homes announced a $736 million single-family rental floating rate deal. This represent their fourth transaction since accessing capital markets last November.

Asset-Backed Securities

Regulators released their final version of risk retention this week. For CLOs, this rule will go into effect in October 2016, while existing CLOs and those issued prior to October 21, 2016 will be grandfathered. Under the rule, the CLO manager must retain 5% of the deal balance in either a vertical or horizontal slice, or the CLO underwriter(s) can retain 5% of the loan tranche for the life of the loan on an unhedged basis. The latter has already been deemed as unlikely by CLO analysts.

While the rule accomplishes "skin in the game" for CLO managers, it will also likely limit the supply of new issue CLOs. If a CLO manager issues a typically sized $500 million CLO, they will be required to retain $25 million. This could be balance sheet and cost prohibitive for many smaller CLO operations and non-diversified asset managers. As a result, analysts are expecting reduced CLO supply in the coming years, and that translates into lower demand for loans. This means less access to the debt market for the universe of single and double-B rated companies because CLOs currently purchase over half of the leveraged loan new issuance.

Municipal Bonds

Last week's spectacular Treasury-led rally echoed into this week. This week's adjustment took the market back to its "pre-rally" levels. However, though the market gave up most of the gains it took, the sentiment is that investor tolerance for aggressive pricing seems unyielding. Because the impetus behind the yield decline was Treasury driven, and a broader reflection of concerns related to the instability of non-US markets, terrorism, general economic malaise, and fear of pandemics, it is unsurprising that "sticker shock" was no deterrent.

Though the municipal market has sort of been playing by its own rules this year, it was pulled off the sidelines last week and performed in line with the Treasury market, even though slightly underperforming. Another week of a full new issue calendar was partially responsible, as well as less robust fund flows and persistently rich muni/Treasury ratios.

High-Yield Bonds

The high-yield market moved higher this week as equities and other risk assets rebounded from recent weakness. The Merrill Lynch BB/B cash pay constrained high-yield index was up 1.95% for the week as spreads tightened by 58 basis points. The negative tone and sentiment of the past few weeks which pushed the market lower and spreads sharply wider has now turned positive, as the worries over a market selloff have been replaced by fears of missing out on a buying opportunity as inflows surged into the asset class. Supportive comments from the Federal Reserve and the ECB as well as a respite in the onslaught of negative headlines encouraged investors to deploy cash back into high-yield securities. High-yield bond funds took in $1.7 billion this week, split evenly between active mutual funds and ETFs. The tone of the market was in stark contrast to last week's softness as prices snapped back quickly and buyers suddenly found it difficult to get offers on their desired bonds. Newer bonds that had traded lower with the market were especially active as buyers were able to put cash to work via the relative liquidity of recently issued bonds.

New issuance resumed this week after a very brief hiatus due to market conditions. The $4.10 billion that was priced across eight tranches was met with a warm welcome as investors struggled to find offerings in the rallying secondary market. Better quality high-yield has been in high demand of late and so investors bellied up to the bar for the $800 million Ba1/BB+ issuance by Constellation Brands, Inc. The producer and marketer of alcoholic beverages priced a five-year note at a spread over treasuries of 248 basis points to yield 3.875%, and a ten-year note at a spread of 257 basis points to yield 4.75%. There was almost $6 billion of demand in the final order book, and both notes traded higher when freed to trade. The forward calendar currently stands at less than $2 billion and is expected to grow if the market remains receptive to fresh supply.

Global Bonds and Currencies

Major non-US sovereign bond markets sustained some losses this week as overall risk appetite increased and equity markets partially corrected after the previous week's sell-off. European bond markets were also nervous ahead of the results of the ECB's stress test on the Euro-zone's largest banks, which are due to be published this coming Sunday. And the week's Euro-zone data also nudged yields higher - Euro-area manufacturing data and German factory output figures both beat expectations.

Ten-year Bund yields rose about 4 basis points on the week and in the UK, 10-year Gilt yields climbed by 7 basis points as UK Q3 GDP growth data aligned with market expectations, despite the fact that the latest Bank of England policy meeting minutes indicated a rather dovish stance on interest rates. In the European periphery, sovereign government bond spreads over German Bunds tightened following the ECB's purchase of about €1 trillion covered bonds under its asset purchasing programme. Italian and Spanish 10-year yields fell by about 9 basis points on the week.

In currency markets, the US dollar advanced against the Euro and the Japanese yen after the unexpected rise in US CPI. Sterling weakened against all major crosses early in the week after a disappointing retail sales report, but recouped lost ground on Friday on the back of the Q3 economic growth data to finish the week unchanged. The Australian dollar rose slightly on the back of positive economic growth and factory output data from China.

Emerging-Market Bonds

Emerging market dollar-pay spreads tightened to 308 basis points over US Treasuries, as markets recovered following the US equity sell-off, while local yields tightened to 6.48%. Emerging market currency performance was mixed against the US dollar; depreciation was led by the Russian ruble (-2.0%) and the Czech koruna (-2.0%), while the Indonesian rupiah gained by (+1.6%) and South African rand by (+1.3%).

Moody's lowered Russia's sovereign debt rating by one notch to Baa2 citing weakened medium term growth prospects. The ongoing crisis in Ukraine has weighed on Russian growth, creating a negative macroeconomic environment. Meanwhile the decline in oil prices has eroded Russia's FX position, another trigger for downgrade, according to the rating agency. Subsequently Moody's downgraded government related issuer Russian Railways to Baa2, reflecting the weakening credit profile of the sovereign.

China reported Q3 GDP at 7.3% y/y, the slowest pace since Q1 2009, largely due to the slowing property market and tighter monetary conditions. Going forward, Q4 growth is expected to pick up marginally on the back of stimulus measures introduced by Chinese policymakers. Elsewhere in Asia, India announced fuel price deregulation, taking advantage of lower global oil prices. The fuel reforms are expected to remove the bulk of the energy subsidies, which will enhance fiscal management and boost sovereign ratings over the long term. The Central Bank of the Philippines held rates steady at 4% in line with expectations. Lower oil prices have given the central bank some breathing room as inflationary pressures cool.

The Central Bank of Turkey kept rates steady at 8.25%. The central bank noted that the 25% reduction in Brent oil prices have significantly improved the inflation outlook. Meanwhile favorable base effects will support headline inflation in the coming months, while the external backdrop remains challenging.

Emerging market debt funds saw outflows of $0.2 billion, led by local currency and blended funds.

Date Report Consensus Last
10/27 (EC) M3 Money Supply YoY 2.20% 2.00%
10/28 (US) S&P/CS Composite-20 YoY 5.65% 6.75%
10/29 (US) FOMC Rate Decision 0.25% 0.25%
10/30 (GE) Unemployment Rate 6.70% 6.70%
  (US) Initial Jobless Claims 281K 283K
  (US) GDP Annualized QoQ 3.00% 4.60%
  (JN) Natl CPI YoY 3.30% 3.30%
  (JN) BOJ 2014 Monetary Base Target -- ¥270T
10/31 (EC) Unemployment Rate 11.50% 11.50%
  (US) PCE Core YoY 1.50% 1.50%
  (US) Univ. of Michigan Confidence 86.4 86.4

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