Week ending February 27, 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 7:50 a.m. PDT
to Date (12/31/14 -2/27/15)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/14 -2/26/15)
High Yield Index
Morgan EMBI Global Diversified
||(US) S&P/CS Composite-20 YoY
||House prices continued to rise in December, as all 20 cities registered increases. The largest increases were in Denver (1.4%), San Francisco (1.3%) and Seattle (1.2%)
||(US) New Home Sales
||New home sales held steady in January. Net revisions totaled 23k, pushing the three month average to 470k
||(UK) GDP YoY
||UK GDP growth was confirmed at 2.7% YoY. Consumption was softer than first reported and gross fixed capital formation contracted for the first time in two years
||(US) CPI YoY
||(US) CPI Ex Food and Energy YoY
||(US) GDP Annualized QoQ
||Fourth quarter GDP was revised lower as consumption growth was slower than initially reported and as inventories were marked down
Federal Reserve Chair Janet Yellen appeared before the Senate this week to provide her semi-annual update on monetary policy. The biggest news at the hearing was what Yellen lugged along with her: the US government accountability office's audit of the Federal Reserve--just in case anyone was wondering. She held the hefty document up with a wry smile on her face when addressing a question about the Fed's $4.5 trillion balance sheet.
Her overall message was unchanged from guidance expressed previously: "it is unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings." While there are a few other interesting stories (see our note last week), the cagey language shows a central bank trying to wiggle out of self-imposed calendar date constraints. The hope is to avoid a repeat of the "taper tantrum" episode of 2013 when the FOMC does alter the "patient" language in its policy statement.
On that subject, Yellen re-iterated that "the Committee will change its forward guidance" soon but that "it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings." In the coming months, we think market participants would do well to remember her counsel: language modifications in the FOMC's statement "should be understood as reflecting the Committee's judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting."
Rest in peace, forward guidance. Long live data dependency.
Further, an "emergency level" on the federal funds rate seems inappropriate within the context of stronger economic growth (the best 3 quarter stretch for the US economy since 2003) and robust job gains (the best 12 month span since February 2000). The missing component continues to be inflation but Yellen once again--when presented by Senator Chuck Schumer with the opportunity in the Q&A to take a more dovish tact--downplayed inflation's significance, attributing the low level of inflation to "transitory factors."
As such, we continue to think the bar to a higher federal funds rate imposed by low inflation has been lowered.
Importantly, with "a couple of meetings" still on the docket before the June FOMC meeting (the March 17-18 meeting and the April 28-29 meeting), a rate hike at the June is possible if the economic data evolves as expected in the interim.
Treasury yields declined on the week after a rally sparked by Fed Chair Yellen's testimony on Tuesday and month-end duration extension. Dealer desks reported better buying flows in cash Treasuries and stop out buying from hedge fund type accounts right above the 2.00% level in 10-year notes.
The market came off highs on Thursday as duration from the auctions continued to be distributed and large corporate bond issuance, including rate locking, put pressure on Treasuries. German Bunds made new highs (7-year Bund dropped below zero for the first time on record) and peripherals outperformed, as it seems that the interest to buy pullbacks across government bond markets could continue. Core CPI came in slightly stronger than expected causing inflation breakevens to rally with the 5-year breakeven point 13 basis points better on the week.
The Treasury auctioned approximately $44.7 billion worth of 10-year note equivalent duration across 2s, 5s and 7s this week. The 2-year and 5-year auctions were well received with stronger than expected end user demand while the 7-year came slightly wider than the pre-auction level. Both 2s and 5s have been trading very tight in the repo market implying a short base that acted as a tailwind in the auction.
The U.S. Equity Market closed little changed in a relatively quiet week of trading. With Euro leaders approving an extension to the Greek bailout and Fed Chair Janet Yellen signaling no expected imminent changes to the Fed's monetary policy, the removal of these near-term risks sent intra-day volatility and trading volumes lower.
Despite touching new life highs on Wednesday, the S&P 500 index was not able to build on any momentum closing the week unchanged. The NASDAQ Composite and Dow Jones Industrial Average indices were able to fare better for the week after adding 0.5% and 0.3%, respectively. The higher beta small-cap stocks were in favor this week after outperforming large-cap stocks. In terms of style, large-cap growth stocks outperformed large-cap value stocks. The best performing sectors were telecom and consumer discretionary, while the worst performing sectors were energy and utilities.
Investment grade issuance was active in the final week of February and finished well above expectations at $37 billion compared to $20-$25 billion anticipated. The market was ready for more paper after a few weeks of slower issuance so most deals did quite well. Mid single-A rated Kimberly-Clark Corp (KMB) brought a 5-year issue to market on Tuesday and was able to close final pricing at a 40 basis point spread to Treasuries, 15 basis points tighter than initial price talk. This priced well through the Nissan (NSANY) and Chevron (CVX) issues sold on the same day. Nissan is a low Single-A rated company and Chevron is mid AA, yet their 5 year tranches priced at a spread of 55 and 50 basis points respectively. Kimberly-Clark Corp's pricing was largely thanks to the scarcity of KMB paper and small issue size which demonstrates how influential market technicals can be.
In the secondary market, demand continued to push down spreads, finishing the week 14 tighter on the month, and continuing tighter regardless of Treasury volatility. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +122, two tighter on the week. Overall, Senior Financials were six wider, Sub Financials widened by seven. Metals/Mining tightened by five and energy widen by three. Industrials & Utilities were tighter by five and two respectively.
Mortgages underperformed as spreads gapped (five to seven basis points) wider with the Treasury market rally. Recently, pass-throughs have been trading directional with interest rates: widening as rates fall and tightening when the market reverses. This week, investors were unnerved by several lines of text in the FOMC statement that hinted at an eventual pause in reinvestment of agency MBS principal and interest.
In commercial MBS, it has been all about supply with a conduit, SASB (Motel 6), and single family rental (American Homes 4Rent) transaction in the marketing phase. Private CMBS issuance reached USD13 billion this week. As for single family rental MBS, spreads firmed five basis points to 130 spread versus 1-month LIBOR for floating rate offerings. As for conduit CMBS 10-year AAA-rated bonds, spreads remain stable in the swaps + 90 basis point area.
There must be a lot of available ABS cash out there. In another post conference heavy week of new issuance, most classes of each deal cleared at or through initial price guidance. With the success of this week, more issuers are in queue for next week including John Deere and Hyundai auto lease to name a few. Secondary spreads have followed and dealer inventories are starting to thin.
The CLO market has likewise been on a tightening tear, especially in non-AAA. Unlike 2014 with record supply, 2015 new issuance has been more muted, and the yield strategy is in full force by investors. BBB-rated classes for example have moved from the mid-to-high 400s down to the low 400s year to date. On the regulatory front, more and more CLO managers are amending their indentures to become Volker compliant.
Munis underperformed treasuries over the week due to downward pressure exerted by technical forces such as heavy new issue supply, slowing fund flows, and choppy secondary markets prior to the release of FOMC minutes.
After the minutes delivered no new information - except further "patience" - and did not contain anything that indicated a material change in the Fed's outlook, markets rallied 5-7 basis points mid-week. Munis are either simply lagging this reversal in market tone or are bogged down by localized sector issues, which have made it difficult for them to keep up pace. Favorably, this periodic dislocation has made munis more attractive with muni/treasury ratios hovering in the 105-110% territory further out the curve. The next few trading sessions will shed more light on what the underlying factors might be.
With the outlook on muni credit spreads unchanged and stable in the near term, curve shifts will be the primary performance driver as investors attempt to get ahead of Fed action. We anticipate more muni curve flattening by the end of the year - consistent with treasury expectations, though timing will be key. In the shorter term, some volatility is inevitable as the muni market tries to manage localized idiosyncrasies while keeping one eye on broader fixed income trends.
High-yield moved higher again this week as cash flowing into the asset class continues to provide strong technical support. The BofA Merrill Lynch BB/B cash pay constrained high-yield index was up 0.55% week-over-week as spreads tightened by 7 basis points to an option-adjusted-spread of 383 basis points. The BofA Merrill Lynch index BB/B index which excludes utilities and energy was up .51% and was also 7 basis points tighter over the same period for an OAS of 352.
Energy names in general were firm on the week and the trading was more balanced as opposed to the strong rally the sector had experienced earlier in the month on the back of steadier oil prices. Buyers continued to outpace sellers this week as high-yield mutual funds cash balances continued to grow and investors found it increasingly difficult to source bonds. Inflows into high-yield are tracking towards $1.25 billion for the week and would be the fifth consecutive week of inflows. This would bring the inflow total for the five-week stretch to $11.25 billion versus a net outflow of $28.70 billion for all of 2014.
New issue for most of the week had been muted as many market participants were attending a high-yield conference that ended Wednesday. On Thursday four deals announced with possible proceeds of $3.50 billion which would bring the total new issuance for the week to five deals totaling $4.425 billion.
Global Bonds and Currencies
Core European government bonds had a mixed week and finished marginally firmer as anxieties over Greece subsided. Financial markets were slightly cautious earlier in the week as the market mulled over Fed Chairman Yellen's comments. However, the tone improved as Greece reached a tentative agreement with its Eurozone creditors for a four-month extension to its financial rescue package.
Sovereign bond markets across the Eurozone were also supported as investors positioned for the imminent start of the ECB's government bond purchase program. Negative inflation and the prospect of further QE by the ECB helped Germany sell five-year Bunds at a negative yield. Ten-year German government bond yields finished the week lower by about 4 basis points, while Gilts were almost unchanged. Peripheral European government bonds benefited from the perceived reduction in the Euro-zone's sovereign credit risk; Italian, Spanish and Portuguese spreads over German Bund yields all tightened on the week.
In the currency markets, the US dollar strengthened against the euro, the yen and the Australian dollar, supported by the outperformance of the US economy and consequent expectations the Fed will begin raising borrowing costs. The AUD's weakness also reflected growing expectations that the Reserve Bank of Australia will cut its benchmark interest rate further, possibly as its meeting this week.
Emerging market dollar-pay spreads were flat at 359 basis points over US Treasuries, while local yields eased 3 basis points to 6.11%. Emerging market currencies were mixed against the US dollar; the South African rand (+1.2%) and Russian ruble (+1.2%) gained while the Turkish lira (-1.9%) and Colombian peso (-1.8%) declined.
Despite lingering price pressures, the Central Bank of Turkey eased interest rates on expectations of future disinflation. The overnight lending rate was cut 50 basis points to 10.75%, while the policy rate and overnight borrowing rate were each lowered 25 basis points to 7.5% and 7.0%, respectively. In Israel, the central bank surprised markets with an earlier than anticipated rate cut, moving the base rate from 0.25% to a new low of 0.10%. Officials are concerned with relative currency strength as economic activity has been muted while inflation runs well below target.
Colombian officials held rates at 4.5%, balancing above-expected inflation readings against the slowing domestic economy. The National Bank of Hungary also kept the policy rate steady at 2.1%, but indicated it was ready to ease at its next meeting pending further disinflation.
Amid continued economic deterioration, Russia's credit rating was downgraded one notch by Moody's to Ba1, making it the second agency to move below investment grade. Moody's also cut the rating on Petrobras, Brazil's government-controlled oil company, by two notches to Ba2. Petrobras has been mired in a major corruption scandal that has led to liquidity constraints.
Emerging markets debt saw inflows of $1.1 billion, the best weekly reading since May 2014.
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||(US) PCE Core YoY
||(US) ISM Manufacturing
||(US) ADP Employment Change
||(CA) Bank of Canada Rate Decision
||(US) ISM Non-Manf. Composite
||(UK) Bank of England Bank Rate
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