Week ending October 31, 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 7:10 a.m. PDT
to Date (12/31/13 -10/31/14)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/13 -10/30/14)
High Yield Index
Morgan EMBI Global Diversified
||(EC) M3 Money Supply YoY
||M3 growth masked continued declines in credit extended to the private sector (-0.6% YoY). Deposits of nonfinancial corporate deposits grew at 5.8% since last year
||(US) Durable Goods Orders
||Durable goods orders came in weaker than expected, as orders for civilian aircraft fell 16%. Ex. transportation, a 16.6% decline in communication equipment orders pushed core orders to -0.2%
||(US) S&P/CS Composite-20 YoY
||Home prices dropped -0.2% on the month but are still increasing year-over-year. August was the fourth straight monthly decline
||(US) Fed QE3 Pace
||(US) GDP Annualized QoQ
||(JN) Natl CPI YoY
||Excluding the effects from the April VAT tax hike, inflation in Japan rose only 1.1% YoY. The adjusted core CPI rose only 0.6% since last year
||(US) PCE Core YoY
||Core PCE rose at the same annual rate as it has since May. Stable increases in services (2.2% YoY) pulled falling durable goods prices (-2.3% YoY) higher
||(US) Univ. of Michigan Confidence
||Consumer sentiment was a bit better than expected as consumers' assessments the economic outlook improved
Wednesday inaugurated a test of the theory we've heard most over the last six years: Treasury bond yields are ONLY where they are (i.e., "artificially low") because of Fed money printing and bond buying. Treasuries are a "bubble" that will burst once the Fed stops buying. One famous bond manager asked rhetorically: "Who will step in when the Fed steps away?" Another wondered, "Who will finance the US budget deficit if the Fed is not buying bonds?"
On account of these fears, we welcomed the results of the FOMC's October meeting. Aside from reporting that "market-based measures of inflation compensation hav[ing] declined somewhat" (a key concern for central bankers as we highlighted last week) and re-iterating that a "considerable time" remains before the first rate hike, the Fed ended their QE3 asset purchase program as most investors expected. While technically the Fed will continue buying bonds to maintain the current size of its balance sheet ($4.4 trillion), this is the way QE ends, not with a bang but a whimper.
A whimpering end to the largest asset purchasing program in U.S. history? That's right, no hyper-inflation, no 5% Treasury yields, no cataclysmic equity market selloff, failed Treasury auction or US dollar debasement. The US economy hardly noticed the incremental slowing of asset purchases in 2014. As we learned in this morning's first read on Q3 US GDP, if you look through the noise in the quarterly reports, annual GDP growth remains on track for 2% this year and has averaged 2.2% year-over-year on quarterly basis since 2010. Payrolls, too, are growing at 2% year-over-year, and inflation has not budged from a steady 1.5% year-over-year rate.
As far as experiments go in the economics world, the end of QE is as close as we can come to a lab experiment. We think it shows that the theory we've heard about most in the last 6 years was flat out wrong. What we think investors will realize is that QE was not all it was chalked up to be. The US economy will grow without a central bank buying its own government's buying bonds. Virulent inflation is not just around the corner. Instead, inflation could be "sticky" below the Fed's target in the near-term. And US Treasuries, not to mention corporate bonds and equities, remain an attractive destination for investors all over the world. As a result, the dollar, instead of being debased, looks like it has found its footing and should continue to gain strength. Finally, for bond buyers, low interest rates reflect low inflation, moderate growth, and the growth in global savings more than they do just the machinations of central banks.
The US rates market came under pressure this week on a more hawkish than expected FOMC statement, continued strength of risk assets and supply. Post Fed, the curve hyper-flattened with the spread between the 30-year bond and 5-year note moving approximately 10 basis points flatter in minutes. The 10-year yield is currently 2.34%. Despite the official announcement to end QE3, the long-end has rallied from pre-FOMC levels.
This move is somewhat counter intuitive to the question of how the long end will absorb record Treasury issuance and massive long end corporate supply (global deflation expectations winning out?). As context for the Fed's balance sheet, MBS reinvestment is currently approximately $20 billion per month depending on prepayment while there is no Treasury reinvestment until February 2016 as the Fed sold all less than 3 year holdings during "Twist".
Another important announcement out of the Fed was the Reverse Repo facility's rate will vary from 3 basis points to 10 basis points for the remainder of the year and will offer an additional $300 billion that would get over the year end squeeze. This represents a total of $600 billion total liquidity that could be drained from the system. The Treasury auctioned a package of $99 billion of 2-year, 5-year and 7-year notes this week with both the 5 and 7 year clearing wide of pre-auction level. Timing of the auction in relation to economic data and the Fed statement along with the lack of specialness in repo created the headwind.
The U.S. Equity Market rallied for the second consecutive week on better than expected economic data and strong corporate earnings. Despite the Fed officially announcing the end of their asset purchase program, economic data releases continue to suggest economic expansion. Domestic stocks and other risk-assets were provided with an additional boost as Japan surprised investors by announcing further stimulus measures and higher equity allocation targets for their public pension funds. The S&P 500 index closed the week up approximately 2.6%, back near their life highs. The Dow Jones Industrial Average and NASDAQ Composite indices both closed the week up 3.3%. The higher beta small-cap stocks outperformed large-cap stocks. In terms of style, large-cap growth stocks outperformed large-cap value stocks. The best performing sectors were health care and financials, while the worst performing sectors were materials and energy.
In earnings news, this quarter is turning out to be better than expected. Out of 363 companies in the S&P 500 index that have reported quarterly results, 80% have topped earnings estimated while 59% have beaten sales estimates. In fund flow news, Lipper reported that U.S. based equity mutual funds saw redemptions of $947 million for the week.
Investment grade primary issuance was just shy of expectations of $20-25 billion for the week at roughly $19 billion. During the week, Treasury yields drifted up as earnings reports have had a generally positive tone and consumer confidence came in at the highest level since 2008. One notable deal this week was a tap deal issued by Liberty Mutual Group Inc., which issued $300 million in one 30-year tranche. The deal was nearly five times oversubscribed, and tightened from a spread of 200 to 180 basis points from price talk to final pricing, which was the level it was trading at before the tap. It tightened an additional two basis points on the break.
This week saw the lowest trading volume in investment grade corporates during the month of October, as market participants awaited the FOMC meeting and new issue slowed down. Spreads stayed mostly flat with a bit of widening when the Fed announced the official end of quantitative easing. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +117, flat on the week. Overall, Senior Financials were three tighter, Sub Financials two tighter, Metals/Mining widened by 14 on commodity weakness, gold breaking through 1200 and continued strength of the US dollar. Media, Industrials, Tech were all unchanged and Healthcare was two tighter.
Agency mortgages performed well relative to Treasuries as interest rates edged higher. No surprise from the Federal Open Market Committee (FOMC) meeting fueled buying of mortgages. The Federal Reserve ended its quantitative easing program but still plans to reinvest portfolio run-off back into agency MBS. Market participants played down stronger economic reports as inflation signals were benign.
As volatility fell, agency pass-through spreads compressed three-to-five basis points with low premium 30-year MBS securities leading the outperformance. In the agency programs, Ginnie Mae mortgages bested conventionals on robust commercial bank and foreign investor buying. In commercial MBS, a balanced pipeline calendar of conduit, single borrower, and single family rental was well received by the market. The latest single family rental CMBS floater deal, issued by Blackstone/Invitation Homes is in the market at Libor+120 basis points for the AAA-rated class. According to Freddie Mac, the primary mortgage rate rose to 3.98% from 3.92%. As for the FNMA 30-year current coupon, the spread versus 10-year Treasury tightened two basis points to 68 bps versus the ten-year Treasury.
The DJIA is back to all-time highs this morning. What a difference two weeks can make! Most ABS issuers had been cautious to approach the marketplace, but the world is a better place now and issuers are in queue for next week. There are even three first time ABS issuers including a Hawaii rate reduction bond, a Bank of the West prime auto deal, and the NextGear dealer floorplan transaction. CarMax is also getting ready.
Due to the combination of market conditions and dealers reducing balance sheets going into the end of the month, secondary trading had been soft, especially on the bid-side. Eyeing much smaller inventories and firming of offering levels this morning, the ABS market is poised for tighter spreads in the near future. Opportunities had been available and accounts with cash inflows were able to capitalize on the recent market weakness.
The interest in munis from street dealers began to strengthen this week after softening much of last week. However, it still remains noticeably softer as investors remain cautious of market volatility and the increase in rates over the last few weeks. This also reveals itself in the modest $41million in municipal bond inflows last week compared to the $250 million weekly average for the year. With sellers not seeing the strong bids they've grown accustomed to, there seems to be a disconnect in the secondary market resulting in a market that has simply tracked the broader Treasury market over the last week.
Municipal rates mirrored the Treasury rate reaction to the FOMC statement on Wednesday; yield curve steepening through 10 years and a flattening further out. Muni/Treasury ratios remain relatively unchanged with the exception coming in the 2-year spot as the 2-year Treasury moved 7 basis points higher while the municipal spot remained unchanged. The ratio moved from 92% to 73% week over week.
A healthy $6 billion new issue calendar this week is dominated by a $1.63 billion non-rated New York Liberty Development Corporation deal to fund the 3 World Trade Center construction project. The other deals to note are a $400 million Illinois State Toll Authority and $350 million California Earthquake Authority. New issues continued to see strong demand and each deal was re-priced to lower yields.
The high-yield market moved higher again this week, albeit at a slowing pace, as the Merrill Lynch BB/B cash pay constrained high-yield index was up 0.04% for the week and spreads tightened by five basis points. Cash continues to flow into the asset class with a net inflow of $1.57 billion for this week on the heels of a $1.7 billion positive flow last week. The rally in high-yield that began two weeks ago has continued as equities have rallied on positive domestic economic news as well as better than expected third-quarter earnings reports. Expectations for a more stable investing environment were reinforced by upbeat comments from the Fed on Wednesday over prospects for U.S. growth, while vowing to continue to keep interest rates low for a "considerable period".
One factor in the strong performance of the high-yield sector of late is the reduction of dealer holdings of high-yield debt. Dealer inventories have been depleted by investors buying as well as the investment bank's desire to reduce the amount of their holdings of speculative-grade rated securities ahead of Federal Reserve mandated stress tests. The dealer holdings of non-investment grade corporate bonds that were released last week by the New York Fed showed a record decline of $4.30 billion to a record low of $2.0 billion for the week ending October 15th. The range of the 22 primary dealer holdings for this category has ranged from $4.80 billion to $8.40 billion since April of 2013 when this data began being disseminated.
Global Bonds and Currencies
European government bonds ended the week firmer as market participants anticipated the outcome of the FOMC meeting on Wednesday and betted on the likelihood of an interest rate hike next year. Most European bond markets saw little change early in the week after the results of the ECB's asset quality review, published on Sunday, generally served to reassure investors about the strength of the Euro-zone banks' balance sheets. The exception was Italy, whose banking system was shown to be the least adequately funded in the Eurozone. As a result, Italian bonds sold off early in the week, but recouped all of these losses and make fresh gains by Friday after a five-year debt auction attracted good demand. In all, ten-year Italian government yields finished the week 17 basis points lower. Spanish spreads were relatively stable, while ten-year Bund yields finished 3 basis points lower, supported by a fall in German business confidence and an unexpected drop in Euro-zone consumer prices.
Long-dated UK Gilts came under supply pressure due to a Â£4 billion ultra-long auction on Tuesday. Ten-year rates finished about 3 basis points higher after UK retail sales exceeded consensus forecasts. However, the shorter end of the curve saw little change.
In currency markets, the US dollar gained against all major crosses after the Federal Reserve announced the end to its quantitative easing programme on Wednesday. The yen reached a six-year low against the greenback on Friday after the Bank of Japan unexpectedly decided to extend its monetary stimulus in a further effort to tackle deflationary pressures. The Euro weakened after inflation in the Eurozone remained well below ECB's target and German retail sales undershot expectations. Sterling and the Australian dollar were little changed on the week.
Emerging market dollar-pay spreads tightened nine basis points to 299 over US Treasuries, while local yields fell modestly to 6.46%. Emerging market currencies showed mixed performance against the US dollar with depreciation in the Indonesian rupiah (-0.6%) and Thai baht (-0.6%) against appreciation in the Brazilian real (+4.1%) and Turkish lira (+1.7%).
Brazilian President Dilma Rousseff won re-election by a narrow margin, securing 51.6% of the vote against 48.4% for opposition candidate AÃ©cio Neves. Markets initially reacted poorly to Rousseff's victory given Brazil's weak economic trajectory during her tenure, but later took solace that the closely split result could lead to more pragmatic policy going forward. Following elections, and in light of inflation that has stayed near the high end of the target, Banco Central do Brasil surprised markets by raising the Selic rate 25 basis points to 11.25%.
Following several rounds of negotiations, a deal was struck to maintain gas supplies from Russia to Ukraine through the upcoming winter. The arrangement was brokered by the European Commission, as Europe sought to avoid gas supply disruptions experienced in the past. In other Russia news, the central bank hiked its key rate by 150 basis points to 9.5%, exceeding market expectations. Officials are facing multiple challenges as inflation has risen on the back of anti-Russian sanctions, oil prices have fallen sharply, and the ruble has been under heavy depreciation pressure.
Ukraine's parliamentary elections appeared to show a pro-Western bias, with President Poroshenko's party and the People's Front of Prime Minister Yatsenyuk securing the most votes. The task has turned to forming a coalition and determining key ministerial posts. The election took place against a backdrop of still-high tensions with the rebel-controlled Donetsk and Luhansk regions, which seek to hold independent parliamentary elections soon.
In Uruguayan elections ruling party candidate TabarÃ© VÃ¡zquez, who served as president from 2005-2010, appeared the favorite to become the country's next president. While Vazquez did not clear the 50% threshold to avoid a November 30 runoff, he is expected to win in the 2nd round.
In other rate setting meetings, Banco de Mexico held rates at 3%, with inflation somewhat elevated and growth still recovering. Matching consensus, Colombian officials maintained rates at 4.5%, balancing robust domestic growth with a weak external environment. Hungary's central bank left its benchmark rate flat at 2.1% given persistent disinflation. In Israel, authorities left rates unchanged at a record low 0.25%, also amid a falling inflation environment.
Emerging market debt funds attracted an inflow of $250 million for the week.
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||(US) ISM Manufacturing
||(EC) PPI YoY
||(RU) PPI YoY
||(EC) Retail Sales YoY
||(US) ADP Employment Change
||(US) Markit US Composite PMI
||(US) ISM Non-Manf. Composite
||(UK) Halifax House Price 3Mths/Year
||(UK) Industrial Production YoY
||(UK) Manufacturing Production YoY
||(UK) Bank of England Bank Rate
||(EC) ECB Main Refinancing Rate
||(EC) ECB Deposit Facility Rate
||(US) Initial Jobless Claims
||(US) Nonfarm Productivity
||(GE) Industrial Production WDA YoY
||(US) Change in Nonfarm Payrolls
||(US) Unemployment Rate