Week ending September 12, 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.
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to Date (12/31/13 -9/12/14)
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|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/13 -9/11/14)
High Yield Index
Morgan EMBI Global Diversified
||US job openings rose again in July to 4.673 million--the highest level in this cycle and a sign that the labor market continues to heal
||US retail sales rose 0.6% for the month of August after turning in a flat reading in July. Excluding autos and gasoline sales, retail sales rose 0.5% for the month. The retail sales data bodes well for consumer spending in Q3.
Financial markets hang on two words as we approach next week's Federal Open Market Committee (FOMC) meeting: "considerable time."
Since December 2012, FOMC policy statements featured the phrase that "it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends." As the end of the asset purchase program nears (slated for October), the market naturally ponders the central bank's next move. We think it's appropriate for the FOMC to ditch the phrase, but we do not think that doing so heralds a material shift in the timing of interest rate changes--though global financial markets are hypersensitive to even minor changes.
Indeed, at her inaugural press conference in March, Chairwoman Janet Yellen learned just how sensitive the market is to the two words. When asked about the time expected to elapse during a "considerable time," Ms. Yellen stammered, "this is the kind of term--it's hard to define... it probably means something on the order of around six months or that type of thing. But, you know, it depends." Ten-year Treasury note yields rose 10 basis points on the day as the market did the math. If six months equals "considerable time" and if quantitative easing (QE) ends in early October, then the first rate hike comes in March 2015.
The March episode highlights a key problem with the "considerable time" phrase: it's a calendar-based signaling tool that the FOMC allegedly wants to avoid as a data-dependent central bank. It seems, then, that a change in language is due. It also makes sense to make the change next week as QE is slated to end in October anyway, and the October FOMC meeting will not feature a press conference in which the Fed Chair could explain the decision in more detail than provided in the 900-word FOMC statement.
Yet simply removing the "considerable time" language doesn't mean that the future is more clear or that a rate hike is more imminent. Instead, the FOMC will likely take the opportunity to change the statement language to emphasize that the fed funds rate will rise once their economic targets have been achieved. While growth rebounded in Q2, the full-year 2014 rate of economic growth is still tracking to be lackluster once more. Slack in the labor market looms large. Inflation, contrary to the squawks of the hawks, has not been a problem for years. If growth and inflation disappoint the removal of two words from the statement won't etch a policy shift in stone.
But, for investors, even a seemingly minor language change matters. While we think that QE and forward guidance policies were for the real economy (i.e., job growth) as homeopathic remedies are to an ailing medical patient, for financial markets the statement language provided a form of comfort. Central bank-provided comfort to investors in making their investment allocations, and, in turn reduced volatility and put a lid on interest rates. Now, as the end of QE nears and language changes seem justified, this is a recipe for renewed volatility in asset markets. The risk: neither investors nor central bankers learned from the "Taper Tantrum" episode of 2013 what central banks were really providing global financial markets.
Treasury yields continued to move higher this week after the release of a white paper by the Federal Reserve Bank of San Francisco, which focused on low volatility across financial markets and it may signal that investors are underestimating potential increases in interest rates. Investor concerns surrounding Fed policy normalization returned to the market as investors setup for next week's FOMC minutes and focus on potential changes to the "considerable time" language regarding the Fed Funds rates. The Treasury auctioned 3-year, 10-year and 30-year notes with solid demand metrics however the supply still weighed heavy on already shaky markets.
The US equity market closed lower for the week in a relatively quiet week of trading. The weekly loss was the first in six weeks as the focus remained on global central bank policies and geopolitical uncertainties. Muted price action on the S&P 500 index suggests investors have a low conviction on a directional bias. The S&P 500 index fell 0.7%, while the Dow Jones Industrial Average index slid 0.5%. The NASDAQ Composite bucked the trend after closing the week unchanged. 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 info tech and financials, while the worst performing sectors were energy and utilities.
In fund flow news, Lipper reported that US based equity mutual funds took in $105 million for the week, bouncing back from last week's large redemption.
The second trading week in September matched new issue expectation, with over $27 billion pricing between Monday and Wednesday. One notable deal this week was a contingent convertible (CoCo) issue brought by HSBC. This was the first CoCo issued since the Societe Generale (SOCGEN) issuance on June 19th. The deal had two US tranches totaling $3.75 billion. Both tranches were six times oversubscribed and priced at $100 with spreads of +385 to Treasuries on each. On the break they traded up with the 5-year opening up $100.75/$101 and the 10-year opening $101.375/$101.75. Currently, the 5-year is +$0.75 (-19 basis points) and the 10-year is +$1.75 (-30 basis points).
Between the influx of supply in the new issue market, currency volatility, and encouraging US data, corporate spreads followed the treasury market lower over the week. Corporate Index Option-Adjusted Spread (OAS) finished the week at +104, two wider on the week. Overall, financials widened by two (banks +3, insurance +1); industrials widened by two (basic materials +4, capital goods +2, telecom +1, consumer cyclical +1, consumer non-cyclical +1, energy +4); and utilities widened by one.
Mortgages outperformed Treasuries as market participants welcomed higher yields and a move away from key refinance thresholds. Yield levels have moved back to the middle of the longer-term trading range and lower dollar prices present sideline investors an opportunity to buy assets at cheaper prices. Agency mortgages also received a boost from a slower-than-expected prepayment report and light supply from originators as stable primary mortgage rates have not led to a pickup in refinance activity. Market complacency remains. Within the agency mortgage programs, Ginnie Mae bonds bested conventionals and higher coupon mortgages held their own compared to lower coupons. Most agency mortgage products outperformed their comparable Treasury hedges. In other markets, a heavy supply calendar in Commercial MBS was already priced into valuations as spreads on recent offerings have not widening with deal announcements. The latest fixed rate conduit transaction, backed by a diversified portfolio of commercial property types, priced 84 basis points over the 10-year US Treasury note for the AAA-rated class.
For the week, the thirty-year current coupon versus the ten-year Treasury spread closed compressed by two basis points to 69 basis points. According to Freddie Mac, the primary thirty-year mortgage rate held edged higher to 4.12%.
The new issue ABS market is back in full force and being met with strong demand as deals are clearing at or through initial price guidance. Auto leasing was represented by World Omni and GM Financial, and subprime auto by CPS and Santander. GE represented the equipment space, while PHEAA brought a FFELP student loan deal. BofA, Citibank and Barclays are in various stages of bringing their credit card deals. Not to be outdone, CLO analysts have been increasing their 2014 issuance forecasts to $100+ billion.
The Manheim used car index fell for the fourth consecutive month. This has been long overdue as the supply from off-lease vehicles should be having a negative effect of used car prices. It is also a seasonal data series, so we will be following it closely since it has an impact on the performance of auto deals, especially subprime deals. New car sales came in at a 17.45 million pace, the highest since January 2006. After oscillating around zero growth for the past three years, credit card debt has increased for the past five months.
The first post-holiday week delivered some long awaited supply ($3.5 billion versus summer averages of approximately $2 billion) and a cooler tone to valuations. Munis sold-off across the curve in sympathy with Treasuries over the past week with 2 to 5 basis point cuts to maturities past five years. Absent any material changes to muni technical factors, the weakness can be attributed to broader Treasury cues and investor unease about sustaining performance through the end of the year. Muni to Treasury ratios remained stable, with municipals still in the rich territory.
The secondary market saw an uptick in activity with an influx in bid-wanteds (indicative of increased market activity), especially in the intermediate maturites. This did not, however, dissuade primary market appetites which easily absorbed large new issue deals from the State of California and Chicago Wastewater, both of which priced at their historical lows.
The high-yield market was lower this week as weakness in rates weighed on prices and buy-side accounts sold bonds to make room for the building new issue calendar. The Merrill Lynch BB/B cash pay constrained high-yield index was down 0.53% for the week and the option-adjusted spread widened by 18 basis points to a spread of 338, which is now 12 basis points wider for the year. Fund flows are negative so far for September with ETF's reporting outflows of close to $500 million month-to-date. Secondary trading activity has remained steady as accounts raising cash to fund new issue purchases, and the subsequent flurry of trading when a new issue frees to trade have kept volumes at higher than average levels.
The new issue calendar continues to grow with both drive-by deals (deals announced and priced the same day) and new deal roadshows being added to the forward calendar keeping accounts busy doing the ensuing credit work. The softness in rates and the burgeoning calendar has resulted in some pushback from accounts on pricing which has helped the recent new issues perform well when freed to trade, but had also helped to weigh on secondary prices. The forward calendar currently stands at just over $10 billion, with $5 billion of that total coming from the three-tranche offering from California Resources to help fund its spin-off from Occidental Petroleum Corp.
Global Bonds and Currencies
Major non-US sovereign bond markets came under pressure in the past week, as improving economic data out of US strengthened the case for the Federal Reserve to raise interest rates sooner than policy makers signalled. In Europe, ten-year Bund yields ended about 14 basis points higher, despite the rising tensions between Russia and Europe on extended sanctions. Gilt markets similarly came under pressure and ten-year yields rose by about 7 basis points following comments by Mark Carney signalling that borrowing costs could begin to increase early next year. Peripheral sovereign bond spreads over Bunds widened due to a lack of information on the scope of the European Central Bank's asset-purchase plan. Spanish government yields were significantly higher, as pressure built on the Catalan President to deliver a referendum on independence.
In the currency markets, the US dollar continued to rise against the other major crosses. Sterling came under further pressure against the US dollar after a poll showed a majority backed Scottish independence. The Japanese yen continued to weaken versus the US dollar following some worsening Japanese economic data and the comments by Bank of Japan signalled further monetary stimulus. The Australian dollar came under significant pressure in sympathy with falling consumer confidence and commodity prices.
Emerging market dollar-pay spreads remained flat at 274 basis points over US Treasuries, while local yields remained unchanged at 6.60%. Currencies broadly depreciated against the US dollar led by the Brazilian real (-2.4%), the Colombian peso (-2.4%) and the South African rand (-2.1%).
Turkey released second quarter GDP at 2.1% year-over-year (y/y), weaker than market expectations for a 2.7% y/y pickup. On a seasonally adjusted sequential basis however, the economy contracted by 0.5% quarter-over-quarter. A broad-based deceleration among domestic demand components was responsible for the decline in GDP growth.
Moody's downgraded Brazil's rating outlook to negative from stable, while affirming the current Baa2 rating. The rating agency highlighted that economic growth had decelerated significantly, showing little signs of returning to potential growth in the near term. Furthermore, Brazil's debt metrics had deteriorated, indicating a reduction in the sovereign's creditworthiness. Elsewhere in Latin America, Mexico announced the budget for 2015 which presented few surprises. The government did not introduce new taxes or increased any existing ones in its budget. The fiscal deficit has been pegged at 3.5% of GDP for 2015.
In Chile, the Central Bank (BCCh) lowered the policy rate by 25 basis points (bps) to 3.25%, in line with expectations. BCCh signaled that the easing cycle may be drawing to a close. Most analysts are penciling in another 25 bp cut before the end of 2014. The Central Bank of Peru reduced rates as well by 25 bps to 3.5%, as expected. While the policy minutes appeared neutral on balance, authorities have not ruled out the possibility of further rate reduction if recovery appears sluggish or if banking loans continue to decelerate.
In Asia, Bank Indonesia (BI) left both the FASBI and the reference rates unchanged at 5.75% and 7.5% respectively. The accompanying policy statement maintained a neutral bias; however, BI noted that changes in administered prices will warrant a more cautionary stance. By contrast, the Philippines Central Bank (BSP) raised the rate corridor by 25 bps. The overnight policy rate was raised to 4.0% and SDA to 2.5%. The policy move comes on the back of strong GDP growth and slightly higher inflation. The latest action could mark the end of the hiking cycle as the outlook for inflation appears benign.
The Central Bank of Russia (CBR) left rates unchanged at 8.0%. The tone of the minutes turned less hawkish, taking market participants by surprise. The CBR previously noted that risks to inflation were skewed to upside, potentially warranting rate hikes. Authorities highlighted that economic activity remained weak due to structural reasons. Overall, given the softer rhetoric, analysts expect rates will stay unchanged for the remainder of 2014.
Emerging market debt funds saw inflows of $43 million, skewed towards blended funds.
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||(US) Producer Price Index (PPI)
||(US) Consumer Price Index (CPI)
||(US) Housing Starts
||(US) Leading Index