Week ending February 5, 2016
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 8:00 a.m. PDT
to Date (12/31/15 -2/5/16)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/15 -2/4/16)
High Yield Index
Morgan EMBI Global Diversified
||(US) PCE Core YoY
||Core PCE inflation in the US reached its highest level in 12 months.
||(EC) Unemployment Rate
||Eurozone unemployment rate fell to its lowest level since May 2013, but still remains above pre-crisis levels.
||(US) Change in Nonfarm Payrolls
||US GDP slowed down in Q4 2015, but the economy still grew by 2.4% for the year.
We've heard the "r" word more times in conversations in the last couple of weeks than in the last couple of years, combined. The "r" word, of course, is "recession."
Why the sudden surge in interest of a word that describes a relatively rare economic event? We think investors see weakness in commodities, equities and other risk assets and need an explanation to help make sense of the world.
But the recession talk goes beyond mere chit chat. A recession-type scenario has been priced into the bond market, with zero rate hikes envisioned in 2016 in the fed funds futures market, falling Treasury yields and the US dollar weakening. A Fed not hiking at all in 2016? A weaker USD? Plunging Treasury yields? Such asset market results would reflect a scenario in which the economy slows to stall-speed, or tips into recession.
Perhaps this morning's jobs report will change investors' tone, somewhat. Job growth advanced at a torrid pace in 2015. The US economy added 2.8 million net jobs to payrolls, with a monthly pace of 228,000. The three-month average through January was 231,000. Yes, January's job gains of 151,000 were below that rate and a touch below consensus expectations, but the results are nothing alarming given the rapid recent run in the jobs data. The manufacturing sector, which has garnered plenty of investor focus given the weakness in the economic data, added 29,000 jobs in the month of January.
Our view going into 2016 was that 2015's monthly pace of payroll gains were unlikely to persist, but that the unemployment rate could still fall further even with a lower pace of payroll growth. Indeed, the unemployment rate did tick down to 4.9% in January even as the labor force participation rate rose to 62.7%. Importantly, the Fed views the 4.9% unemployment rate as "full employment". At such a rate, policymakers will be biased toward increasing their overnight rate target as they are "reasonably confident" that wage and prices pressures will follow the labor market strength exhibited in 2015. And it appears that so long as nonfarm payrolls continue to print above 114,000, the unemployment rate will hold at its current level.
If job gains do persist (even at a somewhat slower pace) and the unemployment rate does drift lower, we do expect higher wage growth. Wages rose 2.5% in the last 12 months. For years investors have been fond of saying, "But, wage growth is stagnant." This has changed. We wouldn't be surprised to see 3% wage gains this year if the unemployment rate stays low.
A labor market that continues to add jobs? A falling unemployment rate? A pick-up in wage gains? These data hardly describe an economy in recession.
Bottom-line: we realize investors yearn to make sense of every tick in the financial markets, but at this point we still think recession tales are far-fetched.
Mid-week felt like the first day since the Treasury rally began at the start of the year that the market traded in full panic mode. The prior two panic rallies in October and August of last year marked short term high prices. This current move ran out of steam just below the 1.80% level in 10-year notes which looks to be the bottom of the range for the time being.
US dollar weakness was a big story which helped boost commodity prices and stabilize stocks as the curve steepened on the probability of a Fed hike being priced out of 2016. The probability of a June rate hike implied by the futures market moved to roughly 32% to finish the week. Weakness in ISM non-manufacturing data added fuel to the fire as many Wall Street trading commentary started to mention the idea of recession. The market took a breath Friday post a mixed payrolls data, with the headline number falling short of analysts' estimates but average hourly earnings ticked up and the unemployment rate fell below 5%. Treasuries initially sold off but came right back to finish the week as equities remained offered.
The Treasury announced reductions of $1 billion for the next 5/7/10/30 year nominal supply in both new issues and re-openings and a $2 billion reduction to each of the next 5/10/30 year TIPS issues and re-openings.
The U.S. Equity Market fell for the week as fears of a global recession weighed on market sentiment. Weaker than expected economic data, corporate earnings contraction, and lower oil prices have kept market volatility elevated and investors seeking a flight-to-safety. The S&P 500 index slid approximately 3% lower for the week, posting its first weekly loss in three weeks.
The Dow Jones Industrial Average fell 1.6% for the week, while the tech-focused NASDAQ Composite slumped 5%. Large-cap stocks outperformed the higher beta small-cap stocks. In terms of style, large-cap value stocks outperformed large-cap growth stocks. The best performing sectors were materials and utilities, while the worst performing sectors were consumer discretionary and info tech.
The earnings season is a more than half way through, with companies largely meeting analysts' expectations. Out of 315 companies in the S&P 500, 77% companies have beaten earnings estimates, but only 46% have beaten sales estimates. For the quarter, earnings have declined by 6%, and sales have declined by 5%.
In fund flow news, Lipper reported investors bought $259 million in domestic equity mutual funds for the week, snapping a streak of 12 consecutive weeks of redemptions. International equities also saw inflows after investors bought $1.8 billion in non-domestic equity mutual funds for the week.
The week's new issue calendar fell short of expectations for the third week in a row, managing a measly $5 billion versus an anticipated $25-$30 billion. Market tone yet again ruled the day, keeping out several issuers who wanted to await fairer weather. So far this year, given the mediocre primary market turnout, the only thing keeping issuance at a reasonable level ($115 billion so far this year) is thanks to the large $46 billion issue from AB InBev in mid-January. One notable pattern is the success of higher rated issuers, such as Home Depot. The A-rated issuer saw its 5-year new issue tranche move initial price talk from 95 to final pricing of 80 basis points. In comparison, the low BBB rated Regions Financial issued simultaneously priced 5 basis points wider than initial price talk at a spread of 195.
Corporate spreads weakened as they have since the beginning of the year, averaging 1.5 basis points per day of widening since January began. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +201, 10 wider on the week. Overall, Metals/Mining were 16 wider as commodities continued their losing streak; energy was 20 wider with oil prices moving in a volatile pattern daily, but ultimately remaining near $30 for most of the week. Senior financials were 5 to 8 wider with the long-end underperforming and subs were wider by 20. Industrials were nine wider and utilities widened by just two.
Agency mortgage securities struggled versus Treasuries as yields fell on equity market weakness and weaker-than-expected economic reports. Crude oil volatility continues to influence market expectations for growth and Federal Reserve policy.
Agency mortgages, the 'safe haven' asset class of yesterday, started to decouple from Treasuries as mortgage edged closer to refinance triggers. Pass-through spreads were wider by 3-5 basis points with cuspy premium coupons at risk of average life contraction with another leg down in rates. There is good news, however, the prepayment for January posted an overall 23% decline in experiences due to day-count and longer processing times for mortgage applications. Within the market, Ginnie Mae mortgages lagged conventionals in a trending/directional move with the broad market. As shared previously, buyers of Ginnie Maes like higher yields and that's not harder to find as prices rise and prepayments poised to increase. In the credit mortgage markets, both non-agency and commercial MBS posted negative relative performance as appetite waned for risk. The benchmark 10-year AAA-rated CMBS bond closed versus Treasuries at 145 basis point spread. Lower-rated classes suffered more with outright price losses over the past few weeks.
For the week, the 30-year current coupon spread versus the 10-year Treasury widened by 2 basis points to 78 basis points. According to Freddie Mac, the primary 30-year mortgage rate fell to 3.72%.
The story of the haves and have nots continued this week in new issue ABS. The Nissan auto loan deal priced all classes through initial price guidance, while subprime auto lender Exeter struggled placing their BBB and BB-rated classes, having to widen roughly 50 and 125 basis points respectively. Next week should be interesting with at least eight deals in the queue, with seemingly every collateral type being represented.
The CLO market remains opaque with junior mezzanine (BB/B) and equity at somewhat of a standstill. Those holders are seemingly all on the same side of the trade. This is making new issuance very difficult. That said, Oaktree is retaining their equity piece (everything below single-A) in a deleveraged CLO structure, offering a pre-placed AAA, AA and A-rated classes.
The municipal market traded to modestly lower yields this week with a steepening bias against a backdrop of weaker readings on the growth of the economy. At mid-week, the 10-year AAA benchmark municipal yield registered in at 1.65% and nearly 87% of its Treasury counterpart. The municipal to Treasury yield is more attractive farther out the yield curve on a relative value basis as 30-year municipal yields are 100% of their Treasury counterpart.
New issue supply was a modest $6.7 billion this week. The 2015 weekly average was about $8.0 billion. One of the largest deals this week included junk rated $725 million City of Chicago Board of Education. New issue supply is lower so far this year due to reduced refunding volume. Most new issues priced at historically traditional spreads due to the excess calls and redemptions generating cash aided by positive mutual fund flows. The largest deal on the forward calendar includes $1.75 billion taxable Florida Development Finance Authority.
Competitive deals saw good demand while most negotiated new issues were priced attractively in order to garner buyer's attention amidst a low interest rate environment. The secondary market experienced reasonable bidding with most trading in-line with the overall markets' improved tone. Dealer's bids are supportive under current market conditions as the market experienced modest bid wanted activity. The 30 day visible supply is $10.0 billion, somewhat larger to averages for the year in 2015. Longer term, municipal bonds should outperform other fixed markets as relationships are reasonable relative to Treasuries.
The BofA Merrill Lynch BB/B cash pay constrained index was down -0.74% this week as spreads widened by 19 basis points to an option-adjusted-spread of +644 basis points. The BofA Merrill Lynch BB/B index that excludes utilities and energy was down -0.59% for an OAS of +570 as that spread widened by 24 basis points. The BofA Merrill Lynch Euro BB/B constrained index was down -0.47% as the spread of that index cinched tighter by 6 basis points for an OAS of +537.
High-yield and other risk markets price action have been closely correlated with the price of oil for some time, and this week was no exception. The rally in oil at the end of the prior week that helped boost stocks and high-yield bond prices higher into January's month-end reversed course on Monday and Tuesday of this week and traded lower, dragging stocks and risky bonds along with it. Oil firmed by mid-week and helped to lift high-yield bonds higher. Metal and mining bonds outperformed the broader high-yield market as commodities rallied on weakness in the US dollar.
Fund flows have reversed course as well after seven straight days of positive flows into high-yield ETF's that totaled +$2.8 billion as $594 million exited the asset class on Tuesday alone. The total net outflow for the week was -$41 million versus an inflow of +$883 million last week. Outflows year-to-date now total -$3.6 billion as compared to an outflow of -$16.6 billion for all of 2015.
Secondary trading volume has slowed slightly as compared to the average daily volume of $12.2 billion in January with an average of $11.0 billion for the nascent month of February.
New issue activity remains light with just $3.9 billion pricing across four tranches. The largest deal of the week was an upsized $1.7 billion eight-year note brought by Charter Communications. The broadband internet communications services provider priced the new B1/BB- rated notes at a spread of 417 basis points to yield 5.875%. The new issue was met with a tepid reception by investors when freed to trade as the new notes were quoted below new issue pricing.
Global Bonds and Currencies
The first week of the month saw a complex combination of market conditions. On the one hand, disappointing US service sector data and concerns over falling PMI numbers in China weighed on market sentiment, yet oil prices rallied after a prolonged period of weakness early in the year. The keenly anticipated US jobs report on Friday did little to remove uncertainty about the future path of US interest rate hikes as the newly created jobs data missed the forecasts, while the unemployment rate continued to decline. Overall, global government bond markets were well supported during the week and yields continued to fall across the board.
Japanese government bond yields reached record lows in the aftermath of the Bank of Japan's unexpected decision last week to introduce negative interest rates. In Europe, Bund yields continued to compress as the likelihood of further quantitative easing measures was reinforced by ECB President Draghi on Thursday. The yield on the 10-year Bund finished the weak 4 basis points lower, while spreads on peripheral European bonds widened as the violent protests in Greece weighed on market sentiment in the region. In the UK, Bank of England's MPC minutes published on Thursday relayed a dovish message, with all members of the committee voting in favor of keeping interest rates unchanged. As expectations of the first UK interest rate hike were pushed to 2017, the yield on the 10-year Gilt fell by 4 basis points on the week.
Currency market movements dominated the headlines this week with the US Dollar weakening against most major currencies after some weak service sector data. The Japanese yen rose against the US Dollar after the sell-off the previous Friday while the Euro firmed up, supported by Mario Draghi's speech on the merits of tackling low inflation. Sterling strengthened against the greenback but lost ground against the other major currencies. The Australian dollar fell against the US Dollar early in the week after the RBA kept interest rates unchanged, but recouped the losses by Friday.
Emerging market (EM) dollar-pay spreads widened by 14 basis points (bps) to 473 bps over US Treasuries, while local debt yields fell 17 bps to 6.83%. EM currencies were mixed against the US dollar, with the Romanian leu leading gains (+3.9%), followed by the Hungarian forint (+3.1%) and the Polish zloty (+3%). The Russian ruble underperformed, depreciating by 2.4%.
Emerging market January manufacturing PMI prints remained largely unchanged versus December. The closely watched China manufacturing PMI registered 49.4, modestly below consensus expectations (49.6) and marking the sixth month below the 50 expansion threshold. In Indonesia, fourth quarter growth came in better than expected, bringing 2015 calendar year growth to 4.8% year-over-year. Fourth quarter domestic demand was supported by robust investment and government consumption.
Most EM central banks left their policy rates unchanged. In India, the RBI remained on hold for the second consecutive meeting, keeping its repurchase rate at 6.75%. The decision was in line with consensus, with the central bank noting that growth was reasonable but somewhat below what should be expected in the medium term. The Polish central bank kept its reference rate at 1.5% amidst a backdrop of deflation; the central bank stated that it expected deflation to persist in the coming months due to lower energy prices. Similarly, in a unanimous decision, the Thai central bank stood pat at 1.5%. In Mexico, Banxico maintained its policy rate at 3.25%, matching market expectations. While highlighting that inflation trends had been benign, it noted that recent currency depreciation could increase risks of pass through moving forward.
The exception was in Colombia where the monetary authority delivered a 25 basis points rate increase, moving its policy rate to 6%. Colombia has hiked 150 bps since September 2015 against a backdrop of above-target inflation (6.6%) and elevated inflation expectations.
In Ukraine, Finance Minister Abromavicius unexpectedly resigned on February 3rd, voicing his concerns with corruption and a lack of progress on the country's structural reform agenda. Turning to sovereign ratings, Standard and Poor's cut Azerbaijan's foreign currency sovereign rating to 'BB+' from 'BBB-' citing the negative impact of the lower oil prices on the economy. Azerbaijan is rated investment grade by Moody's and Fitch.
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||(JN) Real Cash Earnings YoY
||(JN) Money Stock M3 YoY
||(CA) RBC Canadian Manufacturing PMI
||(US) NFIB Small Business Optimism
||(US) JOLTS Job Openings
||(US) Wholesale Inventories MoM
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||(US) Initial Jobless Claims
||(CA) New Housing Price Index YoY
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