Week ending November 21, 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 7:35 a.m. PDT
to Date (12/31/13 -11/21/14)
Jones Industrial Avg
|DJ STOXX Europe
|MSCI EM Index
to Date (12/31/13 -11/20/14)
High Yield Index
Morgan EMBI Global Diversified
||(JN) GDP Annualized SA QoQ
||Japanese GDP contracted for the second quarter in a row, sending the economy into a technical recession. However, with a one-off decline in tax-related consumer spending for Q2 and 60 basis points worth of inventory depletion in Q3, growth could lift in Q4
||(UK) CPI YoY
||Inflation continues to come in below the MPC's forecast. Goods price inflation was only 10 basis points in the last year. Core inflation was 1.5% YoY
||(US) Housing Starts
||Housing starts fell short of expectations but still came in above the year-to-date average monthly annualized rate of new home starts (986K)
||(US) U.S. Fed Releases Minutes from Oct, 28-29 FOMC Meeting
||The FOMC minutes showed a monetary policy committee very focused on inflation data and inflation expectations in the US. In general, the market perceived the minutes as slightly more dovish, especially relative to the more hawkish statement
||(US) CPI YoY
||(US) CPI Ex Food and Energy YoY
Last week we asked, "Where's the inflation?" Our question was aimed at the US, where the key measure of core inflation has been below target for most of the last 6 years.
But the same query can be expanded across the globe. Low inflation is forcing some central banks to become more active (the People's Bank of China, the Swiss National Bank, the ECB, the Bank of Japan, the Bank of Canada) and keeping other central banks (the Fed, the BoE) cautiously and patiently on hold for longer than previously anticipated by markets.
In China, for example, core CPI fell to 1.6% in October. As a result, the People's Bank of China (PBoC) surprised with a rate cut--its first since 2012--at a meeting on Friday. To cut rates in an economy which continues to grow at high single digits annual rates tells us central bankers remain worried about low levels of reported inflation.
At the ECB, weak economic growth and low levels of inflation prompted ECB President Draghi to suggest that more action will come from the central bank at its December meeting. Will the ECB buy corporates or governments? We don't know for sure, but what we do know is that the world's second largest currency bloc (the euro bloc) will keep rates low for years to come.
Even our friends to the north, at the Bank of Canada, worry about low inflation. Of course, global disinflation affects Canada's economy more directly through lower commodity prices and a stronger USD. But more than that, core inflation in Canada has frequently lingered below its target and could remain there for some time.
So Friday central bankers in Canada (never fans of an asset purchase program like the other major central banks) have suggested a higher inflation target may be warranted. Again, such a move implies lower rates for longer.
Markets cheered the news out of the world's central banks, with equity markets and commodities up sharply this morning.
And we think the absence of inflation--coupled with central banks attempts to boost inflation and inflation expectations--will continue to be a key market theme as we head into 2015.
Our core view is a pragmatic one though: we think investors expect too much of central banks. The lesson we think should have been learned is that central banks have less control over inflation and growth than perhaps many believe. The Bank of Japan's balance sheet has expanded to nearly 60% of GDP. The Fed's balance sheet is 25% of GDP. What more should investors expect? Will a rate cut or chatter of a higher inflation target be enough to stymy a global disinflation trend? We doubt it.
Bottom line: No inflation? No rate hikes.
Treasury yields were range bound finishing the week approximately unchanged with 2-year securities trading in a 5 basis point range and 10s and 30s trading in a 10 basis point range. The October FOMC statement, which was released on Wednesday, supported the view that U.S. the recovery remains on track. This drove yields higher, reversing some of the flight to quality moves seen earlier in the week. Thursday's $13 billion 10-year TIPS auction was strong as breakevens, the spread between nominal treasuries and TIPS, held near recent lows of 185 basis points driven by foreign buying.
The U.S. Equity Market rallied for the fifth consecutive week as global central bankers continued to push forward with additional accommodative measures to stimulate their economies. The S&P 500 index made new all-time closing highs four out of the five trading days this week. Better than expected U.S. economic growth data and increased mergers and acquisitions announcements, along with the holiday season just around the corner, have left a positive tone to the markets. The S&P 500 and Dow Jones Industrial Average indices both closed the week up approximately 1.2%, while the NASDAQ Composite climbed 0.8%. Large-cap stocks were in favor this week after outperforming 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 energy, while the worst performing sectors were telecom and info tech.
In fund flow news, Lipper reported that U.S. based equity mutual funds reported a modest inflow of $122 million for the week.
Week to date $27 billion of new issue has priced, slightly below expectations of $30 billion. The main deal of the week was an $8 billion inaugural issue by Alibaba (BABA). Alibaba recently priced the largest equity IPO in history. They issued six tranches across the curve with a final book nearly seven times oversubscribed. Spreads tightened by 10-15 basis points in the front end and as much as 27 basis points in the long end from initial price talk. In the 20-year tranche, price talk started at a spread of 175 and tightened to final pricing of 148, the most tightening seen in any deal in the recent past. Most tranches were 5-10 tighter on the break, only to give most of that up and close relatively flat after sellers emerged. The 20 year tranche continued to outperform trading seven basis points tighter, while the rest of the trances were trading flat to slightly wider to where they priced.
The big driver of secondary market activity this week was supply. Dealers, laden with inventory after buying up secondary paper for new issue-seeking clients, are starting to widen spreads to attract buyers. After months of battling over scraps in new issue, the market finally seems to be slowing down, forcing spreads wider. The Corporate Index Option-Adjusted Spread (OAS) finished the week at +126, five wider on the week, drifting up 1-2 basis points every day. Overall, Senior Financials widened by two, Sub Financials widened by one. Metals/Mining tightened by six, as oil was up nearly two points week-over-week. Industrial widened by three and Energy rebounded at the end of the week to close tighter by five basis points.
It was a low volume/activity week in the mortgage market with agency mortgages outperforming Treasuries as rates oscillated in a very tight (five basis points) range. The FOMC minutes focused on inflation expectations and failed to change market direction. Pass-through spreads compressed two-to-four basis points across the coupon stack. FHFA Chairman Mel Watt testified to Congress with no surprises that should make investors worry about premium coupons. Within the programs, Ginnie Mae mortgages posted mixed performance versus conventionals and 30-year mortgages outperformed 15-years. The 30-year current coupon closed two basis points tighter to 65 basis points versus the 10-year Treasury.
In commercial MBS, the market digested a slew of new deals with a mix of conduit, single borrower/single asset (SBSA), single-family rental and agency CMBS. Supply and demand have been in balance leaving spreads stable over the past couple of weeks. Ten-year AAA-rated conduit CMBS bonds trade in the mid 80s versus swaps. As for single family rental, AAA-rated two-year floaters price at 125 basis over one-month LIBOR. The single family rental market has grown to $7.2 billion from five major issuers.
The fat lady hasn't sung yet, but she's warming up. This week's heavy new issuance feels like the last push before the annual holiday hibernation period. Although the distribution process took a little longer, deals generally priced within the range of initial guidance. American Credit Acceptance, the deep subprime auto lender was the exception. It probably didn't help that there was a "Moody's Joins Fitch Slamming Subprime Auto Bonds" headline story in the news. The concern is not default risk, but rather a difference in necessary credit enhancement to achieve a rating. S&P, DBRS and Kroll are clearly more lax.
Also in the news last week was the announcement that Perella Weinberg Partners will merge Flagship Credit Acceptance and CarFinance Capital into a single subprime auto lending and servicing platform. Looking down the road, the next step is stabilization of the combined company, and then either a sale or an IPO. The Consumer Financial Protection Bureau (CFPB) handed out an $8 million penalty against the buy-here-pay-here subprime auto lender, DriveTime Automotive Group for unfair debt collection tactics and inaccurate information to the credit reporting agencies. None of the mentioned names are on the P&R approved list for ABS.
The municipal market is quickly winding down the year as market participants have just a few more solid trading weeks left in 2014. This week's new issue supply was slightly over $8 billion, led by $550 million State of Connecticut, $456 million Arizona Transportation and $409 million Baltimore Water Authority. The market was mostly mixed on the week as buyers focused primarily on cheap negotiated supply that offered higher yield concession than the secondary market.
The benchmark AAA 10-year municipal yield hovered around 92% of the U.S. Treasury counterpart. Secondary market activity was somewhat subdued as bid wanted items generally received respectable bids. Selling activity was well contained as investors have seen almost 10 percent lower new issue volume this this year than last year, supporting prices.
The October FOMC minutes were a non-event in the municipal market as investors shrugged off a weaker Treasury market and focused on attractively priced deals. The 30 day forward visible new issue supply is modestly lower than recent weeks at $8.1 billion. All-in-all, investors anticipate a supportive market through year-end as December re-investment new cash is just around the corner and demand is still strong from retail investors. With year-to-date total returns exceeding 8% for the Barclays Municipal Bond Index, many bond fund managers are maintaining a defensive posture in the marketplace, limiting major portfolio changes. New issues in the holiday shortened Thanksgiving week will be sparse with trading desks thinly staffed.
The high-yield market traded lower this week as investors focused on the new issue calendar. The Merrill Lynch BB/B cash pay constrained high-yield index was down 0.87% for the week as spreads widened by twenty-two basis points. The metals, mining and energy sectors continue to weigh on the market as oil and iron ore prices tick down, and the bonds of hospital operators have traded lower as well with concerns over the challenging of the legality of the Affordable Care Act subsidies.
The robust inflows that totaled $6.60 billion over the past four weeks have slowed and turned slightly negative as AMG reported an outflow of $281 million for the week. While actively managed funds saw an inflow of $68 million, high-yield ETFs had outflows of $349 million and were active in the secondary market with bid-wanted-in competition lists to fund the redemptions. Daily secondary volumes have averaged a hearty $9.65 billion so far in November, but are lagging the outsized $12 billion average daily volumes seen during the volatile month of October. The hefty new issue calendar was another key factor that put pressure on secondary prices.
It was anticipated to be a busy week for new issuance as issuers and investment banks sought to wrap up their funding needs ahead of the Thanksgiving week slowdown and that expectation was exceeded as roughly $11.50 billion is scheduled to price for the week. The deals for the most part have been well-received, and despite the large volume of deals to digest, most deals came at the middle or tight end of price guidance. Most buy-side accounts are reported to have let their cash balances build after the volatility of late September and early October and should be able to absorb this week's supply fairly easily. The forward calendar beyond this week is very light and the pause in issuance should enable the market to move higher and tighter into the year-end.
Global Bonds and Currencies
Major non-US sovereign bond markets finished the week slightly firmer, outperforming US Treasuries which ended almost unchanged following the release of the Federal Reserve's latest minutes which confirmed that the Committee was in broad consensus on its decision to end its quantitative easing program.
The mood in financial markets was cautious at the beginning of the week after news that the Japanese economy slipped back into recession in the third quarter triggered a government decision to call a snap election to seek a fresh mandate. In Europe, purchasing managers' survey data was weaker than expected and the European Central Bank (ECB) President reiterated the Bank was prepared to take further action to tackle weak growth and disinflation in the region. President Draghi's comments raised hopes the ECB is now close to adding government bond purchases to its quantitative easing program. Ten-year German Bund yields ended around 3 basis points lower while peripheral European sovereign bond spreads over German Bunds tightened on Draghi's comments. Ten-year UK Gilt yields were lower by around 7 basis points following the release of low inflation figures for October.
In currency markets, the US dollar was firmer against most of the major crosses as the relatively hawkish tone of the latest Fed minutes underscored the divergence between the US's likely rate path and that of most other major economies. The yen was also weakened by the week's disappointing Japanese growth data and political uncertainty generated by the forthcoming election. The Euro came under pressure from weak region economic data and the ECB's comments. The Australian also finished the week slightly lower against the US dollar in response to weak Chinese data and falling commodity prices. However Sterling ended the week almost unchanged.
Emerging market dollar-pay spreads widened 2 basis points to 308 over US Treasuries, while local yields tightened 10 basis points to 6.35%. Emerging market currencies showed mixed performance against the dollar; currencies that depreciated included the South Korean Won (-1.6%), the Taiwanese dollar (-1.1%) and the Chilean peso (-0.9%). Meanwhile, the South African rand (+2.3%), the Polish Zloty (+1.1%) and the Turkish lira (+1.0%) gained.
Chile released third quarter GDP which showed the economy grew by 0.8% year-over-year (y/y). The weaker growth was led by a slowdown in private consumption and subdued investment activity. Going forward, net exports are likely to pick up the slack, as subpar domestic demand will continue to weigh on economic activity. Mexico released third quarter GDP, where growth accelerated by 2.2% y/y. The central bank recently revised its growth forecasts down to 2.0%-2.5% for 2014.
Elsewhere in Latin America, Fitch upgraded Dominican Republic's rating by one notch to B+. The rating agency applauded the sovereign's resilience through challenging external conditions. Fitch anticipates that a diversified services sector and a strong link to the US economy will help Dominican Republic grow around 6%, higher than B rated countries' GDP growth of 4%.
In Asia, Indonesia delivered the widely anticipated fuel price hike. The IDR 2000 hike, expected to save the government roughly $9.8 billion, will be diverted toward productive spending. The subsidy rationalization has been well received by rating agencies as such adjustments will meaningfully support both fiscal and current account balances. Bank Indonesia (BI) responded by hiking the reference rate by 25 basis points to 7.75% in an unscheduled monetary policy meeting. The central bank's policy action is largely symbolic - to anchor inflation expectations. BI projects that the fuel price hike will result in inflation peaking around 7.5% from 4.4% currently. In another surprise policy meeting, the People's Bank of China (PBoC) lowered the one-year lending rate by 40 basis points to 5.6% and the one-year deposit rate by 25 basis points to 2.75%. The PBoC simultaneously announced that banks can offer deposit rates up to 120% from 110% previously. Overall, these easing measures indicate that Chinese policymakers are reluctant to allow growth to slip substantially below 7.5%
Turkey's central bank maintained rates at 11.25%, in line with consensus expectations. The central bank indicated that inflation could surprise on the downside on the back of lower oil prices. The South African Reserve Bank (SARB) maintained rates at 5.75% with the monetary policy committee unanimously voting to hold rates. In line with many oil importing nations, the central bank highlighted the benign outlook for inflation on lower crude prices.
In Romanian elections, the leader of the Romanian Liberal Party, Klaus Johannis unexpectedly won the second round of presidential elections over the current Prime Minister, Victor Ponta. This unexpected outcome is viewed as market friendly given Johannis' focus on getting the fiscal house in order and clamping down on corruption during his election campaign.
Emerging market debt funds experienced a small outflow of $0.2 billion for the week, skewed toward local currency funds.
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||(US) GDP Annualized QoQ
||(UK) GDP YoY
||(US) PCE Core YoY
||(US) Univ. of Michigan Confidence
||(US) New Home Sales
||(GE) Unemployment Rate
||(EC) M3 Money Supply YoY
||(JN) Natl CPI YoY
||(JN) Natl CPI Ex Food, Energy YoY
||(JN) Industrial Production YoY
||(EC) Unemployment Rate