Author Archives: CFAMNEB

World’s Cup Runneth Over

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Once again, one of the world’s central bankers was in charge of the game. On Wednesday, the FOMC released its much anticipated statement, confirming as expected that the Fed would continue to taper its bond purchase program. Its 2014 growth outlook was slightly lower, but not very negative. If there was any surprise, it came during Yellen’s press conference, when she spooked a few corners of the bond market by dismissing recent inflation figures as noise. This led to a steepening of the yield curve which persisted into Thursday. It seemed to be exacerbated by the 30-year TIPS (treasury inflation protected securities) auction, which didn’t go quite as well as dealers were expecting. Nominal 30 year levels recovered sharply on Friday – but still ended the week higher by about 4 basis points. It seems that the bond market is struggling to figure out the FOMC’s next step. It may be that the FOMC is struggling to figure out its next step.

There was no uncertainty, however, on the part of credit markets, which once again took its cues from a Dovish central bank. Not worried about any increase in inflation, 10 year bank spreads rallied by 5 basis points or so, and higher vol sectors like materials have also had a good week. Utilities felt like they lagged a bit, so data all around showed support for the central bank-induced risk-on trade. The World Cup of liquidity continues to flow.

The new issue market, on the other hand, slowed down this week. Most issuers tried to get in ahead of the Fed, so Monday and Tuesday were the big days, with about 80% of the week’s volume. Total supply this week was just over $20 billion, so a pretty slow week overall. The week had more than its share of energy companies, as Cameron, ERP Operating, and Hess all brought deals to market. The interesting trade of the week was our local friend Target – the company had to widen the price from initial talk in order to get its deal done, which we haven’t seen in a while. The company brought $2 billion total, $1 billion of a 5 year at +60, and $1 billion of a 10 year at +90. These bonds ended up among the better performers on the week, so the initial guidance wasn’t that far off, but the market demanded a concession given the noise around the company’s story recently.

So in the end, we think it was a pretty solid week for credit. Should we be worried about liquidity driven bubbles? Maybe, but I think we’ll just focus on soccer for now. Gooooooooaaaaaal!

Super Mario

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Mario Draghi announced the ECB’s monetary policy actions on Thursday, June 5th, and on balance they were largely as anticipated. Without getting into too many details, the ECB launched a new series of “targeted longer-term refinancing operations”, began to set the stage for certain asset purchases, and lowered a variety of policy rates, including moving the deposit facility to -10 bps. We are not quite at QE in Europe, but they appeared to edge in that direction, and the ECB has made it clear that Deflation is a primary concern for the economy, even though it has returned to modest growth this year.

Credit markets reacted positively to this week’s data, including the ECB actions. Bank spreads seemed to be the biggest beneficiaries, with on-the-run banks tighter by 5-10 basis points. So far this month, we are seeing a complete reversal of last month, with higher rates, a steeper curve, and tighter spreads, especially on the long end. It was definitely risk-on in Europe – in addition to the ECB actions, Standard & Poor’s raised the credit ratings of a number of Spanish Banks, following a hike in Spain’s sovereign rating a week earlier. Rates in all of the peripheral countries in Europe have rallied like Luigi in a go-cart, and are trading at their lowest level in years. Spain and Italy, the two poster children for European chaos, saw rates drop by 20 basis points to 2.6% and 2.7%, respectively – just a hair above levels in the U.S.

The primary market did not wait around to see the data – as usual, the weekly calendar was front-end loaded, as few issuers wanted to take the risk of a bad outcome on the news front. Total supply was about $29 billion, which is a decent week. Large deals included Express Scripts, with $2.5 billion across three tranches, $2.4 billion of shorter paper from American Express, and $2 billion of an AT&T 30 year bond. Most deals are performing well, as most of the spread tightening this week took place on Thursday and Friday. The market is expecting more of the same next week – probably about $25 billion in supply.

There was a range of positive or at least benign data supporting credit markets this week, but we are inclined to attribute most of the rally to the ECB. At least for now, markets are expecting the announced policy measures to act like our own little Yoshi, gobbling up all the bad stuff – slow economic growth, deflation, weak banks – and turn them all into gold coins to toss back to Mario.

A CFA Candidate’s Perspective

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Each season CFA Society Minnesota invites finance students to learn about the CFA Program by interning with the local society. Students assist society committees with research for their projects, and are encouraged to take on tasks that broaden their skills and industry insight. Augsburg College senior Kyle Louzoun-Heisler will be sitting for Level I next year, and wrote this commentary with the assistance of Freezing Assets contributor Lissa Rurik, CFA. If you’d like to work one-on-one with a future CFA Candidate this season, please contact us to volunteer!

There seems to be a consensus in the literature of the major financial institutions that stocks, despite a five year bull, will continue to make small but positive gains. They seem to agree that low interest rates, low inflation, and an improving economy will continue to support increases in the stock market, albeit small. However, there are risks, including shifting geopolitical climate, the Federal Reserve, and asset bubbles that pose threats to stock market gains. Despite these concerns, the majority of firms recommend a Bull market strategy.

With the stronger stock market many firms suggest investing in stocks instead of bonds in 2014. However, there are strategies to navigate a rising interest environment. The recent climate has many financial firms predicting a higher treasury yield and a steeper yield curve. The Fed is central to this topic because there is reason to believe the fed funds rate will be increased in the future. BlackRock and Ascent are predicting a modest increase in rates to about 3.5%. However, this is largely based on the pace of tapering. And despite the recent fear over the fed raising tapering ahead of schedule, the meeting minutes show no such thing. Both Ascent and Columbia Asset Management recommend investing in shorter financial institutions debt, rather than utilities and industrials, citing a bank’s ability to pay lower interest on deposits and receive higher rates on loans.

In order to gain in a rising rate environment, BlackRock and US Bank are in favor of investing in munis and high yield bonds. Those in favor of high yield bonds cite the investment climate (with the Fed’s quantitative easing, economic improvement, and low default rates) and interest rate risk as the primary reasons to consider those options. Furthermore, as interest rates increase, high yield bonds can protect from that risk. Although last year high yield bonds offered the best return in 2013, BlackRock believes they will be closer to fair value.

In addition to high-yield bonds, BlackRock and US Bank favor municipal bonds as well. BlackRock mentions that March was one of the three best months for munis in 20 years. However, despite these ending, it still makes sense to look at these bonds because of their tax exemptions.

Although BlackRock mentions the Emerging Markets as a potential investment, Columbia asset management recommends it. Columbia believes that investors should stop playing duration defense. Furthermore, credit risk is preferred to duration risk. Like BlackRock, Columbia mentions the possible increase in the yield curve, but they believe that the curve has already taken most of it in. They say that if you want more of an investment-quality bond, corporate and munis make sense, but that if you have longer latitude it makes sense to look at the EM debt. Although EM debt did poorly last year, they believe it will perform better as those economies improve. Columbia believes global demand to increase and thus EM debt values to react favorably. Abbot Downing also believes that EM debt will improve as those markets grow and will be a good long-term investment.

BlackRock and Columbia are asset management firms.
Ascent is a private wealth management firm- subdivision of US bank.

Summertime

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One of the greatest things about the bond market is early close. While our equity counterparts are slaving away until 4:00 ET today, SIFMA has recommended a pre-holiday close of 2:00 ET. There are fewer early closes than there used to be, but we still get to leave early to kick off the summer.

And the livin’ is easy…

You could barely work today in Credit even if you wanted to. Judging from the number of messages we’re getting, it feels like the street has already sneaked away to the Hamptons.

Fish are jumpin….

Supply this week reflected the anticipated exodus – there was about $20 billion in new issue, and the fish did most of their jumping on Monday and Tuesday. Concessions were a bit spotty, with some deals priced to go, and others, not so much. Secondary trading was again a mixed bag, with some weakness showing up in longer-dated bonds. The Enable Midstream deal was a case in point – this midstream gas company is a new issuer, and they brought $1.65 billion across three tranches. All looked to be well oversubscribed, but the 5 year has tightened 6 basis points in the secondary, while the 10s and 30s are a couple wider. It looked like the market was going to jump all over this deal, but ended up throwing some of the catch back.

And the cotton is high….

Spreads are still tight. Even though summer is barely upon us, it’s hard to imagine the cotton getting too much higher. Maybe investors should think about harvesting. There was very little movement in spreads overall, and excess returns month-to-date are slightly negative, driven entirely by the long end. As we doze off in the Adirondack chair, a cool beverage resting on its wide arm, it looks like credit spreads will be stable as far off into the horizon as the eye can see…

…so hush…

When Doves Cry

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Credit is a funny asset class. It is part risk-on, part risk-off, and sentiment in and around the sector reflects its Jekyl and Hyde nature. This past week was a case in point. We’ve had dovish comments recently out of both Yellen and Draghi, both suggesting that current economic activity allowed for plenty of flexibility on monetary policy. The prospect of continued or even further stimulus gave risk assets a bit of a boost, and credit spreads did well for a few days. Not coincidentally, it was the same period in which equities did well.

Then the market saw a couple of days of bad news – mixed signals from the economy, and weak earnings out of Wal-Mart sent stocks lower, and credit followed suit. 10 year bank credits are usually the most visible in the cash markets, and they widened by about 5 basis points.

As a result, credit markets were very receptive to new issue in the early part of the week, but supply tapered off as spreads moved wider. $40 billion in investment grade corporates came to market, and follow-on secondary trading activity has been mixed. Most new issues look like they’re trading wider, some are trading tighter. Pfizer was among the biggest issuers, bringing $4.5 billion across five tranches, and Volkswagen did $3.5 billion. Pfizer bonds are lagging since their deal priced on Monday, with spreads wider by 3-5 basis points. The Volkswagen deal priced amid some spread weakness on Thursday, which perhaps explains why their bonds are trading 3-5 tighter.

At the same time, interest rate levels dropped to the low end of their range – 10 year rates dipped below 2.5%. Bottom line, even though credit felt squishy going into the end of the week, the average spread month to date has barely changed, and prices of investment grade bonds have moved higher. As one trader commented, in spite of the spread weakness, the market still feels constructive.

Or maybe the market just doesn’t know what else to do. It is totally hooked on central bank stimulus. Maybe I’m just 2 demanding, but it’s hard to see valuations surviving a hawkish attack.