Dear friends, investors and traders:
This week will be dominated by major central bank announcements in the UK, US and Japan. Risk is ‘on’, ‘full-on’ and equities and oil prices are higher. Fortunately. After the latest data the stage is set for the FOMC to sound hawkish this week, even if it’s too early for them to raise rates again. The Fed meeting starts Tuesday and ends Wednesday.
But first, the BOJ starts the week tomorrow with their meeting. Their last stimulus moves failed miserably, and I expect them to pass, especially with their year-end in two weeks. The Fed will clearly pass on making a move Wednesday, but will lay the groundwork for a move at the June meeting. Fed probabilities have gone from the low of 1.9 for June on 2nd Nov to 49.6% on Friday.
This coincides with what I think is the low yield for the US 10 year for the year of 1.53, 1.98% currently. The 10 year should stay in a 1.82 to 2.02 range until Wednesday afternoon. Anyway, I expect no surprises out of the Fed meeting and they are still on the path of at least 2 raises for 2016. The Dollar is in a reasonable range versus the Euro, China is stable for now, and inflation numbers are ticking up. At the same time, I would suggest not to really be too active during the phase of the FED meetings. Markets are a bit choppy with hight volatility still.
Over the weekend, the more I read about the steps by the ECB, the more I warm up to the idea that it could or will work. I could care less about negative rates, and increasing them is a waste of time, but the buying of corporates and creative lending via the LTRO, look very interesting. Corporates first!
Spread action in credit markets should return to normal this week, following two days of euphoric tightening at the back end of last week. Well, we all know the reason. As an idea of the tightening in cash credit: Senior non-financial spreads in the iBoxx index tightened nearly 8bp. Senior financial spreads tightened by over 4bp. Subordinated spreads were 15bp tighter in financials and 34bp tighter in non-financials! One of the greatest ‘headless’ rally I can remember in my almost 30 years (wow, I am so old already) in business.
Spreads across all credit markets and regardless of whether the bonds in question might be CSPP-eligible or not, the positive side to ‘guilt by association’. For example, it seems very unlikely hybrids will be eligible but the tightening there was substantial.
I had some arguments with my partners lately, whether the purchases of corporates by the ECB will work. I am of the opinion they will. First, the details: 5-10 billion a month starting at the end of the second quarter, targeted bonds are IG non-bank corporates that are based in EU countries. The total amount of EU IG corporate debt is 1.6 trillion, of which 550 billion will qualify.
I think credit spreads could rally more, once more what we saw over the last week, to where they were one year ago. This will be positive for all companies. I raised the question on Friday that European corporations will issue debt to the ECB and use the proceeds to buy back their stock, similar to what we have seen in the US. It should be good for the wealth effect in Europe. Risk is being taken out by the ECB which should have benefits globally (i.e. US corporates, equities and yes, even hybrids). Part number two of the ECB stimulus is even stronger for growth.
The new TLTRO is geared specifically to bank lending of money to corporations and consumers, but not mortgages. This means that there is much more of a connection for a bank lending that will be used for expansion, rather than financial engineering. While the initial money available will be just shy of 800 billion, it could get up to 1.7 trillion. Banks will get paid 0.4% to borrow from the ECB to lend out to consumers and corporations. They will get paid to lend. This helps the banking system to make money, and should stabilise the Euro
If you believe that currencies move with the future outlook of an economy, rather than with interest rate differentials, then the Euro zone should start to lend, which will feed into economic growth, and the Euro will move up. Probably 112-114 then to around 117.
I’m optimistic over the short term for risk assets. Peripherals should outperform Bunds. Treasuries could get ugly, but I think they will continue to expand their range towards higher yields on a gradual basis, and the Fed will lay out a path of higher interest rates. Flows and sentiments have been changing to the better for equities and HY. This week should be interesting.
Wishing all my readers a great week ahead.