- Oil turns lower, equities follow. WTI crude oil is down this morning ($45/barrel) following an International Energy Agency report that suggested the global supply and demand imbalance may take longer to rectify than expected. The S&P 500 is down 1%; reversiong, reversing a portion of Monday’s gains. All sectors advanced yesterday, led by defensives telecom (2.0%), consumer staples (1.9%), and utilities (1.7%) after dovish comments from Federal Reserve Bank (Fed) speakers soothed rate hike fears. Overnight, the Nikkei Index gained modestly (0.3%) as investors await the next week’s Bank of Japan meeting; the Shanghai Composite closed near flat. Similarly, European shares are near flat after economic sentiment indicators came in below expectations. Elsewhere, COMEX gold is little changed at $1327/oz. while the yield on the 10-year Treasury is holding steady at 1.67%.
- Have Treasuries moved into a new range? Following several weeks of low volatility, Treasury yields broke higher on Friday, with yield on the 10-year note moving above the recent resistance point of 1.6%. Most of the move was centered around the intermediate to long end of the yield curve, which led to a steepening in the curve, though the move was limited and the message from the bond market continues to be one of slow long-term growth. The bond market has absorbed several news items over the past few weeks, including more hawkish than expected Fed speak, comments from the European Central Bank (ECB) and Bank of Japan (BOJ), high levels of corporate issuance, and the discussion of fiscal stimulus in the face of U.S. presidential elections. We will continue to watch yields this week to see if the breakout holds. Although even if it does and Treasuries move into a 1.7%-2% range, this outcome would not materially alter our view that core holdings of intermediate-term investment-grade corporate bonds and mortgage-backed securities (MBS), along with a small allocation to credit-sensitive areas of the market, may make sense for suitable investors in this environment.
- Foreign government yields also higher. The ECB’s meeting concluded on Thursday, and it not only announced no further easing, but also didn’t give any hints that more is coming in the future, a double whammy for foreign bond markets. This put upward pressure on German bund yields, and led the 10-year bund yield to close in (barely) positive territory on Friday. Rumors that the BOJ is considering measures to steepen the Japanese yield curve also led to higher long-term yields in Japan. Treasury yields continued to track closely with both, and these central bank actions were likely part of the reason for the rise in long-term Treasuries last week.
- This is not likely to be taper tantrum part 2. The recent rise in rates has led some to question whether U.S. bond markets are about to experience another taper tantrum like the one that sent the 10-year Treasury higher by more than 1% over the course of three months, starting in May 2013. We don’t expect this to be the case, as markets today, which price in an approximately 55% chance of a rate hike in December, are much more prepared for Fed tightening than they were in 2013. Additionally, even though central bank comments haven’t been as dovish recently, we expect them to remain a force in the near future, which should help limit any rise in yields. We explore this question in more detail in this week’s Bond Market Perspectives, due out later today.
- High-yield spreads compress for the week. High-yield spreads, which did see some widening on Friday as markets turned more risk-averse, still managed to end the week tighter than they started. Energy spreads again saw the largest improvement, with markets potentially seeing recent activity in the energy sector, including some limited land acquisitions and merger activity, as a positive and a sign that the worst of energy defaults are behind us. Spreads near the 5% level remain on the expensive side of fair value in our view, and the potential for complacency regarding oil prices could lead to more downside for the high-yield market if oil prices take a sudden turn lower.
- Bank loans outperform high-yield as rates rise. Bank loans racked up a second week of outperformance versus high-yield bonds last week, with the Barclays U.S. High-Yield Loans Index returning 0.3% versus the Barclays U.S. High-Yield Index which returned 0.0%, as rising rates and another move higher for Libor benefited the sector. We continue to believe that the yield advantage of credit-sensitive sectors such as high-yield and bank loans mean that a small allocation may be suitable for some investors. Bank loans are likely close to fully valued, and call provisions may mean that capital gains may be limited, but the fact that Libor is nearing the 1% floor is a positive for the sector, and may lend a slight edge to the asset class versus high-yield bonds at this stage.
- Municipals down for the week, but outperform as yields rise. The Barclays Municipal Bond Index lost 0.14% last week, though as is often the case when rates rise, the asset class managed to outperform Treasuries, leaving 10- and 30-year AAA municipal-to-Treasury ratios at 90% and 93%, respectively, near the bottom of their recent ranges. The new issue calendar this week is very active, with $14 billion scheduled for sale, though last week’s announcement that muni bond funds experienced a 49th straight week of inflows also shows that investor demand remains strong, and may be able to absorb the higher than average amount of issuance.
- Oil volatility. The International Energy Agency forecast indicated that the oil market will remain oversupplied longer, suggesting both that demand growth will slow and that production will continue. The price of oil has declined on this news, down 2.5% this morning. In our view, there isn’t really a lot of “new news” in this announcement. The resilience in oil production despite relatively low prices is fairly well known at this point. The ability of oil producers to bring new supply to market definitely caps potential upside gains.
- Chinese data shows rebound. Chinese economic data for August rebounded after a very weak July. Retail sales, industrial production, and fixed asset investments all increased and were better than expected. The quality of this data varies. Retail sales can be verified independently, at least to some extent. Fixed asset investment includes infrastructure investments, which are heavily influenced by government policy. Last month was the first in eight that this indicator has risen. Overall, we see the Chinese economy stabilizing on economic stimulus and some increase in consumer spending.
- Bounce back. On the heels of the 2.4% drop on Friday, the S&P 500 bounced back with a solid 1.5% gain yesterday. Remember, it had gone 43 straight days without a single 1% move (up or down), now it has had two in a row. It hasn’t had three straight 1% moves since a streak of six in late June thanks to the Brexit vote. It is worth noting that the last two times the S&P 500 lost more than 2.4% on a Friday and bounced back with a gain of at least 1.4% on the next Monday were August 2007 and April 2000. Both of those times were right before major bear markets. Today on the LPL Research blog we will take a closer look at this development and see if it is as a worrisome as it sounds.
- UK: Jobless Claims (Aug)
- European Commission President Jean Claude Juncker Delivers “State of the Union” Address
- Retail Sales (Aug)
- Philadelphia Fed Mfg. Report (Sept)
- Empire State Mfg. Report (Sept)
- UK: Bank of England Meeting (No Change Expected)
- Household Net Worth/Flow of Funds (Q2)
- EU Leaders Summit Meeting
- Russia: Central Bank Meeting (Rate Cut Expected)