Market Update

• Global stocks jump, oil breaks above $50. U.S. markets closed in the green yesterday and are on the upswing again, following comments from Federal Reserve Bank (Fed) Chair Janet Yellen that soothed investor fears about the pace of potential rate hikes. The bullishness carried into global markets overnight, as Asian equities finished higher across the board, and in afternoon trading European markets are looking to do the same. Monday’s session saw a 0.03% bounce in Treasury yields, which boosted financials, but caused telecom and utilities to close lower. WTI crude oil moved back above $50/barrel on continued softness in the dollar, and COMEX gold is moving lower.

Macro View

• Rate hike expectations decline on weak jobs figure.The market-implied probability of a June rate hike dropped from 21% on Thursday (June 2) to less than 4% as of yesterday. The weakness of the May jobs report sent rates down across the yield curve on Friday. Shorter-term yields fell as the market believed a June rate hike was all but taken off the table; longer-term yields fell on concerns over the pace of economic growth. According to the futures markets, by the end of 2016, there is a 43% chance of one Fed rate hike during the year, 34% chance of no rate hikes, and 23% chance of more than one rate hike. Long-term fed funds rate expectations reached their most benign ever, with the market implying a rate of 1.78%, well under the Fed’s median projection of 3.25%.

• Yield curve continues to flatten. The decline in short-term interest rates on Friday (as a result of reduced interest rate hike expectations) steepened the yield curve slightly, but not enough to keep it from flattening overall on the week. Reduced growth expectations, despite the implication of a more dovish Fed, indicate the bond market is not convinced that the economy is ready for interest rate hikes, which are still likely in coming months based on Yellen’s comments on Monday.

• 10-year Treasury hits meaningful 1.7% level of resistance. The 10-year yield fell over 0.15% last week to end the week at 1.7%. This level has proven to be a strong resistance point, as it represented the bottom in yields in 2013 pre-taper tantrum, in early 2015, and multiple times thus far in 2016. Therefore, another catalyst may be needed before this barrier is breached.

• ECB corporate bond purchase program set to begin this week, but impact largely priced in. The European Central Bank’s (ECB) Corporate Securities Purchase Program (CSPP) is set to begin on June 8. This program was initially announced in March, and brings corporate bonds into the European quantitative easing (QE) program, in an attempt to lower debt costs broadly. Though the first purchases are yet to be made, European corporate yields have fallen significantly, showing that the market has priced in its impact, making further broad gains less likely. Still, the low-yield environment is likely to push foreign cash toward the relatively higher yields in U.S. markets, potentially keeping a lid on U.S. Treasury and corporate yields as well. We discuss further in this week’s Bond Market Perspectives, due out later today.

• High-yield rally takes a break as oil stalls and jobs disappoint. High-yield bonds eked out a gain of 0.16% for the week based on the Barclays High Yield Index, butspreads moved higher to close the week at approximately 6.1%. Most of the movement came on Friday, as Treasuries unsurprisingly outperformed the credit-sensitive high-yield sector in the aftermath of the weak employment report. Overall though, the correlation between high-yield and the price of oil remains strong, and we continue to view high-yield bonds as fair to slightly expensively valued, given the expected continued rise in defaults.

• Municipals underperform Treasuries^[1] as weak seasonal period begins. The 10- and 30-year AAAmunicipal-to-Treasury ratios moved higher to close the week at 97% and 103%, respectively, as municipalsunderperformed during Friday’s Treasury rally. Supply, as is typical in June, may act as a headwind in the week ahead, as the 30-day visible supply ended Friday at nearly $16 billion, near a one-year high.

  ^[1] As measured by the Barclays Municipal Bond Index and the Barclays US Aggregate Government- Treasury Index.

• Yellen stays data dependent. During a speech in Philadelphia on Monday, Fed Chair Janet Yellen reiterated that the next Fed rate hike is data dependent, and that the rate hike path would be gradual. She did not repeat the phrase she used on May 27 that rates would be going up “probably in the coming months.” In addition, Yellen largely dismissed the weak May jobs report, reminding the audience that “one should never attach too much significance to any single monthly report.” The bottom line is that a July hike remains on the table, but is dependent on a strong run of data over the next eight weeks or so.

• Small caps and mid caps in new bull markets. We have mentioned lately that small caps are finally starting to lead after lagging for years. It doesn’t stop there though, as mid caps are also performing well on a relative strength basis. In fact, from the lows on February 11, small caps are up nearly 24% and mid caps just cracked 22%. In other words, if down 20% is a bear market, you could argue that small and mid caps are now in bull markets. For comparison, the S&P 500 is up 15% over this time frame. Historically, healthy bull markets have strong participation from small and mid cap names; this could be another nice positive for the bulls here.

• Highest close in 2016. The S&P 500 gained 0.5% yesterday, for its highest close of the year and highest since November 3. In fact, the S&P 500 is now just 1% away from a new all-time high. It is worth noting that the S&P 500 Total Return (including dividends) did close at another new all-time high yesterday. For the year, the S&P 500 is now up 3.2%, a far cry from the 10.5% drop after the first 28 days of the year. Remember, that was the worst start to a year ever for the S&P 500. Fortunately, improvements in energy prices and credit markets (among other things) have stabilized and allowed for equity prices to bounce back.

Monitoring the Week Ahead

Tuesday:

• FOMC Quiet Period Begins
• India: Reserve Bank of India Meeting (No Change Expected)
• China: Imports and Exports (May)

Wednesday

• JOLTS (Apr)
• Brazil: Central Bank Meeting (No Change Expected)
• China: CPI (May)
• Japan: Economy Watchers Survey (May)

Thursday

• Flow of Funds (Q1)
• ECB’s Draghi Speaks in Brussels
• China: Money Supply and New Loan Growth (May)

Click Here for our detailed Weekly Economic Calendar

 

Important Disclosures

Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio, as the principal is adjusted semiannually for inflation based on the Consumer Price Index (CPI)—while providing a real rate of return guaranteed by the U.S. government. However, a few things you need to be aware of is that the CPI might not accurately match the general inflation rate; so the principal balance on TIPS may not keep pace with the actual rate of inflation. The real interest yields on TIPS may rise, especially if there is a sharp spike in interest rates. If so, the rate of return on TIPS could lag behind other types of inflation-protected securities, like floating rate notes and T-bills. TIPs do not pay the inflation-adjusted balance until maturity, and the accrued principal on TIPS could decline, if there is deflation.

Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.

High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.

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