Market Update

• Global markets mostly higher; central banks, G20 in focus. U.S. equities opened mixed this morning, though overseas indexes are mostly higher as traders are looking ahead to a series of central bank meetings this week; overnight, Australia’s central bank opted to maintain the status quo, as expected. Looking back, U.S. equities ended higher last week after gains in Friday’s session were led by energy, utilities, and materials. Asian markets advanced overnight on the heels of an announcement from China’s central bank that it would ramp up fiscal spending in another effort to fuel its economy; the Shanghai Composite rose 0.6%, while the Nikkei Index finished up 0.3%. Elsewhere, WTI crude oil is moving lower ($44.25/barrel) after an initial jump following an agreement between Russia and Saudi Arabia at last weekend’s G20 summit to help stabilize prices. COMEX gold is up almost 1% ($1339/oz.), and the yield on 10-year Treasury note is little changed at 1.60%.

Macro View

• Credit sectors outperformed in August. Credit-sensitive areas of the bond market, including high-yield, emerging markets debt (EMD), and bank loans, saw the strongest performance in August[1]. The backdrop of rising rates was a headwind for Treasuries and the broad high-quality bond market. Treasury yields remain range bound for the time being, as fixed income markets search for direction amid mixed messages from the Federal Reserve Bank (Fed) and middle of the road economic data. We discuss this phenomenon in this week’s Bond Market Perspectives,due out later today.
• 10-year testing 1.6% resistance level. Friday’s jobs report was enough to push the 10-year Treasury to the top of its recent range, leading yields to close above 1.6% for just the second time in as many months. An unsteady mix of economic data, along with continued demand from foreign buyers, has kept the 10-year yield range bound between 1.5% and 1.6% since mid-July. We continue to believe that more consistent data (good or bad) are likely needed before Treasuries are able to break meaningfully out of their current range.
• Inflation expectations remain muted. Inflation expectations have been range bound in recent months as well, with a current 10-year breakeven (10-year Treasury yield minus 10-year TIPS yield) of approximately 1.45% remaining well below the Fed’s 2% target. Longer-term 30-year breakeven levels also remain stubbornly low at 1.66%, showing that markets believe the Fed’s targets may never be met. Though we don’t expect a significant rise in core inflation, we believe the market may be underpricing the potential of an uptick in headline inflation, given that oil prices staying at current levels may cause headline Consumer Price Index (CPI) to exceed the Fed’s 2% target.
• Drop in oil prices gets mixed reaction from bonds.High-yield bonds shrugged off last week’s decline in oil prices, with overall spreads remaining basically flat for the week; but energy spreads actually compressed by 0.14%. EMD, which has seen strong performance in recent months, took an opposing view, with spreads widening by 0.11%. We continue to believe that both high-yield bonds and EMD are on the expensive side of fair value, though given the reach for yield in the current environment, we also don’t expect a sharp reversal absent an economic shock that impacts the credit markets.
• Is Libor finally starting to impact bank loans? Bank loans managed to log a week of outperformance versus high-yield bonds for the first time since late July, as both asset classes saw positive returns last week. The rise in three-month U.S. dollar Libor (London interbank offered rate) continued last week, though the rate of increase slowed, with last week’s increase amounting to less than abasis point. At a current yield of 0.83%, Libor remains below the 1% floor implemented by most bank loans, though forward-looking market participants may be starting to look at the impact a continued rise may have on the asset class.
• Oil rallies, then stalls. The most interesting item from the G20 summit in China over the weekend was an agreement between Russia and Saudi Arabia to work together during the OPEC meeting later this month. Oil prices rallied on this news. But what did the parties actually agree to? The agreement is little more than a symbolic gesture. It does make an output freeze more likely, though even the real impact of such a freeze would be questionable. Oil prices pared their gains as the impact of this agreement became clearer.
• Dividend-paying stocks have been thriving in the low interest rate environment[2]. Investors have increasingly used stock dividends as a substitute for fixed income in the low interest rate environment. But has the market’s thirst for yield gone too far? In our latest Weekly Market Commentary, due out later today, we take a look at high-dividend-paying stocks to assess whether they are in a bubble and whether those yields should be viewed as a warning sign.
• Will this be a September to remember? This week in theWeekly Economic Commentary, due out later today, we will take a look at all of the many important events ahead this September. Most months have important events, but with the U.S. presidential election right around the corner, this month is even more significant, and we’ll run through 11 of the most important market and economic changing events. The August jobs report and the G20 summit have already happened, but the rest of this month still has interest rate decisions from the European Central Bank, Fed, and Bank of Japan. Also on tap in September are hurricane season, presidential debates, an emergency OPEC meeting, and more.
• Another look at September equity seasonality. We noted on the blog last week that September tends to be a weak month historically. Today on the blog we’ll take another look at seasonality and how it relates to where things are right now. The S&P 500 had its worst start to a year ever after 28 days and is now to up 6.7% year to date, which is stronger than the average year since 1950 at this point in the year. What matters though is that from mid-September until late October has been a time of seasonal weakness.
• Busy week ahead for data and events amid a quiet week for U.S. data. The week after the release of the monthly jobs report is typically a quiet one for U.S. economic releases, and this week is no different, with the service sector Institute for Supply Management (ISM)report for August as the only key entry on the docket. There are a few Fed speakers, including Federal Open Market Committee (FOMC) voter Rosengren, and the Fed will release its Beige Book ahead of the September 20-21 FOMC meeting. Overseas, the key events are the start of the Chinese data release for August and the European Central Bank meeting on September 8.[1] As measured by the Barclays US High Yield Index +2.09%, JPMorgan EMBI Global Index +1.80%, and the Barclays High Yield Loan Index +0.78%, versus the Barclays US Aggregated Government Treasury Index -0.55%.

  [2] YTD, S&P GICS Telecom Services +19.64%, Utilities +16.62%, versus S&P 500 +8.27%.

Monitoring the Week Ahead

Tuesday

• ISM Non-Mfg. (Aug)

Wednesday

• JOLTS (Jul)
• Beige Book
• Germany: Industrial Production (Jul)
• Sweden: Riksbank Meeting (No Change Expected)
• Canada: Bank of Canada Meeting (No Change Expected)
• China: Imports and Exports (Aug)

Thursday

• Eurozone: European Central Bank Meeting (No Change Expected)
• China: CPI (Aug)
• Japan: Economy Watchers Survey (Aug)
• Japan: Money Supply (Aug)

Friday

• European Union: Central Bankers and Finance Ministers Meeting in Bratislavia
• China: New Loan Growth and Money Supply (Aug)

Saturday

• European Union: Central Bankers and Finance Ministers Meeting in Bratislavia

 

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) are subject to interest rate risk and opportunity risk. If interest rates rise, the value of your bond on the secondary market will likely fall. In periods of no or low inflation, other investments, including other Treasury bonds, may perform better.

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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