Top of the Street: Politics and markets

Top of the Street: Politics and markets

All Brexit, all the time. The Street interprets its impact on rates, credit and anything else that trades. The muni market handicaps the US presidential race. Contributions from JPM, GS, DB, Barclays.

Markets: Rate expectations
One more Fed hike, most likely in September, and a 1.70% rate on US 10-year notes by the end of the year. At least that’s what JPMorgan’s rates team is now expecting. A further 10-12 bp drop in 10-year rates also makes it onto JP’s list if the UK votes this week to leave the EU, a 5-7 bp rise in rates otherwise. Goldman Sachs sees a bigger swing on Brexit, with 10-year yields dropping 30 bp if the UK votes to leave and 20 bp if it votes to stay. For Deutsche Bank, however, Brexit is just the latest symptom of broader global economic uncertainty that should keep rates low regardless of this week’s results. And the rates market broadly agrees, putting the forward 10-year Treasury rate at 1.77% on the last day of 2016. See JPMorgan’s US Fixed Income Markets Weekly, 17 Jun 2016, Goldman Sach’s Global Markets Daily: Where Would Bond Yields Go in the Event of Brexit, 20 Jun 2016, and Deutsche Bank’s US Fixed Income Weekly, 17 Jun 2016. (JPM, GS, DB, Milepost).

Markets: All credit markets eyes on the UK
The credit crowd expects spreads on corporate debt and structured products to widen if the UK votes on Thursday to leave the EU. Some of that would come as central banks pump cash into the markets and drive down yields on sovereign debt. Some would come as capital fled the EU into US Treasuries. And some would come simply because Brexit would hurt fundamental economic growth. Corporate debt, CMBS and other spread sectors trail behind the sovereign curve in that case. The IG corporate sectors seem especially vulnerable since 30% of that debt comes from the financial sector, which would reflect economic risks. But Oleg Melentyev and Dan Sorid at Deutsche Bank argue that wider credit spreads reflect emerging weakness beyond energy names and point to increasingly tight financing terms in riskier parts of the high yield market.  See Deutsche Bank’s US Credit Strategy: Illusory Benefits of Cheap Money, 17 Jun 2016. (DB, Milepost).

Markets: Muted MBS prepayment risk
For every 10 bp drop in Treasury rates, the rate available to mortgage borrowers should drop only 5 bp, according to JP Morgan. Chalk up the drag in mortgage rates in part to limited capacity among mortgage originators to process refinance applications. The slow response in primary mortgage rates should give some protection to holders of MBS. And that’s worth noting as Bankrate.com’s average primary 30-year mortgage rate hovers around 3.66%. See JPMorgan’s US Fixed Income Markets Weekly, 17 Jun 2016. (JPM, Milepost).

Markets: The muni market watches the US
Tax, infrastructure, healthcare and energy policy are the places where the two likely US presidential nominees could have the most impact on the muni market, according to Barclays. A simpler Republican tax structure could trim muni valuation while more taxes on high earners under a Democrat and a cap on itemized deductions could raise muni value. Both parties favor big infrastructure spending, which could boost muni issuance. Republicans propose to roll back Obamacare, with the Democrats keeping it. The Republicans would revitalize coal, with the Democrats pushing renewables. See Barclays Municipals and the US Elections: All Eyes on November, 15 June 2016. (Barclays, Milepost).

Markets: Behind the latest fall in inflation expectations
Expectations for 5- or 10-year inflation keep falling in both surveys and market measures, but Goldman Sachs argues for looking behind the averages. Most of the drop in survey measures has come from fewer participants looking for very high inflation, which these days means something above 3%. That has outweighed a decline in participants expecting inflation below 1%. Goldman reads this as a strengthening consensus around inflation in the neighborhood of the Fed’s target and sees little reason for the Fed or the markets to worry. See Goldman’s US Economics Analyst: Expectations Anchor Still Secure, 17 Jun 2016. (GS, Milepost).