Top of the Street: Credit, callable debt, funding, student loans and government spending

Stretched credit fundamentals, calls in agency debt, rising funding costs, expected downgrades in student debt, a likely limited economic lift from government spending. Items from DB, JPM, Fitch.

Markets: Stretching in investment-grade credit
With some of the highest gross and net leverage in the last 15 years and continuing YoY declines in earnings, “it is hard to ignore that IG issuers in the aggregate are as stretched as they have ever been,” writes Deutsche Bank’s Oleg Melentyev and Dan Sorid. Of course, that has not stopped credit spreads from marching tighter. It’s all relative to other available investments, but Melentyev & Co. keep a balanced eye on credit macro. See the third section of their report US Credit Strategy: Introducing Factor-Weighted Index, 29 Jul 2016. (DB, Milepost).

Markets: It’s the agency calling
More than a third of the agency debt callable in the next 12 months is likely to be redeemed, according to JP Morgan, keeping the pressure up on portfolios reinvesting at current interest rates. Some of the shortest structures, such as 2-year non-call 6-month debt, have nearly an 80% chance of being called. US agencies redeemed $46 billion or roughly 16% their outstanding callable debt in June, the largest share since mid-2011. See JPMorgan’s US Fixed Income Weekly, 30 Jul 2016. (JPM).

Markets: Money market reform pushes up funding costs
The cost of money has jumped since late June with 1-month LIBOR up 4 bp, 3-month up 13 bp and 6-month up 20 bp. Chalk it up to the coming Oct 14 deadline for US money market fund reform. Prime institutional funds, which take in lots of cash from corporate treasurers and invest in a range of assets, have to start posting floating daily prices and potentially impose liquidity fees and gates in a crisis. In expectation of $100 billion to $800 billion in withdrawals, these funds have cut back on longer investments. Longer LIBOR rates should remain elevated after Oct 14, as should the cost of longer bank funding. See JPMorgan’s US Fixed Income Weekly, 30 Jul 2016. (JPM).

Markets: Fitch finalizes rules on FFLEP
Fitch will likely downgrade a sizable share of outstanding ABS backed by FFLEP student loans in coming months, although most have been on Fitch’s watch list since December. This comes as the agency last week finalized its rules for rating the ABS. Fitch had proposed draft rules in December and noted then that 55-60% of AAA classes could remain AAA and that 10-15% of AAA and 35% of subordinates could drop below investment grade. The final rules only involved small changes from the December draft. Student loan ABS currently trade at some of the widest spreads in the ABS market. (Milepost).

Economics: Global fiscal stimulus: meh
With central bank efforts showing few signs of getting economic growth back to some version of normal, some countries, including Japan this week, have reached for the government purse. But Peter Hooper and his Deutsche Bank team this week conclude that global fiscal easing might lift real growth by only 21 basis points. Hooper lays out the pluses and minuses of spending our way out of the mud. Fiscal stimulus could work if it persists, Hooper notes, but spending eventually loses its mojo as the public anticipates higher taxes to pay for it all. Deficit can trump tax-and-spend but only because debt defers taxes to later. Government spending and infrastructure work better than transfers to consumers in part because consumers usually save some of the money. And stimulus works better with high than with low unemployment because government jobs just crowd out private hiring. It also helps if central banks resist counteracting possible inflation. And foreign exchange rates can counter fiscal stimulus as growth and monetary policy raise the value of the currency and curb exports. Nothing is simple, but Hooper’s usually balanced approach lays out the possibilities. See Global Economic Perspectives: Global fiscal stimulus to the rescue? 26 July 2016. (DB, Milepost).