Top of the Street: Low inflation, the spread impact of corporate tax reform and concern in CMBS

Surprisingly low US inflation gives the Fed more room to run with low rates. The Street sifts the investment impact of corporate tax reform. CMBS worries about weakening prospects for retail. Contributions from DB, GS, JPM, the SF Fed.

Markets: Still waiting for inflation
“Core PCE inflation has increased at an annualized rate of only 1.0% over the last three months,” notes Goldman Sachs this week. “If the latest run rate were to persist over the next four months, the year-over-year rate of core PCE inflation would fall to just 1.3% by the April report—the last available to the FOMC before its June meeting.” Goldman still expects inflation to eventually meet the Fed’s 2% target. Still, the slow pace of inflation for now could push the next Fed hike to June. Or beyond. See Goldman’s US Economics Analyst: Core Inflation Roadmap, 10 Feb 2017. (GS, Milepost).

Markets: The tipping point on corporate tax reform
Corporate earnings get pinched under proposed tax reform as lower corporate rates help earnings while cuts in the interest expense deduction hurt. The tipping point, according to JP Morgan, comes in the average ‘B’ rated company. Earnings on stronger balance sheets rise by 7% to 9%, according to the bank’s analysis, while earnings on weaker balance sheets fall by 15%. The ‘B’ rated companies roughly break even. The differences reflect debt load -- low for the stronger companies, high for the weaker.  Lower tax rates help all. As debate on reform continues, the fortunes for companies above and below the tipping point should change along with their debt spreads. See JPMorgan’s Credit Market Outlook & Strategy, 09 Feb 2017. (JPM, Milepost).

Markets: Lower corporate issuance and wider swap spreads
Eliminating the deduction for interest expense could reduce corporate issuance by as much as 28%, according to Deutsche Bank, and widen 10- and 30-year swap spreads by 5 bp. The lower issuance would reflect the higher effective cost of debt. The wider swap spreads would reflect a drop in demand to swap new issuance from fixed to floating. See Deutsche Bank’s US Fixed Income Weekly, 12 Feb 2017. (DB, Milepost).

Markets: CMBS investors worry about getting malled
Steady pressure from e-commerce on the stores that often anchor retail malls keeps pushing spreads wider on some CMBS. Credit default swaps on deals with the most mall exposure, such as CMBX Series 6 BBB-/BB, widened as much as 11 bp last week as new investors reportedly have started coming into the market to take short positions. Other speculative grade CMBS credit default swaps have widened, too. Goldman Sach’s also weighs in with a few highlights of the hard times for retailers and the impact on commercial real estate and CMBS. See JPMorgan’s US Fixed Income Markets Weekly: CMBS, 10 Feb 2017, and Goldman Sach’s The Mortgage Trader, 10 Feb 2017. (JPM, Milepost).

Banking: Crash and learn
When banks take a hit in the loan book, other borrowers may not feel the pain, according to a recent study by the San Francisco Fed. Banks with loans to oil and gas firms tightened lending when oil prices began to plummet in mid-2014, but many of those firms still found financing. Banks with less exposure to energy, the capital markets and other sources stepped into the breech. Banks affected by the energy crash tightened local mortgage credit, too, but loosened it on loans that fit agency MBS. Competitive lending markets cushioned the borrower impact of the energy crash. The San Fran Fed paper is here.