Top of the Street: Growth without inflation, fuzzy Fed rates, the rise of Super Firms and MBS gets the REIT stuff

Global growth continues without inflation. The Fed’s terminal may be falling. Super Firms take profit share. MBS gets a lift from REITs, and more. Contributions from Barclays, DB, GS, Wells Fargo and Milepost.

Markets/economy: Steady global growth, no visible inflation
Prospects for global growth continue to improve. China came in last week at 6.9% YoY, slightly above expectation despite government efforts to reduce state-owned enterprise debt. The US, UK, France and Spain report this week. EU growth should continue around 2%, US around 2.5%. Despite full capacity in a number of countries – US, Germany, Japan – inflation is still a marshmallow. Central banks will likely struggle tighten without clear signs of rising inflation. Look for the Fed next week to pass on a hike and signal a reduction in balance sheet starting in September. See Barclays, Global Economics Weekly: A tough time to be a central banker, 21 Jul 2017. (Barclays, Milepost).

Markets: Looking for the Fed’s terminal rate
The Fed’s dot forecasts have signaled for more than a year that the central bank thinks the neutral rate for fed funds is around 3.0%, down from 4.25% since 2012. But that natural rate may sink further. The Fed has acknowledged along the way that the current natural rate is near zero but expects that rate to rise. Lately, however, confidence that it will rise has possibly waned. Governor Brainard this month echoed earlier comments from Chair Yellen and Governor Williams that any rise in the natural rate may take longer than expected. If so, flagging confidence in a rising neutral rate could mean that most of the Fed’s work has already been done. The Fed may not have many hikes left. Any signal of that should show up in new and lower dots and lead to lower rates across the curve. See Deutsche Bank, US Economic Perspectives: How far to r-star?, 24 Jul 2017. (DB, Milepost).

Markets: The rise of Super Firms
S&P 500 profit margins have started to rise again after hitting a 65-year peak in 1Q15 and then dropping, and an increasing share of those profits are going to fewer firms, according to Goldman Sachs. From 1998 to 2016, the five largest firms increased their share of revenues in 12 out of 19 business categories studied by the bank. Rising industry concentration typically is followed by rising profit margins. Technology, globalization and public policy all may have contributed to the rise of these Super Firms, which tend to be much more productive than their smaller competitors. The analysts think technology is the driving factor. See Goldman Sachs, US Economics Analyst: Super Profits and Superstar Firms, 22 Jul 2017. (GS, Milepost). 

Markets: MBS gets the REIT stuff
Central bank policy could end up giving MBS a lift, according to Wells Fargo. Slow Fed tightening has helped lift broad equity valuations this year, mortgage REITs included. REITs have issued $2.1 billion in equity into the stronger bid, according to the bank, creating more than $14 billion in buying power.  “Potential MBS widening in response to the Fed’s tapering of reinvestments could further elicit REIT interest (in MBS),” the bank’s analysts write. Wells started this year assuming no net new REIT investment in MBS but raised its estimate last week to $25 billion. The bank expects 30-year MBS to benefit the most with 15-year MBS and ARMs next. A flatter yield curve, however, could dampen REITs’ appetite. See Wells Fargo, Agency MBS Weekly: REIT Rebound, 21 Jul 2017. (Wells Fargo, Milepost).

Markets: Caution on auto ABS
A likely decline in annual auto sales and loose auto loan underwriting from 2011-2016 point to rising auto loan ABS losses, Goldman Sachs analysts write. “We think the ABS are structured in such a way that senior bonds will be insulated from actual writedowns,” the analysts note. “However, bad news in the auto sector will likely translate into spread volatility for the auto ABS bonds.” See Goldman Sachs, MBS Trader, 21 July 2017. (GS, Milepost).

Markets: Opportunity in Illinois
In the aftermath of Illinois’ passage of a budget this month for the first time in three years, a related market has suddenly perked up. This one focuses on the $14.6 billion in unpaid Illinois state bills. State law allows vendors to sell their state government receivables to trusts, which issue debt to fund the purchase. With the state suddenly looking like it may be able to pay, interest in this market has returned, especially since many of the notes pay 8.5% to 9.5% at the end of their 2- to 3-year maturities. See Barclays, Municipal Research: Investing in Illinois Receivables, 21 Jul 2017. (Barclays, Milepost).