Covenant Weekly Market Synopsis as of February 26, 2016

February 26, 2016

Equities, for the most part, built on last week’s gains, advancing 0.6% – 2% in developed and frontier markets. Meanwhile, emerging markets were slightly negative on the week dragged down by a 3.5% decline in Chinese equities. US Treasuries were flat on the week, though the 10-year yield touched an intraday low of 1.65% on Wednesday before closing the week at 1.76%. Precious metals declined, copper rose, and the US Dollar bounced +1.6%, but none of these moves were particularly large. On the other hand, WTI Crude nearly cut year-to-date losses in half, rising 10.9% to $32.97 per barrel. Today, the Bureau of Economics revised Q4 2015 GDP growth from 0.7% to 1%. The revision was unexpected, and while positive, 1% annualized growth is not worth writing home about. On a brighter note, Consumption was up 0.5% in January (the strongest reading since last May) implying that fears of an imminent recession are overstated.

Detailed asset class performance data is available here.

Shrinkage – If you have even a passing interest in the rise and fall of oil production in the U.S. since 2011, this is a must see infographic.  It provides extraordinary detail, allowing you to watch the contemporaneous movements of Total Rig Count, Oil Price and Crude Production over the last five years. Moreover, you can ‘drill’ down to see how oil production has changed in specific counties by moving the mouse pointer to different locations on the map.

Interest Rate Path – Once one of the more hawkish members of the Federal Open Market Committee (FOMC, the group that determines monetary policy in the U.S.), St. Louis Fed President James Bullard abruptly changed course last week. Bullard had argued throughout 2015 that the FOMC should raise the Federal funds target interest rate, so it is notable that he has done a 180 to turn dovish “I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations”. It’s not only Bullard that has declining inflation expectations, the Conference Board’s February survey of consumers’ 12-months ahead inflation expectations registered its lowest level in eight years. Turning to the markets, according to data provided by Bloomberg, coming into today, the market was only pricing in a 10% chance that the Fed will raise rates at their March meeting, and a mere 35.7% chance that the Fed will increase rates at all in 2016. Following this morning’s data release which showed stronger than expected consumption and inflation levels (see Economic Data Summary below), the market increased the odds of a rate rise in 2016 to 53%, and the yield on the 10-year jumped from 1.72% to 1.78% (it later closed at 1.76%). The table below from Bloomberg shows the market implied probabilities of interest rate increases at each of the next FOMC meetings.

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Taking Bullard’s comments and actual market positioning into account, it appears we can expect rates to rise very slowly. However, these circumstances also create a condition in which a faster than expected pace of rate increases will catch a majority of the market offside, generating large losses for certain fixed income instruments.

Economic Data Summary: The Conference Board’s measure of consumer confidence fell from 97.8 to 92.2 in February, likely reflecting the toll that financial market turmoil has had on consumers. US Existing Home Sales notched up to 5.47 mm in January, bringing the 12-month moving average to a new nine-year high. Meanwhile, US New Home Sales in January came in at 494k, slightly below consensus estimates, but still at a respectable level. Moreover, the 12-month moving average is 10% higher than the level seen last January. Although new home sales are being constrained by tight inventory as developers are simply more risk averse than prior to the Financial Crisis, the overall housing market (along with consumption) remains one of the brighter spots in the domestic economy. As noted above, Consumption levels in January were solid and December’s data was revised from flat to +0.1%. Wage and salary growth data were also strong, with Disposable personal income increasing by 0.5% (the strongest growth since May ’15). Growth in income should lend support to future Consumption levels – if not immediately then down the road.

Be well and enjoy the w/e,

Jp