March 2. Corporate buybacks funded with debt boost stocks, but increase risk

–Yields eased Friday with tens down 1.7 bps to close at exactly 200 bps at the futures settlement.  Back month eurodollars were up 3-3.5 bps.  Somewhat interesting to note that USDCNY had made a new high Friday over 6.27, and on Saturday the PBoC cut rates for the second time in three months, (not that anybody could have known…)  Again, the slowdown in China coupled with a weaker currency means deflationary exports to the US.
–Open interest in treasury futures was once again down right across the board with TU -26k, FV -28k, TY -31k, US -19k and WN -5k.  Though the roll of March contracts is probably the main factor, these are total open interest numbers.
–From the Fed’s Vice Chair Stanley Fischer on Friday:  “I know of no plans to behave by following one of those deterministic paths for the next three years,” Fischer said. “I expect that our interest-rate policy will continue to be data driven, and that interest rates will be set at each meeting on the basis of what the FOMC believes will best enable us to meet our dual goals” for price stability and full employment. (BBG)
–Fischer is trying to move the Fed and the market away from the idea of pre-determined rate moves, perhaps to inject a bit more uncertainty and market discipline into the mix.  Certainly he wants to get away from the zero bound.  I would suggest that some of the reason might be due to concerns about financial stability.
–In that regard, I would note a couple of things.  First, Moody’s downgraded Chicago’s debt to Baa2 Friday and warned it could fall further.  (Reuters) – Chicago drew closer to a fiscal free fall on Friday with a rating downgrade from Moody’s Investors Service that could trigger the immediate termination of four interest-rate swap agreements, costing the city about $58 million and raising the prospect of more broken swaps contracts. [Get ready for the city to shave another few tenths of a second off yellow lights to boost red light camera ticket revenues].  The much broader question is, does the piper EVER get paid?  Will the city and Illinois ever tackle the pension and other problems to dig out?  It’s really a global question.
–Low rates didn’t cause Chicago’s problems.  But higher interest costs are going to accentuate them.  Near zero rates are creating fault lines in other ways though.  There was a fascinating zerohedge article over the weekend citing Goldman and DB research noting record stock buybacks which have almost single-handedly created the bid for equities. http://www.zerohedge.com/news/2015-02-28/here-reason-why-stocks-just-had-their-best-month-october-2011
Certainly, safe haven flows from non-US investors are another factor, but the article notes that in 2014 net equity inflows were $415B from corporations and just $103B from foreign investors.  In conjunction with these figures (though not from the article) are the Fed’s flow of funds data.  As of the end of Q3 2014, Corporate debt outstanding is a record $7.438T, up $404B yoy at a rate of 5.5%.  Net equity buybacks are almost exactly equal to the increase in corp debt.  The conclusion of course, is that companies are simply substituting debt for equity, thereby making earnings comparisons look good, but increasing risk.  Shouldn’t corporate debt be used for new technological investments?  Even if companies are funding capex (at its abysmal rate) out of cash flow, the article further notes that expected corporate revenues will show a yoy DECLINE in 2015. Is this dynamic part of what Fischer wants to lean against?

Posted on March 2, 2015 at 4:40 am by alexmanzara · Permalink
In: Eurodollar Options

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