Nov 18. Inflation measures are low, but high yield spreads may start to expand

–Light volume Monday which featured a steepening curve.  Red/gold pack spread rose nearly 5 bps to 180.5.  Ten year yield was up 2 to 233.6.  Two year yield was lower by 1/2 bp.
— Gold is a star performer this morning up nearly $20 and over $1200, EUR has also rebounded to above 125, and oil too, is moving higher. Today’s news includes PPI expected -0.1 headline but +0.1 Core.  Several analysts pointed out that one of the Fed’s preferred inflation measures, 5 year forward inflation expectations, made a new low yesterday.  Not too surprising as 5/30 treasury spread is also near a new yearly low.  The ten year inflation index note spread to 10y treasury is likewise at a new low just below 188.   Given the plunge in commodities including oil, and corresponding strength in the USD, it’s no surprise that measures of inflation are in the dirt.  Next year’s comparisons will almost certainly indicate an inflation bounce, as long as the EU can avoid a debilitating asset depreciation spiral.
–The other interesting aspect of yesterday’s trade was divergence in stock index net changes.  DJIA and SPX were both higher, while Nasdaq finished with a small loss, and Russell small caps were again the weak link, closing down nearly 1%.  High yield ETFs HYG and JNK also are showing signs of rolling over, both lower yesterday, and now testing gaps left from October 16 after the plunge and subsequent bounce.  My guess is that high yield will again become the focus of trouble ahead, given record levels of business debt ($11.6T, nearly as large as Fed’l gov’t at $12.6T).  It’s not a problem if underlying assets stay strong and rates low; cash flows can easily service debt in this environment.  However, if underlying assumptions start to change, then it may become much more difficult to roll loans.  Given fairly heavy trading volumes of the ETF’s, it’s a quick way to track high yield sentiment.

Posted on November 18, 2014 at 5:19 am by alexmanzara · Permalink
In: Eurodollar Options

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