What Are the Odds?
German 10 year bonds go negative. Brits say they want to leave. Investors go to cash. Shoppers shop. FOMC conclave. Net neutrality survives.
Financial Review by Sinclair Noe for 06-14-2016
DOW – 57 = 17,674
SPX – 3 = 2075
NAS – 4 = 4843
10 Y – .01 = 1.61%
OIL – .39 = 48.49
GOLD + 1.70 = 1286.50
The rally for sovereign debt has passed an important milestone, with the yield on Germany’s benchmark 10-year bonds hitting zero for the first time and closed slightly negative, -0.01%. And as German bond yields slide into negative territory, the European Central Bank is running out of German debt to buy for its asset-purchase program. The central bank may have to consider scrapping the minimum yield limit or dropping a rule that prevents it from holding more than a third of any bond issue.
The strong demand is standing out in cautious trade ahead of a series of policy meetings at major central banks and rising uncertainty over whether the UK will stay in the EU. Four polls put the “Leave” campaign ahead of “Remain”. The latest polls show as much as a 7 point lead for the exit camp. The polls might be wrong; they were wrong about the vote for Scottish independence. While a significant numbers of voters say they want to leave the EU, when it comes time to actually cast their vote, fear over the potential political and economic impact might steer them to take the safer course. British betting parlors still have odds of a Brexit at just 40%. One month ago, the oddsmakers were placing a 20% chance on the possibility of the UK leaving the EU. Betting doesn’t tell what the future will be, it tells us what the probable future will be. The bookies are usually right.
Reuters is reporting the ECB would publicly pledge to backstop financial markets in tandem with the Bank of England should Britain vote to leave the European Union. The preparations illustrate the heightened state of alert ahead of the June 23 referendum. An official announcement from the ECB would come on June 24 if an early-morning result showed that British voters had chosen to leave the EU. The aim is to underpin investor confidence across Europe and contain further market jitters. Providing extra funds to banks after a Brexit vote would ease pressure on them and reduce the potential for panic as financial markets digest the result on Friday, June 24, shortly before closing for the weekend. The Bank of England has already sought to avert any liquidity squeeze by providing injections of cheap funding for banks ahead of the vote.
Investors have amassed their largest cash pile since 2001 and cut equity holdings to a four-year low. Even though world bond yields have never been lower and many bank deposit rates around the world are now negative, investors are willing to hold more cash in their portfolios than at any time since November 2001. According to a Bank of America Merrill Lynch report, risk appetite fell to its lowest level in four years, consistent with recession, although growth and profit expectations hit a six-month high and inflation expectations a one-year high. Fund managers held an average 5.7 percent of their portfolio in cash, up from 5.5 percent in May. If you are looking for the pony, consider that there is a lot of cash that can come off the sidelines fast.
The cost of imported goods rose 1.4% in May, the biggest increase in four years, largely because of a rebound in oil prices, which jumped 17.4%. Although import prices are still 5% lower compared to a year ago, they are no longer falling. Excluding fuel, import prices rose a much smaller 0.3% in May. That was still the largest gain since March 2014. The price of goods exported by the US to other nations, meanwhile, climbed 1.1% in May.
Shoppers increased their spending in May. The Commerce Department reports retail sales rose a seasonally adjusted 0.5 percent last month, the second straight increase after a 1.3 percent gain in April. Online and non-store purchases climbed 1.3 percent in May. Sporting goods stores, restaurants, clothiers and auto dealers also enjoyed higher sales. Rising gasoline costs fueled a 2.1 percent jump in spending at gas stations; we didn’t buy more gas, we just paid more. Sales declines hit building material stores, furnishers and department stores last month. Total retail sales have risen 2.5 percent from a year ago.
The Federal Open Market Committee meeting for June kicked off today, with the interest rate decision and press conference due tomorrow. Market implied odds of a rate hike at this meeting have dropped to zero in the aftermath of the latest jobs report. They were higher than 30 percent as recently as May 26. Of course, the FOMC could hike rates or take other action; not likely but not totally impossible. The more probable move is that the Fed continues jawboning.
Today’s retail sales report would probably be enough to justify a rate hike, were it not for the May jobs report, which came in at a very weak 38,000 jobs. Federal Reserve Chair Janet Yellen said in a June 6 speech in Philadelphia, “We are now close to eliminating the slack that has weighed on the labor market since the recession.” And the unemployment rate now stands at 4.7%; if you think back 7 years ago, or even 2 years back, you would think that 4.7% unemployment would indicate full employment, but it doesn’t.
Payrolls have increased by an average of 116,000 per month over the past 3 months; well below last year’s 229,000 per month pace of job growth. The Labor Department reported on June 8 that job openings rose to 5.8 million in April from 5.7 million in March. Hires, meanwhile, fell to 5.1 million, from 5.3 million. Businesses complain that there is a shortfall of qualified workers. Usually this might indicate that we are near an inflection point in the labor market. Business needs workers, even if that means paying up and even training candidates for the position; the scales might be tipping from employers to employees, but the transition is slow.
The National Federation of Independent Business’s optimism index rose 0.2 point to 93.8. Most of the index’s sub-gauges rose or stayed neutral. Fewer owners expect to invest in capital expenditures, and the number of job openings and earnings trends both declined.
Oil prices are down this morning, pushed lower for the fourth consecutive day, despite a bullish report from the International Energy Agency. The IEA revised its demand forecast upward for this year by 100,000 barrels a day, to 1.3 million barrels a day from 1.2 million barrels a day. The possibility of a Brexit is also weighing on oil; if the UK leaves the EU, the British pound will likely take a hit and the greenback will appreciate. As oil trading is conducted in dollars, a stronger dollar would push down oil prices in the US.
Moody’s has placed Microsoft’s ‘AAA’ credit rating under review for downgrade following the software giant’s deal to buy LinkedIn for $26 billion, citing concerns that it would be funded through new debt. Why is Microsoft taking out such a big loan if it has enough cash to buy LinkedIn 4x over? Taxes. Microsoft can avoid paying a 35% tax rate to repatriate cash from overseas and could also deduct interest payments.
Marriott International is on track to win unconditional EU antitrust approval for its cash and share purchase of Starwood Hotels and Resorts Worldwide. The deal $12.5 billion deal will combine Marriott’s Ritz-Carlton and Starwood’s Sheraton and Westin chains together to create the world’s largest hotel company.
Zenefits announced another layoff today. It’s cutting about another 106 people, about 9% of its salesforce, and it is shutting down its Arizona sales office, though it is not pulling out of Arizona altogether.
Iran is preparing to unveil an agreement for Boeing jetliners within days that could be valued at about $25 billion. The transaction would be the first struck by the planemaker since sanctions were lifted in January and would require US government approval. An order listed at $27 billion announced by Europe’s Airbus Group SE also needs a US Treasury Department license before it can be finalized. Boeing is poised to land a comparable deal if they can get the appropriate government permissions. Iranian officials say the country needs to invest about $50 billion to bolster its fleet with 400 mid- and long-range jetliners and 100 short-haul planes.
High-speed internet service can be defined as a utility, a federal court has ruled in a sweeping decision clearing the way for more rigorous policing of broadband providers and greater protections for web users. The decision affirmed the government’s view that broadband is as essential as the phone and power and should be available to all Americans, rather than a luxury that does not need close government supervision.
Today’s 2-to-1 decision from a three-judge panel at the United States Court of Appeals for the District of Columbia Circuit came in a case about rules applying to a doctrine known as net neutrality, which prohibit broadband companies from blocking or slowing the delivery of internet content to consumers. The court’s decision upheld the FCC on the declaration of broadband as a utility, which was the most significant aspect of the rules. For now, the decision limits the ability of broadband providers like Comcast and Verizon to shape the experience of internet users. Without net neutrality rules, the broadband providers could be inclined to deliver certain content on the web at slower speeds, for example, making the streams on Netflix or YouTube buffer or shut down. Such business decisions by broadband providers would have created fast and slow lanes on the internet, subjecting businesses and consumers to extra charges and limited access to content online. Cable and telecom companies say they will continue to fight the rule, and the next step would be to take the case to the Supreme Court; which you will recall is short one justice.