BMA Market Insights: Market Jitters Continue, Experts Discuss LIBOR’s Replacement

The markets’ jitters were felt throughout last week as volatility remained high with Treasury yields ricocheting as the stock market endured tumultuous swings. Trade tensions, lower global growth forecast, and rising Treasury yields all triggered a selloff in equities mid-week. Last Wednesday, the Dow Jones had its biggest drop since February, falling 831 points. Both Apple and Amazon saw their steepest descent in about two and a half years. The S&P 500 also then dropped about 3.2%.

Nevertheless, equities bounced back on Friday on the back of strong corporate earnings and solid Chinese trade data that assuaged concerns about global growth weakening. Further, some market practitioners felt possible Chinese/U.S. trade tensions easing, when the U.S. Treasury Department reported that China is not manipulating its currency. The late week developments lifted Treasury yields, with the 10-year capping off the week at 3.167%. Domestic equity markets also rallied on Friday, although the S&P 500 and Dow Jones had their worst week since March.

Oil also edged higher towards the end of the week, but rising crude supplies attributed to a 4% weekly loss, the biggest drop in over a month.

Separately, industry experts and members of the Alternative Reference Rates Committee “ARRC”, the committee convened by the Fed to find a replacement for LIBOR, participated in a roundtable discussion regarding the current status of LIBOR’s replacement (see more below).

I. U.S. Economic Data/Markets

• September Consumer Price Index rose less-than-expected at 0.1% versus expectations of 0.2% and compared to rising 0.2% in August.
  • For the year ending September, the CPI rose 2.3%, compared to the year ending in August with a 2.7% rise.
  • The more subdued inflation can partly be attributed to falling energy prices and a smaller-than-expected increase in rents.
• Mortgage rates jumped to a seven-year high, according to Freddie Mac.
  • The 30-year fixed-rate average jumped to 4.90%, the 19 basis point week-over-week change was the biggest increase since November 2016. A year ago, the rate was about 3.91%.
  • Similarly, the 15-year rate moved nearly 15bps to 4.29% over the week.
  • Strong U.S. economy, trends in U.S. Treasury yields and bullish rhetoric from Fed Officials served as a boon to rates.
• Jeff Gundlach, the highly respected bond investor noted that bond yields could jump to multi-year highs by year end, with the curve steepening as well given the recent trends in the market.
  • His forecasts included 10-year and 30-year Treasuries possibly hitting 3.6% and 4% respectively.

II. Trade Talk

• Brexit meeting is scheduled for mid this week with less than six months to go before the UK leaves the EU.
  • As of Friday UK Prime Minister, Theresa May, was struggling to find a consensus among her ministers for a Brexit proposal. One of the biggest bottlenecks is the Irish border issue.

III. Other

• Secured Overnight Financing Rate, “SOFR” (LIBOR’s replacement).
  • The Bipartisan Policy Center held a panel discussion on SOFR with key stakeholders focused on SOFR, including architects of ARRC which has been charged with developing and implementing SOFR. Key takeaways from the discussion included:
    • No certainty whether LIBOR will be completely discontinued after 2021 or that it will remain. But given the challenges in producing LIBOR in a robust manner for an extended period of time, odds are that it will stop at some point.
    • Key for markets to understand the basis risk between LIBOR and SOFR for a smooth transition. A basis market between the two indices will also: allow for a more functional SOFR, ideally limit the volatility between the two indices and potentially allow borrowers to choose between the indices at their own pace.
    • SOFR should rise less than LIBOR in times of a credit crunch because unlike LIBOR, it is not tied to the banks’ cost of funding.
    • The existence of current mechanisms where if LIBOR ceases, lenders have a right to name a new rate, however, there is still a need to ensure that the process will be fair to borrowers.
    • Mortgage rates based off of SOFR could be based on a term structure of SOFR (which has yet to be developed) or an average of SOFR.
    • Currently, ARRC has open consultations on fallback language on floating rate notes and syndicated loans with similar consultations on bilateral loans and securitizations fairly soon. Such language is meant to serve as a guide and may be tweaked over time.
  • CME Group cleared its first SOFR related swaps.
    • Five participants (JPM, BNP Paribas, Credit Suisse, Morgan Stanley, and NatWest) cleared trades with a collective notional of over $200 million.
• IMF
  • Cuts global growth outlook for 2018 and 2019 by 0.2% to 3.7%. Uneven economic growth globally and rising trade tensions attributed to the change in the forecast.
• China
  • Both the IMF and U.S. Treasury reported that Chinese officials have not been manipulating the yuan.
    • IMF Chief Lagarde largely attributed the yuan’s decline this year to the strength of the U.S. dollar.
    • Similarly, U.S. officials provided a report to Secretary Mnuchin advising that the Chinese have not intentionally interfered with the yuan. The Treasury Department is expected to release a semiannual report this week that assesses whether trading partners are manipulating currencies.
  • Trade data reflected a record surplus of $34.13 billion with the U.S. last month.
    • China’s September exports increased 14.5% from a year ago, beating expectations of an 8.9% increase.
    • Analysts believe the data reflects increased orders before U.S. tariffs hit and expect growth to slow in the coming months.

This week: A particular focus will be on economic data from China scheduled throughout the week including inflation and GDP. Market gurus will also pay close attention to any progress regarding Brexit negotiations at the EU Brexit summit scheduled for Wednesday and Thursday. The FOMC will release the full minutes from its last meeting, while surprises are not expected, nuances in the language may spark moves in the current highly volatile market environment.

Key data/events include:

• U.S. September retail sales (Monday)
• Bank of Canada Business Outlook survey
• NZD CPI
• CNY CPI (Tuesday)
• CNY National Bureau of Statistics press conference
• AUD central bank minutes
• GBP earnings data
• U.S. September industrial production and capacity utilization data
• EU Brexit Summit (Wednesday)
• GBP retail price index
• EUR/GBP CPI data
• U.S. building permits/housing starts
• FOMC minutes
• JPY trade data
• AUD unemployment data (Thursday)
• GBP retail sales
• U.S. Philadelphia Fed manufacturing survey
• JPY inflation data
• CNY retail sales/industrial production/GDP (Friday)
• CAD retail sales/CPI
• U.S. existing home sales