Article / 16 December 2015 at 11:00 GMT

Daily Shot: High-yield hype alerts contrarians Team / Saxo Bank
  • High-yield fear on junk bonds could offer contrarian opportunity
  • Risk-on sentiment returns ahead of FOMC meeting
  • Baltic Dry Shipping Index all-time low points to demand question marks
By Walter Kurtz*

As crude oil stabilised on Tuesday, some risk appetite returned to global markets. Both credit and equity markets rallied. Here is the Barclays HY index (ETF).
Note that for those willing to take on some volatility, US HY market remains attractive at 9% yield. As discussed yesterday, an increased default rate is already priced into the market. Moreover, the media is now hyping the HY bogeyman, which should make most contrarians pay attention.
The Baltic Dry shipping index hit an all-time low. There are plenty of economic challenges ahead. 
Baltic Dry
US lawmakers agreed to lift the ban on crude oil exports which has been in place for some 4 decades. Will this have an impact on crude prices? Unlikely, since the markets already priced in this change in the law. That's why we've seen the Brent-WTI spread narrow lately. 
US export ban lifted
Is the massive crude oil correction already priced into the equity markets? This chart suggests they are.
S&P vs S&P energy
And then there is US natural gas. Futures fell nearly 5% on Tuesday, hitting a 16-year low (as New Yorkers walk around in t-shirts in the middle of December). El nino? Perhaps.
Turning to China, the RMB depreciation continues. According to Bloomberg, this is the longest losing streak since 2007 and the weakest level since 2011. The PBoC is clearly trying to weaken the currency ahead of the FOMC meeting to reduce the impact of a stronger dollar.
Turning to the Eurozone, we have a couple of developments to cover.

1. Here is real GDP growth comparison across the Eurozone. Ireland continues to outperform.
Eurozone GDP growth
2. Finland's economy is struggling.
3. While the Eurosystem (ECB) balance sheet expansion has a while to go, the monetary base is approaching the previous peak. 
ECB balance sheet
Back in the United States we are approaching the big event - the FOMC meeting. While it's going to be entertaining, most of what the Fed is about to do is already priced into the markets - so don't expect "shock and awe".
Yellen's Judgement Day
Here are some comments with regard to the rate hike.

1. While the Fed will hike the Fed Funds target range by 25bp the rate will rise by only 20bp. Fed Funds will trade at a small spread above the RRP rate (technical reasons discussed here), and the RRP rate will move up by 20bp (from 5bp now to 25bp).

2. Inflation expectations remain way too low to start a rate hike cycle. This is unlikely to deter the FOMC since they view this indicator as "transient". Nevertheless, the FOMC will telegraph an extraordinarily slow path of rate increases going forward.  
3. US monetary conditions have already tightened in anticipation of these hikes as real rates rise
US monetary conditions
4. The markets are betting on slow growth going forward as the treasury curve flattens further.

5. Here is what the key economic indicators looked like the last time the Fed started a tightening cycle.
key indicators now and then
6. Tuesday's inflation report showed core inflation at the Fed's target, which should give the FOMC more confidence to proceed.

Moreover, the so-called "sticky" CPI (described below) continues to rise.
sticky CPI
Markets are well positioned for this policy change - here are a couple of examples.

1. Short-term treasury yields have risen materially all the way out to three years.

2. Money market rates have all moved higher. Similarly, commercial paper rates have risen in response (financial and nonfinancial CP rates are shown below).

It's going to be an interesting day.
Finally, to remind us all of the investment minefield out there, here is Third Avenue's fund.
Third Aveneue Fund
Turning to Food for Thought, we have 3 items this morning:

1. In which countries are pensioners most at risk of poverty? 
WEF poverty risk for pensioners
2. Since we are talking about inflation, here is what US CPI looks like going back to 1775. 
US inflation now and then
3. Are labor problems in China about to get worse? 
— Edited by Clemens Bomsdorf

*Walter Kurtz is an alias

**This is an abridged version of the Daily Shot. To subscribe to the full version, link to the Daily Shot and select the appropriate command. E-mail addresses are never shared with anyone.


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