The Market Today
OPEC Agrees to Increase Output
by Craig Dismuke, Dudley Carter
Quiet Finish to a Week Heavily Impacted (Early) by Trade Concerns: Friday’s lone U.S. economic report will be Markit’s flash PMI package for June. Both surveys, which cover the manufacturing and services sector of the economy, are expected to cool modestly but remain at notably strong levels for the cycle. As-expected results would be another data point to support the story that the U.S. economy remains strong and activity picked up in the second quarter. Earlier, Markit released its PMIs for Asia and Europe which showed mixed results (more below). The quiet calendar should keep investors focused on any details released throughout the day that add color to this morning’s OPEC decision to raise its output caps (more below).
Yesterday – U.S. Stocks Swept Up in Global Risk-Off Trade: Resumed selling of global equities pushed down U.S. equities on Thursday and handed the Dow its eighth consecutive daily decline. The 30-component index fell just under 200 points, or 0.8%, and the duration of its losing streak now matches its longest since a nine-day run in 1978. The S&P 500 fell a slightly smaller 0.6% while the Nasdaq underperformed with its 0.9% decline. Energy companies were the biggest drag on the S&P 500 as investors awaited Friday’s OPEC decision on whether to increase supply. Industrial companies, which have been pushed and pulled by the ebbs and flows of the U.S. trade spat with China, were the second worst performers. U.S. automakers were extremely weak, following a softer lead from European counterparts related to reduced forward guidance in part because of trade concerns. The Supreme Court announced a decision that will allow states to force online retailers to collect state sales tax. Amazon dropped more than 1% on the day. As multiple factors weighed on risk sentiment, longer maturities led a bid for Treasurys which resumed the recent flattening trade. The 2-year yield dropped 2.9 bps (2.54%) while the 10-year yield settled down 4.2 bps (2.90%), leaving the related spread at 35.6 bps, the second lowest of the cycle.
Overnight – Oil Prices Gain Modestly after OPEC Agrees to Raise Output: Market tensions ebbed somewhat overnight while investors awaited OPEC’s final decision on whether to increase its output caps. Despite some scattered daily gains in the region, MSCI’s Asia Pacific index wrapped up its worst week since March on early-week losses caused by heightened trade concerns. Worth pointing out was a second 0.7% YoY increase in Japan’s core CPI inflation index in May and a slight uptick in its manufacturing PMI for June. In Europe, the improvements were more broad-based with national indexes up strongly and the Stoxx Europe 600 0.8% higher. Italy’s FTSE MIB was leading gains despite comments from the country’s new budget director that, while it’s not in the official government program, leaving the EU would solve many of the Italy’s problems. On the data front, the EU’s composite PMI topped estimates but remained at its second weakest level in 17 months. A surprise jump in the services PMI was responsible for the gains and offset the manufacturing PMI falling for a sixth consecutive month to an 18-month low. Hidden in the headlines were reports that Greece had reached a deal with its creditors on a portion of its debt. Looking to the oil markets, both U.S. and Brent crude were up over 1% and held those gains after headlines hit that OPEC had agreed to raise nominal output by 1 million barrels per day. However, because some producers lack spare capacity, analysts estimate the real increase may be closer to 600k barrels per day. In November 2016, the group cut roughly 1.3 million barrels per day from their combined output. U.S. equity futures are firmer and Treasury yields recovered, with the 2-year yield moving up 0.8 bps and the 10-year yield 1.5 bps higher.
White House Proposes GSE Reform, Remains Lofty Goal: The White House released a proposal to reorganize many aspects of the federal government yesterday which included a list of 32 recommendations. Two of those recommendations, which had previously been discussed by the administration, are relevant for high-grade fixed income investors, divestiture of assets owned by the TVA and GSE reform. Divestiture of TVA assets could result in a widening of spreads for TVA debt to more resemble secured utility debt. GSE reform would have a bigger impact on investors but the proposals protect bondholders and passage of reform still appears distant. While Congress has made some legislative progress recently, that has slowed and the looming mid-term elections are likely to keep that slow. The GSE proposal paralleled the Corker (and other) plans and called for ending the conservatorship of Fannie and Freddie, reducing the housing market’s dependence on the GSE’s, and providing an explicit government backstop for some smaller component of housing finance that would be accounted for on-budget.