Monday Musings: December 30, 2019

Dec 30, 2019


Public Trust Credit Team

U.S. markets set blistering pace in 2019 as the U.S. economy was a global

The S&P 500 has returned north of 28% year-to-date, and the bond market has also had strong performance with the Bloomberg US Agg returning 8.97% over the same period. Debt markets benefited from the Federal Reserve’s rate cuts that sent bond prices higher, while optimism surrounding the global economy for 2020 has also stoked strong asset returns and buoyed investor confidence. The U.S. Treasury Curve now sits at the steepest it has been in 14 months after inverting in 2019 though financing conditions continue to remain attractive. Mergers and acquisitions remained strong with total deal value increasing 12% over 2018 levels in the U.S. However, this was not a global phenomenon as transactions were down in Europe a whopping 30%. Moving into 2020, the U.S. stock market is at an all-time high and valuations across the spectrum remain rich, leaving most market participants wondering how much more room to run there is on these rallies.  

U.S. Global Systemically Important Banks (G-SIBs), essential players in money market lending, have discovered new and innovative ways to participate in repurchase agreement (repo) operations without incurring large capital surcharges

Some of the largest domestic banks have been limited in their ability to participate in the repo market, helping to fuel September’s ‘repocalypse’ and the subsequent funding crunch. This is in part due to the fact that participation in these trading operations can increase banks’ capital requirements and, in some cases, even result in a higher G-SIB surcharge. According to a recent article in Financial Times, G-SIBs such as JP Morgan or Goldman Sachs have found new ways to continue trading in the repo market without facing the same regulatory burden as with traditional repo operations. Banks are using total return swaps (a derivative position that synthetically creates returns tied to Treasuries without actually owning the securities) and sponsored repo deals (where the Fixed Income Clearing Corporation acts as a central clearing house that allows dealers to net transactions against each other), two ways to mimic traditional repo trading but with lower capital requirements. It is expected that these efforts by U.S. G-SIBs and the Fed’s repo interventions should help alleviate another potential spike in repo rates at year end thanks to increased liquidity in the market.
The Credit Team wishes you all a Happy New Year!
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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