To Raise, or not Raise? That is the Question
Comment of the Day

May 07 2015

Commentary by Eoin Treacy

To Raise, or not Raise? That is the Question

Thanks to a subscriber for this report by jeff gundlach at DoubleLine Capital. There are some really interesting charts in this presentation, not least those pertaining to European equity yields relative to bonds as well the maturity schedule for Treasury and Covenant Light debt. 

Eoin Treacy's view

Here is a link to the full report. 

The Euro STOXX 50, an Index of Eurozone Blue Chips, yields 3.38%. Spanish debt yields less than 2% and Bund yields are much lower. 

This chart of the Index redenominated to US Dollars highlights just how much of a role the Euro’s weakness has had on the Index’s nominal performance. This is a similar situation to Japan when it embarked on its QE program in 2012. It took a while for earnings expectations to catch up with the benefit that accrues from the competitive advantage of a sharply weaker currency. 

The natural state of affairs would be to expect the divergence between equity yields and sovereign yields to converge. With quantitative easing the prospect of meaningful yield expansion in the Eurozone is diminished which suggests that the medium-term outlook for equities is for yield compression. This should limit the current pullback to no more than a process of mean reversion. 

Turning to the debt markets: The bulge in covenant light loan issuance will need to begin refinancing in 2017/18 and will ramp up to more than $350 billion between 2019/20 and 2021/22 respectively. It is reasonable to assume short-term interest rates will no longer be at zero in four years. If one were looking for when the bond markets are most likely to have difficulty digesting refinancing and the resulting default risk, 2017/18 onwards would have to be high on the list of probabilities. 

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