The Great Unwind Begins

The Fed raised interest rates this week and finally gave a signal that they will let their $4T portfolio of treasury and mortgage bonds run-off in what begins the great unwind of their ultra accommodative monetary policy. This policy started in 2008 amid the financial crisis and begins its ending in 2017. The unwind process will be very gradual but it will eventually pick up over the next 12-18 months so look for the market to focus away from interest rate rate changes and on to how much the Fed’s balance sheet shrinks each quarter. The last time the Fed “tapered” their balance sheet holdings, the stock market didn’t perform too well – down over 10%.

There is not a lot to add this week in terms of technicals as the markets went sideways and are in a range between breaking down or pushing to new highs. What is significant is that the market leaders are wounded (Apple, Facebook, Google, Amazon) and may lead the market lower. I don’t think we reach new highs unless these names are able to recapture their strength.

The muni bond market showed another crack this week. If you remember, we have already seen one “bankruptcy” with Puerto Rico which is currently under a restructuring process. The state of Illinois also is having its troubles and may need some kind of debt relief like Puerto Rico if the politicians can’t agree on how to fix their budgetary process – it may already be too late.

Economic data is light this week so the markets will have to rely on the price action to dictate which direction is next. I expect this time next week that we will have our answer.


Economic & Central Banking Snippets

  • The Federal Reserve has defied weak inflation figures and hiked interest rates for the 3rd time in 6 months as it lifted the Fed funds rate by 0.25% on Wednesday. Of significance is the plans to reduce the size of its balance sheet later this year. The last time the Fed tapered their balance sheet, the S&P 500 traded sideways for two years, however, they did not raise interest rates at that time so we are crossing into unchartered territory. The Fed will start allowing up to $6B in Treasury securities and $4B in mortgage bonds to roll off without reinvestment every month – these amounts are expected to rise over time. Fed chair Janet Yellen and her colleagues boosted the target range for the federal funds rate of 1-1.25% on Wednesday, reiterating that they expect inflation to return to target but stressing they are watching low inflation numbers “closely” after a raft of disappointing readings.

Market sentiment


  • Core Producer Price Index (PPI), an inflation measure, dropped 0.1% in May – correcting a surge of 0.7% in April. Core goods PPI has accelerated to +2.2% year/year as ex energy import prices have risen three straight months and picked up to +1.1% year/year. Two services categories that surged in April and had an outsized impact in boosting the core corrected in May, hotels (-4.7% v. 7.5%) and securities brokerage (-1.5% v. 6.6%). (FT, MS)
  • Both the CPI and the Core CPI figures came in below expectations, continuing a downward trend.



Politics! Politics! Politics!

  • The state of Illinois is on a straight path to becoming junk credit at the end of this month. The state’s budget crisis has opened a range of legal and even constitutional issues over the prioritization of claims by pensions, debt holders and social benefit recipients. Illinois has more than $14.5B of past-due bills from suppliers, debt of $27B and unfunded pension liabilities of $130B. Annual tax revenues are running about $30B for a point of reference. Adding insult to injury, last week Judge Joan Lefkow of the Federal District Court in Chicago ordered the state government to prioritize payments for its Medicaid obligations to over other obligations owed by the state. On its face, as one muni bond portfolio manager says, “she is starting the process of reprioritizing the primacy of debt service under state law and the state constitution. That would be game over.” In other words, bondholders do not have priority over social welfare recipients. Whether that position is morally correct or not, it will make it very difficult for Illinois to issue bonds in the future which may be needed to fund pension obligations or fix its highways.
  • Puerto Ricans recently voted to support becoming the 51st US state in a non-binding referendum. More than 97% of those voting had endorsed statehood, according to a tally posted on the Puerto Rico election commission website. (FT)
  • The US Treasury on Monday recommended that a 2013 regulatory framework meant to stymie risky lending practices be reopened for comments and refined. The change has been awaited by lenders, who have complained of ambiguity in the so-called leveraged lending guidelines. Banks have each developed their own frameworks for deciding when a deal will be dinged by regulators, which has at times created inconsistencies between lenders looking to underwrite a transaction.
  • The U.S. Senate has voted 97-2 for fresh sanctions in response to a trio of Russian actions, including interference in the 2016 election, engagement in Syria and the invasion of Crimea. It was filed as an amendment to the Iran sanctions bill. Lawmakers also agreed that the additional penalties on Russia would prohibit President Trump from being able to lift them without Congressional approval.
  • Qatar is ready to listen to the concerns of Gulf Arab states that have cut diplomatic and economic relations, according to Kuwait, as it tries to mediate a solution to the worst regional crisis in years. Saudi Arabia, Egypt, Bahrain and the UAE severed ties with Qatar last Monday, accusing it of supporting Islamist militants and Iran. Qatar’s stock market fell 7.1%, becoming the worst global performer this year.


Chart Time!

S&P 500 (SPY)
S&P 500 (SPY)


Dow Jones (DIA)
Dow Jones (DIA)




Russell 2000 - Small Caps (IWM ETF)
Russell 2000 – Small Caps (IWM ETF)


10 Year Treasury Yields - TNX
10 Year Treasury Yields – TNX


Market Snippets

  • Inc. said on Friday it would buy Whole Foods Market Inc. for $13.7 billion, including debt, instantly transforming the online giant into a major player in the bricks-and-mortar retail sector it has spent years upending. The acquisition gives Amazon a network of more than 460 stores that could serve as beachheads for in-store pickup and its distribution network. It would make Amazon an overnight heavyweight in the all important grocery business, a major spending segment in which it has struggled to gain a foothold because consumers still largely prefer to shop for food in stores. (FT)
  • Discount grocery store chain, Aldi, is expected to unveil plans to invest $5B toward opening 900 stores over the next five years. The expansion puts the German grocer on track to becoming the third-largest American food retailer by store count, behind Wal-Mart and Kroger.
  • J. Crew continued to bleed red ink during the fiscal first quarter, with the struggling US apparel retailer posting a sharp jump in net losses as the unrelenting sales decline at its namesake stores forced it to book a hefty impairment charge. After receiving the backing of some key creditors, J. Crew announced terms of a debt restructuring deal that would roughly cut in half the value of its nearly $567M in bonds, as well as extend their maturity by two years. (FT/WSJ)
  • General Electric Co has begun testing autonomous drones and robotic “crawlers” to inspect refineries, factories, railroads and other industrial equipment with an eye on capturing a bigger slice of the $40 billion that companies spend annually on inspections. In trials with customers, aerial drones and robots are able to move around and inside remote or dangerous facilities while photographing corrosion or taking temperature, vibration or gas readings that can be analyzed by computer algorithms and artificial intelligence. (Reuters)
  • A 10% decline in oil prices since late May could push traders to keep crude in storage, looking to sell down the line when forward prices are higher. That would undermine the impact of supply cuts led by OPEC countries, which partly aimed to force traders holding oil in storage to sell to reduce bloated inventories that have sapped global prices. Shipping data shows that at least 15 supertankers are sitting in Southeast Asia’s Strait of Malacca and Singapore Strait, filled with unsold fuel. (FT)
  • Proterra Inc., the electric-bus maker heading toward a possible initial public offering, has raised an additional $55 million in funding from investors including BMW AG’s BMW 0.19% venture-capital arm and Al Gore’s investment fund. The fundraising follows a $140 million investment in January and brings the total capital collected by the company to $345 million since it was founded in 2004. Proterra, has sold more than 400 buses ($750,000 each) to cities and communities such as Dallas and Philadelphia.
  • Children’s clothing seller Gymboree filed for bankruptcy, hoping to cement a deal to slice more than $900 million in debt off its books and survive the shakeout in the retail sector. With major debts starting to coming due in December, earnings in decline and vendors demanding tighter payment terms, Gymboree faced liquidity issues that pushed it into talks with lenders, and a chapter 11 filing Sunday. Gymboree’s private-equity owners, led by Bain Capital, will relinquish their holdings under the chapter 11 plan. Bain led a $1.8 billion buyout of Gymboree in 2010, and launched a global expansion of the brand into China, South Korea, Australia and parts of Latin America. As of the end of April, Gymboree operated nearly 1,300 stores under its three brands: Gymboree, Janie and Jack and Crazy 8. (WSJ)


International Snippets

  • The volume of alcoholic drinks consumed globally fell by 1.4% in 2016 according to IWSR, a research firm. It is the second consecutive year of decline, and only the third since data started to be collected in 1994. The drop-off is caused by people drinking less beer, which accounts for three quarters of all alcohol drunk by volume. The overall decline is almost entirely because of downturns in three of the five biggest markets – China, Brazil and Russia.
  • Output from Opec countries accelerated last month as Nigeria and Libya offset cuts from their peers in the cartel. The two countries have been exempt from the supply curb deal agreed among big producer countries, that started in January and which was extended in May for a further nine months. The data in Opec’s monthly oil market report illustrates the latest challenge facing the group, which is already grappling with a renewed price drop and a reinvigorated US shale industry. (FT)
  • Greece’s creditors have agreed to release the next €8.5B tranche of its bailout program, but put off a final decision on debt relief until August 2018. The delay will make it more challenging for Athens to reenter capital markets after its current rescue ends, possibly risking the need for another bailout down the road. (FT)
  • Takata is preparing to file for bankruptcy protection in the U.S. and Japan – as early as next week – amid mounting liabilities stemming from its exploding airbags, WSJ reports. (WSJ/FT)

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.