CME Rally Signals Volatility as Tapering Mulled: Credit Markets
The surge in bond market volatility and trading volumes stemming from the prospect of rising interest rates, which JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon called “scary,” has only just begun, based on shares of CME Group Inc. (CME)
The owner of the world’s largest derivatives market, which offers contracts that span Eurodollars to Treasury (USGG10YR) bonds, has risen 55 percent this year, more than any other financial firm. Chicago-based CME Group gained 23 percent since Federal Reserve Chairman Ben S. Bernanke suggested on May 22 the central bank could begin to reduce its $85 billion in monthly mortgage bond and Treasuries purchases.
“That’s the equivalent of opening the barn door and letting the horses out,” Brad Hintz, an analyst at Sanford C. Bernstein & Co., said in a telephone interview, referring to Bernanke’s comments. “The actual movement of U.S. interest rates does not have to occur for CME’s revenues to increase,” the analyst, ranked second-best last year in covering brokerage firms and exchanges by Institutional Investor magazine, wrote in a June 17 note to clients.
Speculation over rising rates, which push bond prices down, handed high-grade debt its largest monthly loss in more than four years in May and has led investors to increase hedges and to trade in the futures market, boosting volume on CME’s exchanges. Volatility, a measure of price swings, rose to a one-year high of 84.8 on June 6, according to the Bank of America Merrill Lynch MOVE index. The gauge, which is based on over-the-counter Treasury options, has averaged 62.2 in the past year.
CME Group said average daily trading in interest-rate futures and options at its exchanges rose to 7.8 million contracts last month, closing in on the all-time record of 9.8 million trades reached in August 2007. Trading fell to a low of 2.7 million a day in December 2008 after the Fed’s policy of near-zero interest rates reduced the need for investors to hedge or speculate with futures contracts.
Michael Shore, a CME Group spokesman, declined to comment on volatility or volume projections, citing company policy.
Global markets will face increased volatility as central banks bring interest rates back to normal levels, JPMorgan’s Dimon said June 6 at the Fortune Global Forum in Chengdu, China.
“We should all hope for a normalization of interest rates, that’s a good thing,” Dimon said during a panel discussion. “As we go back to normal, it’s going to be scary, and it’s going to be kind of volatile.”
What’s been good for CME Group has had the opposite effect on bond investors. Dollar-denominated, investment-grade bonds declined 0.8 percent this month through June 17, according to Bank of America Merrill Lynch index data. That followed May’s drop of 2.3 percent, the largest loss since a 7.4 percent decline in October 2008.
Yields on global corporate and high-yield debt have increased to 3.5 percent from a record-low 3.09 percent on May 2, Bank of America Merrill Lynch index data show. The six-week surge marks the longest stretch of increases since October 2008, following the collapse of Lehman Brothers Holdings Inc. that plunged financial markets into their worst crisis since the Great Depression.
Elsewhere in credit markets, Mylan Inc. (MYL), the second-biggest generic-drug maker, issued $1.15 billion of debt in its first bond sale this year. Rising interest rates may trim issuance of commercial-mortgage bonds by $15 billion this year, S&P said. Travelport LLC increased the rate on a $1.55 billion term loan it’s seeking to refinance debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 0.4 basis point to 15.9 basis points. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
The cost of protecting corporate bonds from default in the U.S. fell, with the Markit CDX North American Investment Grade Index, used to hedge against losses or to speculate on creditworthiness, decreasing 0.2 basis point to a mid-price of 81.9 basis points, according to prices compiled by Bloomberg.
The Markit iTraxx Europe Index, tied to 125 companies with investment-grade ratings, was little changed at 108.3 as of 11:04 a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan gained 4 to 139.4.
The indexes typically fall as investor confidence improves and rise as it deteriorates. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds of Chevron Corp. (CVX) were the most actively traded dollar-denominated corporate securities by dealers yesterday, accounting for 3.5 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The second-largest U.S. oil company sold $6 billion of bonds on June 17 in a four-part offering, according to data compiled by Bloomberg. Its $2.25 billion of 3.191 percent, 10-year notes issued at par rose to 100.629 cents on the dollar to yield 3.117 percent, Trace prices show.
Mylan split its sale between $650 million of 2.6 percent, five-year securities that yield 160 basis points more than similar-maturity Treasuries and $500 million of 1.8 percent, three-year notes at a spread of 135 basis points, Bloomberg data show.
Mylan, which canceled plans for floating-rate notes due 2016, last sold debt in December, issuing $750 million of 3.125 percent, 10-year debentures at 145 basis points, Bloomberg data show.
Commercial-mortgage bond sales that Credit Suisse Group AG says are poised to climb as much as 50 percent to $70 billion are being checked by investor concern that the Fed will soon pare $85 billion of monthly bond purchases. The unprecedented stimulus has suppressed interest rates and pushed investors into higher-yielding assets.
An increase of 55 basis points on 10-year Treasury yields coupled with a rise of 30 basis points on relative yields on top-ranked securities linked to property loans will put a damper on the resurgent market, S&P analysts led by Howard Esaki said in a note to clients. The analysts estimate 2013 sales of $65 billion after adjusting for the rising rates.
Travelport, the travel-reservation system controlled by Blackstone Group LP, will pay interest at 5 percentage points more than the London interbank offered rate on the six-year debt, up from the 4.5 percentage points initially proposed, said a person with knowledge of the transaction who asked not to be identified because terms are private.
The lending benchmark, which was set at 27 basis points, will have a 1.25 percent floor. The new loan is being offered to lenders at 98.5 cents on the dollars, lowered from 99 cents.
The S&P/LSTA U.S. Leveraged Loan 100 Index rose 0.02 cent to 97.86 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 2.59 percent this year.
Leveraged loans and high-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.
In emerging markets, relative yields widened 9 basis points to 338 basis points, or 3.38 percentage points, according to JPMorgan’s EMBI Global index. The gauge had tightened for four straight days from the highest level since last July.
The Federal Open Market Committee began a two-day policy meeting yesterday, with Bernanke scheduled to hold a news conference today. Investors are speculating when the central bank will move to change its monetary policy, which has suppressed interest rates.
“An inactive Fed hasn’t been good for rates trading,” Niamh Alexander, an analyst at KBW Inc. in New York, said in a telephone interview. “An environment where you don’t have much movement in rates means you don’t have to hedge.”
CME Group, formed in 2007 by the Chicago Mercantile Exchange’s acquisition of the Chicago Board of Trade, is the 12th best performer in the S&P 500 this year through yesterday, Bloomberg data show. Since May 21, the day before Bernanke’s comments, it’s the third-biggest gainer.
Bernstein’s Hintz raised his adjusted earnings-per-share estimate on June 17 by 10 cents to $3.26 for 2013 and to $3.86 for 2014, Bloomberg data show.
The company united trading of short- and long-dated futures with the 2007 combination of the two dominant Chicago derivatives markets. The Chicago Merc was home to Eurodollar trading while the Board of Trade developed U.S. Treasury bond futures. In 2008, CME Group bought the New York Mercantile Exchange, giving it contracts in energy and metals. It controls about 98 percent of all U.S. futures trading.
“Despite being a near monopoly with substantial barriers to entry to new competition, post crisis, the CME was not able to achieve the volume growth needed to support” the growth estimates investors had come to expect, Hintz wrote in the note.
The rise in rate volatility will make interest-rate contracts the biggest revenue generator in the second quarter at CME Group, ahead of energy contracts, said Richard Repetto, an analyst at Sandler O’Neill & Partners LP.
CME Group was hit hard by the financial crisis, when its shares, which it split five-for-one in July last year, fell to a low of $31.31 on Nov. 20, 2008, after reaching a record $142.15 on Dec. 21, 2007.
As the crisis unfolded, “clients pulled back on hedging, hedge fund activity levels fell and the industry de-risked,” Hintz wrote in the note. With volatility now on the rise, that’s no longer the case, he said.
“CME’s the bet on the recovering U.S. economy and differing monetary policies around the world,” he said in the interview. He added that once the Fed actually does raise rates, the company should see another boost in its share price. “There’s the smart money that anticipates rates moves and hedges themselves” by buying futures, Hintz said. “And then there are the guys who say, ‘Oops, I forgot,’ and then they hedge.”
To contact the reporter on this story: Matthew Leising in New York at email@example.com.