Equity Markets – April Showers?

Recovery may be looking for help

by Marisa D’Vari,Managing Director of Corporate Communication, New Oak Capital

Connect with Marisa by e-mail: [email protected]

“The March jobs report delivered mixed headlines – less than expected job creation, but an improved unemployment rate,” says James Frischling, President and Co-Founder of NewOak. “A careful look at report, including the number of Americans no longer looking for work, gives reasons for folks to be concerned about the strength of the recovery.”

While the negative report provides some level of evidence that the recovery is fragile, it also gives the Fed reasons to maintain its existing policies and to continue with its bond buying programs. For equity markets, the Fed’s policies have been the single most important driver of stocks. While a weak jobs report is bad for Main Street, it may prove to be just what Wall Street needs to get through the second quarter.

Over the past three years, April has proven to be a key turning point for the markets with peaks being followed by 10% to 19% declines. With consumer confidence falling and volatility sitting at multi-year lows, complacency seems to be taking shape and there’s a growing concern of a pullback. Add to that the start of earnings season and concerns that estimates are too high and you have to worry whether April will again prove to bring a correction. It’s hard for stocks to rally when earnings are being revised lower.

The result puts an even greater spotlight on Chairman Bernanke, who will be speaking twice this week in addition to the release of the Federal Reserve’s minutes from the last meeting. A strong message from the Fed about a continuation of the monetary backstop is what the market will need to avoid a fourth April pullback in a row.

MBS Central Counterparty: What’s Holding It Back?

“There are many ways the buy-side could benefit from a regulated multilateral Central Counterparty (“CCP”) trading platform for executing To-Be-Announced (“TBA”) agency MBS, a form of OTC derivatives,” says, Ron D’Vari, CEO and Co-founder of NewOak. “The key drawbacks are initial and variation margins as well as related operational and collateral management challenges.”

The Agency MBS TBA market is over $5 trillion in size and it is one of the most liquid OTC derivatives markets. The overall long and short trades net out every month. Some of the TBA positions settle through electronic delivery of conforming agency mortgage loan pools, and the remaining trades roll over to the next month at market levels. The MBS TBA market has had an established trading platform for some time which is now part of the Fixed Income Clearing Corporation (“FICC”), a subsidiary of DTCC. The FICC has also developed the necessary services to support an MBS CPP for several years: Specified Pool Trade (“SPT”), Pool Substitution for Electronic Pool Notification (“EPN”), and Pool Netting service with the FICC as the guarantor on all netted trades and the novation counterparty on eligible pool obligations.

Most asset managers do not post collateral on their TBA positions. CCP platform for TBA by construct requires initial and variation margins. Partly due to daily margin requirements, most TBA trades remain to be bilateral and have not been settling through the FICC CCP. Many buy-side firms don’t have the streamlined straight-through-processing of derivatives and lack robust collateral management and posting. However, TBA CCP would offer lower systematic risk and mitigates the counterparty risk to the real money accounts. Given the general resistance to strict margin rules and absence more stringent capital requirements, it is not certain when majority of TBA participant would migrate to FICC CPP. Hence we expect TBA would remain a bilateral derivatives market for the time being.