Hillary Clinton Email Problem

March 2nd, 2015 10:41 pm

The NYTimes is leading with a piece on Hillary Rodham Clinton who it seems chose to conduct her official business while Secretary of State via her personal email. How would that go over with the Department of Justice if a bond dealer salesman had chosen to do that? I doubt that would receive a cordial reception from the legal eagles nor would it fly with compliance departments at major firms.

Apparently Mrs Clinton is planning to launch her bid for the highest office in the land sometime next month and I doubt that this is the type of run up that she wants or needs prior to the coronation.


Merrill Lynch on Eclectic Topics

March 2nd, 2015 9:39 pm

Via Merrill Lynch Research:

  • Dudley’s remarks highlight why we should expect the coming rate hiking cycle to be much less favorable than the previous one.
  • Clearly if Dudley’s views are shared the Fed is going to want to see higher long term interest rates once they start hiking.
  • This is one reason we are only tactically (next 0-2 months) overweight IG credit, and not longer term.
  • Hiking long term interest rates. New York Fed President William C. Dudley’s remarks at the February 27th 2015 U.S. Monetary Policy Forum highlight once again why we should expect the coming rate hiking cycle to be much less favorable to asset prices than the previous (2004) cycle. This is because the 2004 environment of Fed rate hikes, rallying stocks, tightening credit spreads and long term interest rates that did not increase was a policy mistake (see: The Fed’s dual goals: wider spreads, higher vol). Remember that in each cycle there comes a point when the Fed must hike interest rates in order to tighten financial conditions to avoid a situation where the economy overheats and bubbles are created. Clearly, with the benefits of hindsight, in 2004 when the Fed was hiking the Funds Rate, financial conditions actually loosened significantly. This was one of the reasons for the housing bubble and the trouble we have been in during the post crisis years. Thus, while financial market charts from 2004 are amazing and pretty, the longer run costs from the policy mistake of not tightening monetary policy aggressively enough were severe.
  • This is one reason we are only tactically overweight IG credit (see: Tactically overweight). We are bullish the next 0-2 months, as strong economic data and the resulting rebound to 2% 10-year interest rates are positive for spreads. Additionally, US credit benefits from attractive relative value to EUR credit, as well as the general global re-allocation into US fixed income. If we were not concerned about the Fed, this would be a longer term view. Furthermore, should the Fed communicate to the market a goal of higher long term interest rates as well, the risk would be that the global re-allocation flows that currently benefit US fixed income pause. Thus, we are much more bearish on credit into the summer and fall. – Hans Mikkelsen (Page 4)
  • Feb ’15: Yields and risk assets rebound. For the second consecutive year risk assets rebounded in February after a weak January. The catalysts for this rally include most prominently the very strong US employment report for January, which showed that economic growth can continue to be very robust despite global weakness, the rebound in oil prices and reduction in Greek political risks. With such bullish market action stocks leaped 5.75% in February, beating high yield (+2.33%), while high duration, low credit risk asset classes like high grade and Treasuries lost 0.87% and 1.75% in total return, respectively. With more evidence that inflation is rebounding TIPS again outperformed Treasuries (-1.33%). High grade corporate bonds turned in impressive excess returns of +115bps in February, as spreads tightened 16bps. With such a rally not surprisingly credit spreads compressed as high beta Metals and Mining (+339bps), Oil & Gas (+285bps) and Pipelines (+211bps) outperformed while sectors with tight spreads – such as Aerospace & Defense (+41bps) and Technology (+60bps) – underperformed. However the worst performing sectors were Cable (+18bps), on concerns the merger between Time Warner Cable and Comcast might not go through, and interest rate sensitive REITs (+37bps). – Hans Mikkelsen, Yuriy Shchuchinov, Jon Lieberkind (Page 7)
  • Monthly market reviews. We published our monthly HG market review today. Please see here: Monthly HG Market Review: Feb ’15: Yields and risk assets rebound . Our European credit strategists published their monthlies here for EUR and here for Sterling. Finally, our equity and quant strategy team published their monthly performance monitor here, while our equity small and mid-cap strategists published their monthly here, here and here.
  • USD-EUR spread compression. USD high grade spreads have significantly outperformed their EUR counterparts in February and year to date. Being tactically overweight USD credit, and with tight valuations in Europe, we look for this outperformance to continue. In February 10-year USD bond spreads tightened 8bps relative to EUR spreads for European issuers and, similarly, by 9bps for US issuers. Year-to-date USD spreads of European issuers outperformed the corresponding 10-year EUR-denominated bond spreads by an even larger margin of 21bps. We estimate that 10-year spreads in EUR are 26bps tighter for European issuers and 8bps tighter for US issuers. – Hans Mikkelsen, Barnaby Martin, Yuriy Shchuchinov, Ioannis Angelakis, Jon Lieberkind, Souheir Asba (Page 9)
  • Auto Monthly: Motorin': February SAAR expected at 16.5mn. SAAR estimate at 16.5mn, GM +10.0%, F +7.5%, FCA +5.0%. We expect U.S. light vehicle sales in February to run at a SAAR of 16.5mn units, up from a SAAR of 15.4mn a year earlier. We estimate that GM sales will be up 10.0% YoY, driven by continued strong truck sales. We forecast Ford sales to increase 7.5% YoY, as sales of the new F-150 start to pick up and Ford faces an easy comp from last February when sales fell -6.1%. We expect FCA sales to rise 5.0% YoY, continuing the robust momentum in trucks last year (Jeep and Ram) and the more recent momentum in cars. - Douglas Karson, Mark Hammond, Max Hubbard (Page 12)
  • Paltry prices. The core PCE price index rose by only 0.1% mom in January (+0.06% unrounded), in line with expectations. The health care services price index, which accounts for 19.2% of core PCE, was down 3.8% mom. Excluding that category, the core PCE deflator would have been up at a 0.16% mom pace. Yoy core PCE inflation in January was steady at a sluggish 1.3% pace. Personal spending fell by 0.2%, but this was entirely due to the 0.5% mom drop in headline prices. Incomes rose by only 0.3%, a bit softer than expected. As a result of rising incomes and falling spending, the savings rate increased by five tenths of a percent to 5.5%. After inflation-adjusting the nominal spending data, real personal consumption expenditures were actually up 0.3% mom, not far from our expectations. Overall, the report pointed to a decent boost to real spending, but still very muted underlying inflationary pressure.
  • Construction slips. Construction spending in January disappointed, falling 1.1% vs the 0.3% pace of increase expected. There were slight upward revisions to the prior month. As a result of the weaker-than-expected construction spending data for January, we cut our 1Q 2015 GDP tracking by two tenths of a percent to 2.4%. Non-residential construction spending was the key driver of the disappointment, falling 2.0%, with declines in both private and public non-residential spending. Residential construction rose by 0.6%, driven entirely by private residential spending. Federal spending fell by a sharp 9.0% in January, driven by weakness in the non-residential category. State and local spending fell by 2.0% mom.
  • Factory sentiment slides. The ISM index weakened to 52.9 in February vs 53.5 in January. Industry-side commentary in the report pointed to continued disruptions from West Coast port disruptions, which were noted to have hampered activity in a number of sectors including food, transportation equipment, computer & electronic products and machinery. The index level, above the 50 expansion-contraction threshold suggests rising production, although only at a modest pace. – Emanuella Enenajor (Page 13)

More on the Rush to ETFs

March 2nd, 2015 9:23 am

This morning  I posted this article on  the surge of assets flowing to corporate bond ETFs. Here is an WSJ piece on the same story:

Via the WSJ:

March 1, 2015 6:02 p.m. ET
Institutions are piling into exchange-traded bond funds at the fastest pace on record, driven by forces reshaping the increasingly illiquid corporate-debt market and their desire to stay nimble ahead of expected interest-rate moves.

Bond ETFs took in $32 billion globally this year through Feb. 26, according to data from Bloomberg LP, in what has been the strongest start to any year since the funds began in 2002.

More than half the $20 billion that flowed into fixed-income ETFs at BlackRock Inc. ’s iShares unit in the first eight weeks of this year came from institutions such as insurers and endowments. In some large funds, institutional money in ETFs has more than doubled in the past few years, the firm said.

The shift is the latest good news for providers of exchange-traded funds, which essentially are index-tracking funds that trade like stocks. Bond ETFs are already popular with individual investors because they have low fees and are easy to trade, qualities that are now appealing to more sophisticated investors who typically focus on hand-picking individual debt securities to beat their benchmarks.

“There was a monster rotation into fixed-income ETFs in February,” coming out of sector-based stock funds, said Reginald Browne, global co-head of ETF market making at Cantor Fitzgerald & Co. He said a client recently traded $1.8 billion in bond ETFs in a single trade.


A host of factors is behind institutions’ adoption of bond ETFs, analysts say. Among them: Deteriorating liquidity in corporate bonds has frustrated large investors as many individual bonds have become difficult to buy or sell quickly at a given price, thanks in part to rules limiting banks’ risk-taking.

U.S. corporate debt outstanding has grown by more than $2 trillion since the financial crisis to $7.7 trillion, but trading in many bonds has slowed as new rules caused dealers to pare their holdings by two-thirds from precrisis levels.

“You can’t get things done in a day anymore” in bonds, said Cliff Noreen, president at $212 billion money manager Babson Capital Management LLC, who saw an ETF sales pitch by iShares last year. “It’s more like a week.”

Meanwhile, billions of dollars have flowed into ETFs after an exodus from the giant Pimco Total Return fund peaked last fall, when longtime manager Bill Gross left Pacific Investment Management Co. for Janus Capital Group Inc.

The top 10 bond ETFs have returned 1.57% so far this year, while the top 10 bond mutual funds have returned 0.89%, said fund tracker Lipper.

Institutions’ growing adoption of bond ETFs could improve those funds’ performance and their ability to track baskets of bonds in a choppy market.

Some of the popularity of ETFs may be coming at the expense of derivatives long seen as an attractive means of getting broad exposure to bonds. Average daily trading in U.S. index credit-default swaps has fallen to $5.3 billion this year from $8.5 billion a year earlier, according to Markit data.

Some worry that the ETFs haven’t been tested sufficiently amid a three-decade-long bond price rally. In the second quarter of 2013, when the Federal Reserve signaled it could raise rates faster than anticipated, withdrawals from corporate-bond ETFs exceeded $250 million on 15 days, three times the average frequency since 2013, said Fitch Ratings.

The mismatch between the accelerating ETF growth and slow trading in bonds also raises the risks of forced selling, if there are ever significant enough outflows from the funds to depress their underlying asset prices, said Jeffrey Meli, co-head of fixed-income research at Barclays PLC.

But the growth in fixed-income ETFs has brought efficiencies and “generated a trading opportunity,” said Ari Rubenstein, chief executive of high-frequency trading firm Global Trading Systems LLC. “As the volume increases, more institutions will be attracted to that.”

BlackRock and others have gone on the offensive, selling their customers on the advantages of ETFs, including publicly quoted prices and liquid trading conditions. Teams from BlackRock’s iShares unit, the world’s largest ETF provider, have been crisscrossing the U.S., pitching bond ETFs as a cheap and easy way for institutions to manage their cash fluctuations at an unpredictable time in the bond markets.

There are now 260 bond ETFs, up from 62 in 2008, according to research from Tabb Group. Last month, DoubleLine Capital LP, run by bond maven Jeffrey Gundlach , teamed up with State Street Global Advisors on their first joint bond ETF.

Big banks are responding by retooling their trading desks. Citigroup Inc. and J.P. Morgan Chase & Co. in recent months combined their credit ETF trading units with equities groups that have been quoting ETFs and managing their risks for longer, said people familiar with those firms. The changes also have enabled institutions to trade ETFs in “blocks,” or larger sizes than would be quoted on exchanges.

The growth in bond ETFs stands to further compress transaction costs, to the benefit of retail investors, traders and analysts said. An investor would pay 0.01%-0.03% to trade a liquid corporate bond ETF, but as much as 1.03% for certain hard-to-find securities, Tabb researchers found.

The Employees Retirement System of Texas disclosed in 2013 that it had put about $2.7 billion into bond ETFs, and hedge-fund manager Pine River Capital Management LP held $197 million in a short-term, high-yield bond ETF as of Dec. 31, filings show.

Jim Ross, global head of the SPDR family of ETFs at State Street Global Advisors, said he has been working closely with institutions like insurers for several years, and they are “just starting to use them.”

Brendan Dillon, a senior investment manager at Aberdeen Asset Management Inc., now has permission to use bond ETFs for up to 5% of the firm’s $5 billion high-yield-bond portfolio. He said he was skeptical when iShares first pitched him in April 2012, but he became convinced that the ETFs are doing a better job of tracking bonds than other instruments.

Aberdeen is “more open now than we have ever been” to bond ETFs, Mr. Dillon said.

Write to Katy Burne at katy.burne@wsj.com

Personal Income and Spending

March 2nd, 2015 8:58 am

Via Millan Mulraine at TDSecurities

Personal income rose at a relatively decent 0.3% m/m pace in January, though it fell short of the market’s consensus for a 0.4% m/m gain. This marks the 12 consecutive monthly gain in this indicator, and the rise was driven by the strong 0.6% m/m gain in wage income on the month. Disposable income rose at a 0.4% m/m pace. Despite the strong gain in PDI, nominal spending slipped 0.2% m/m on the heels of a 0.3% m/m decline the month before on account of weaker gasoline prices and soft auto sales.
Total spending was driven lower by the 0.5% decline in goods purchases, which more than offset the 0.5% m/m advance in spending on services. However, real spending activity rose at a very robust 0.3% m/m, suggesting a very decent start to spending activity this month. On the inflation front, the pace of core inflation was relatively subdued, rising at a modest 0.1% m/m, with the annual pace of core inflation remaining unchanged at 1.3% y/y. Headline PCE declined at a rapid 0.5% m/m pace, with the annual pace of inflation falling to +0.2% y/y from +0.8% y/y the month before.
Despite the disappointment on the headline spending front, the overall tone of this report was encouraging as the relatively strong start to real spending activity in January will support the underlying narrative of sustained positive momentum in the US economy – with GDP growth in the 2.5% or better range this quarter. The weak inflation performance, however, continues to be the key concern for the Fed and we expect core inflation to remain weak for the better part of this year, before slowly reverting back to the Fed’s 2.0% target by late 2016. Given this, we continue to expect the Fed to remain on hold until September, delivering two rate hikes by the end of this year.

ETFs as a Source of Liquidity

March 2nd, 2015 6:55 am

I just found this in a site called ETF Trends.

Money is pouring into corporate bond ETFs and some of the buyers have turned to the funds because they believe that there is increased liquidity in that instrument. That is an extremely facile and simplistic view as the fund which manages the ETF faces the same liquidity problems when it buys or sells.

Via ETF Trends:

Liquidity Concerns in Corporate Bond ETFs

February 26th at 11:30am by Tom Lydon

As banks and institutions hoard fixed-income securities, investors have turned to bond exchange traded funds in response to the lack of liquidity across the underlying markets, potentially setting the stage for liquidity problems if ETFs experience large redemptions.

For instance, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) has attracted $2.2 billion in new inflows year-to-date, Vanguard Intermediate-Term Corporate Bond ETF (NYSEArca: VCIT) brought in $358.3 million, SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEArca: ITR) added $34.3 million and PIMCO Investment Grade Corporate Bond Index ETF (NYSEArca: CORP) saw $99.4 million in inflows, according to ETF.com data.

Now, Barclays analysts led by Jeffrey Meli warned of a potential “fire sale” risk in ETFs and bond funds, notably those that track illiquid assets like corporate bonds, after large traders poured into bonds as rates fell and regulators forced financial institutions to obviate another 2008 crisis by holding more quality assets, reports Tracy Alloway for the Financial Times. [Rate Risk Raises Liquidity Concerns in Junk Bond ETFs]

“Regulations aimed at bolstering stability at the core of the financial system, combined with a growing demand for liquidity, may eventually lead to increased instability and fire-sale risk in the periphery,” Barclays analyst said.

As investors found it more difficult to price fixed-income securities, many have turned to ETFs for their greater perceived liquidity. For instance, LQD, with $21.9 billion in assets, has an average daily volume of 1.7 million shares. Taxable bond funds have attracted $1.2 trillion in inflows since 2009, and credit ETFs now make up 2.5% of the investment-grade corporate debt market.

“ETFs are being used not only by end investors looking for instruments with daily liquidity, but also by mutual funds seeking to mitigate the differences between the liquidity their investors expect versus the (poor) liquidity available in the underlying bonds,” Barclays added.

The potential problems ahead are associated with large redemptions in the ETFs or secondary markets. If enough people exit the funds, the ETF providers will have to swap shares for bond securities in the primary market. However, if there is not enough bond securities in the underlying market to meet redemptions, ETF investors may not be getting what they bargained for. [How ETFs Are Traded]

What to Watch Today

March 2nd, 2015 6:48 am

Via Bloomberg:

* (All times New York)
Economic Data
* 8:30am: Personal Income, Jan., est. 0.4% (prior 0.3%)
* Personal Spending, Jan., est. -0.1% (prior -0.3%)
* PCE Deflator m/m, Jan., est. -0.5% (prior -0.2%)
* PCE Deflator y/y, Jan., est. 0.1% (prior 0.7%)
* PCE Core m/m, Jan., est. 0.1% (prior 0%)
* PCE Core y/y, Jan., est. 1.3% (prior 1.3%)
* PCE Core y/y, Jan., est. 1.3% (prior 1.3%)</li></ul>
* 9:45am: Markit US Mfg PMI, Feb. final, est. 54.3 (prior
* 10:00am: Construction Spending m/m, Jan., est. 0.3% (prior
* 10:00am: ISM Mfg, Feb., est. 53.0 (prior 53.5)
* ISM Prices Paid, Feb., est. 37 (prior 35)
* ISM Prices Paid, Feb., est. 37 (prior 35)</li></ul>
Central Banks
* 10:30pm: Reserve Bank of Australia sets cash rate target,
est. 2% (prior 2.25%)
* 11:00am: U.S. to announce plans for auction of 4W bills
* 11:30am: U.S. to sell $26b 3M bills, $26b 6M bills


March 2nd, 2015 6:38 am

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

- This week, there will be four major central bank meetings (BOE, ECB, RBA and BOC) and the US employment report
- The PBOC explained the rate cut on Sunday in terms of a decline in inflation, which results in an increase in real rates
- The pro-EU ruling party in Estonia secured a victory in Sunday elections against the pro-Russian opposition party
- In the EM space, Brazil is expected to deliver a rate hike this week, while Poland should deliver a rate cut

Price action: The dollar is mostly firmer against the majors.  CAD is outperforming and up slightly on the day, while the antipodeans and sterling are underperforming.  The euro is holding just above $1.12 after a brief dip below, while cable is trading just above $1.54.  Dollar yen is nearing the 120 level, trading at its highest level since February 12.  EM currencies are mostly weaker, led by MYR, RUB, and ZAR.  In addition to its weekend rate cut, PBOC fixed USD/CNY higher again, leading spot higher as well.  The CEE currencies are outperforming within EM.  MSCI Asia Pacific is flat on the day, with the Nikkei up 0.15%.  The Shanghai Composite was up 0.8% after the surprise PBOC rate cut.  Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a higher open.

  • March is said to come in like a lion and leave like a lamb.  It does indeed appear to be coming in like a lion for investors.  There are four major central bank meetings and the US employment report.  Although Yellen did not convince many that the Fed is set to hike rates in June, yields in the eurozone continue to fall in anticipation of the bond buying scheme that will start later this month.  The resulting widening of the interest rate differentials lent the dollar support.
  • Two emerging market central banks are in play as well.  Brazil is one of the few central banks engaged in a tightening cycle.  It is set to continue. The Selic rate bottomed in 2012-2013 at 7.25%.  It stands at 12.25% now.  The consensus expects another 50 bp rate hike.   A 25 bp rate hike would be seen as a potential signal that the central bank is taking its cue from the tighter fiscal policy and a pause and possibly the end of the tightening cycle is at hand.  
  • Poland is expected to cut the base rate by 25 bp to 1.75%.  It had cut the base rate 50 bp last September. The main issue is not growth.  Fourth quarter GDP expanded 3% year-over-year.  Poland, like so many countries in Europe, is experiencing deflation.  In January, consumer prices were 1.3% below year ago levels.  
  • There were three developments over the weekend that may help shape the investment climate. First, the People’s Bank of China cut its rates on Saturday.  The 25 bp cut in the key one-year lending and deposit rates (to 5.35% and 2.50% respectively) was the first move since November.  The fact that the PBOC cut rates is not very surprising, but the precise timing is nearly always unpredictable.  Most of the speculation has focused on possible yuan depreciation, and some analysts have been playing up the risk that the 2% dollar-yuan band would be widened.  The rate cut overshadows the official PMI readings that were also reported over the weekend.  The manufacturing PMI ticked up to 49.9 from 49.8 while non-manufacturing PMI firmed to 53.9 from 53.7.  
  • The PBOC explained the rate cut in terms of a decline in inflation, which results in an increase in real rates.  Consumer prices were 0.8% higher year-over-year in January while producer prices have been falling for three years.  Also on Saturday, China reported that housing prices in the 100 major cities fell by 3.84% in the year through February.  The rate cuts are not expected to reverse the slowing of the economy, arrest the deflation, or lift house prices.  They will, though, help large businesses and state-owned enterprises to cope with the more challenging economic conditions.  The rates cuts will also help facilitate the rolling over of existing debt.
  • The second important development over the weekend was the Sunday election in Estonia, where the ruling party came out victorious.  The elections shaped up to be a referendum on the country’s relationship with Russia.  The government is pro-EU and pro-NATO, and won 27.7% of the votes.  The opposition party, which has formal ties with Putin’s United Russia Party, took 24.8%.  A third of the population (~1.3 mln) is comprised of ethnic Russians.
  • As it has done with several countries, Russia has made incursions into Estonian airspace.  In recent years, Russia has developed a hybrid warfare in Moldova, Georgia, and Ukraine.  Although Russia’s economy is being squeezed through sanctions, its tactics have seemingly succeeded.  It continues to occupy part of Georgia.  It supports a separatist region in Moldova.  Its annexation of Crimea stands and Ukraine’s dismemberment is a fait accompli at Minsk, where the cease fire was agreed to before the insurgents made one more strategic thrust.
  • Estonia could be a target of Russia’s ambitions should Putin chose to challenge NATO itself, which up until now Russia has shied away from doing.  Narva is a town in Estonia near the Russian border.  Half the people do not have Estonian passports, and 90% are native Russian speakers, according to press reports.  Given Putin’s view of the world, and the apparent success of his tactics, Narva (or a town like it) would seem to be a potential target as the next theater of Russian ambitions.
  • The third development takes us from Russian foreign policy to domestic.  One of the leading opposition critics of the Russian government, Boris Nemtsov, was assassinated early Saturday morning in Moscow.  Putin called it a “provocation” which opposition leaders took as an indication the President was going to blame the opposition itself.  A large opposition rally was held Sunday, protesting the economic crisis and Russia’s involvement in Ukraine but turning to more of a memorial for Nemtsov.  
  • Four major central banks meet in the week ahead.  The least interesting is the Bank of England’s meeting.  It is still seen to be at least a few quarters away from hiking rates, and despite the low inflation, and possible deflation, the bar is high for an easier policy.  More important for sterling and UK assets than the MPC meeting are the PMI reports.  They will likely confirm that the UK’s economic recovery remains on track after slowing in H2 14.
  • The ECB meeting on the same day will command more attention.  However, it is most unlikely to do anything.  Having announced a larger and more aggressive effort to expand its balance sheet through asset purchases at its last meeting, no new measures are likely to be announced.  Still, it can provide more operational color to its bond purchase program.  The ECB’s staff will produce new macro-economic forecasts.  Growth may be revised higher, but inflation forecasts may be shaved.
  • The ECB, through the Eurosystem, will launch its bond buying program later this month.  It still appears to be some legal, technical, and operational issues that need to be sorted out before the purchases can begin.  Many participants are skeptical that it will lift price pressures for consumers (CPI) which is its declared objective.  The BOJ, which is many times more aggressively expanding its balance sheet, has seen consumer prices pressures fall steadily for several months and could slip back into deflation in Q2.  
  • Many participants also are wary of potential operational difficulties.  In the US, foreign holders of Treasuries were more willing to sell them to the central bank than domestic investors.  In Europe, banks and pension funds appear to be among the largest holders of government bonds.  There are many reasons why they may not be so eager to part with their securities.  What can replace them and the yields they generate?  Remember the yields are locked in at the purchase of the fixed income instrument.  Selling them is a tax event that some investors will not want to incur.  Some of the demand for sovereign bonds by banks stems from the regulatory considerations.  
  • Another significant group of investors are foreign central banks.  They could pare holdings by selling to the ECB.  This could be reflected in a reduction of the euro’s share of reserves, but it might not be clear until the COFER report at the end of the year.  Nevertheless, investors will be sensitive to market talk along these lines.  
  • The central banks in Australia and Canada meet.  These meetings are live in the sense that rate cuts are possible.  Both central banks have cut interest rates already this year.  The derivatives markets show a high degree of confidence that both central banks will cut rates again.  The issue here is timing, and it affects short-term traders more than medium- and long-term investors.  
  • In the past week, the pendulum of expectations for this week’s meetings has shifted away from cuts.  A weak capex survey from Australia at the end of last week encouraged the doves to stick with their views.   It is a close call, and our impression is that officials had framed the issue as February or March last month.  Back-to-back cuts may be more aggressive than is warranted by the data.  
  • With some verbal guidance by Bank of Canada officials, investors had been convinced that another rate cut would be delivered at the March meeting.  However, last week, Governor Poloz was understood to mean that a cut is not imminent.  In our reading, Poloz simply restated the official policy – that the January rate cut was an insurance policy meant to buy time for the economy to adjust to the fall in oil prices.  
  • We suspect that there is a greater risk of a Bank of Canada rate cut than an RBA rate cut in the week ahead.  That said, the failure to cut rates might not spur a strong rally as the lack of action now will simply raise the conviction for a later move.  
  • It is a big week for US economic reports, culminating with the employment report at the end of the week.  There an economic report every day.  The economic data will provide insight into the pace of growth in the first quarter, but the key is the impact on Fed policy.  High frequency data may help create the price action that short-term participants like, but no one wants policy to be based on such noisy time series.  The general picture of the economy suggests we are returning to trend growth after a period of acceleration in April-September period last year.  
  • Headline inflation has been pulled down by the drop in oil prices, but the core rate, which is the aim of policy, is steadier.  Weakness in the parts of the country most linked to oil production will also likely be borne out by the Beige Book prepared for the mid-March FOMC meeting.  However, most businesses have lower input costs, and households have more disposable income.  The data is expected to confirm consumers are not necessarily increasing their consumption, though household consumption did rise 4.2% in Q414.  Rather, at least at the start of the 2015, it appears households bumped up their savings.  
  • The core PCE deflator is not expected to have changed in January from the 1.3% pace in December.  The Federal Reserve would feel better if this measure ticked up in the coming months.  It would make the June rate decision easier.  Fed Chair Yellen was clear on the matter, however.  The core rate has also likely been knocked down by the drop in oil prices.  This is transitory, and the base effect wanes late this year and early next.  At the January FOMC meeting, the statement indicated that after some near-term softness, the Fed continues to expect inflation will approach the 2% reference rate.  
  • It is that expectation coupled with continued improvement in the labor market that underpins our expectation for a June hike.  There has been a clear acceleration in jobs growth.  The three-month average is 336k while the six-month average is 282k.  Growth in February is expected to have slowed considerably.  The consensus expectation of 235k would be the slowest since last August.  Hourly earnings, which had fallen 0.2% in December, rose 0.5% in January and are expected to have risen 0.2% in February.  This would cause the year-over-year pace to slip to 2.1% from 2.2%.  
  • On balance, the Federal Reserve will likely see the employment report as consistent with continued improvement.  There is no compelling new piece of evidence that would shake their confidence that the 2% inflation target will be achieved in the medium term.  Yellen argued that the international factors are mixed, and net-net are in neutral.  We think the most likely scenario is that the Fed drops “patience” in March, and true enough, it will not signal an immediate rate hike, which would be April.  Instead, it really is still patient and waits for June.  

Secondary Corporate Bond Trading on Friday

March 2nd, 2015 6:17 am

Via Bloomberg:

IG CREDIT: PETBRA Issues Led Trading; ACT May Be Today
2015-03-02 10:40:33.106 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $16.4b Friday vs $17.8b Thursday, $13.4b the previous
Friday. 10-DMA $15.9b.
* 144a trading added $1.8b of IG volume Friday vs $2b
Thursday, $2.4b last Friday
* Most active issues longer than 3 years
* PETBRA 6.25% 2024 was first with client flows taking 71%
of volume
* T 5.35% 2040 was next with client flows taking 100% of
volume; client buying was twice selling
* PETBRA 4.375% 2023 was 3rd, client flows at 82%
* PETBRA 4.375% 2023 was 3rd, client flows at 82%</li></ul>
* VZ 4.862% 2046 was most active 144a issue; client flows took
100% of the volume
* BofAML IG Master Index at +132, a new tight for 2015, vs
+137; 2014 range was +151, seen Dec 16; +106, the low and
tightest spread since July 2007 was seen June 24
* Standard & Poor’s Global Fixed Income Research IG Index
unchanged at +173, the tightest level of 2015; +183 was the
wide for 2015; +182, the wide for 2014, was seen Jan. 16;
+140, the 2014 low and post-crisis low was seen July 30,
* Markit CDX.IG.22 5Y Index at 61.3 vs 61.5; 76.1, the wide
for 2014 was seen Dec 16; 55 was seen July 3, the low for
2014 and the lowest level since Oct 2007
* IG issuance totaled $1.4b Friday; week’s total $41.775b
* Weekly issuance stats; tenors, ratings, sectors
* Month’s IG issuance $134.875b; YTD $267.125b
* Pipeline: ACT deal may be as soon as today; KORESC added to

Overnight Flow

March 2nd, 2015 6:14 am

The Treasury market is about a basis point cheaper across the curve when compared to Friday closing levels. Within that context the moves along the curve are miniscule and where the curve has moved it is in tenths of a basis point.

Dealers report Japanese pension fund buyers of 2s 5s and 10s in modest size and US domestic money managers selling 2 year notes.

Wage Pressures and the Fed

March 1st, 2015 7:05 pm

Via the WSJ:

U.S. bond investors are behaving as if they have all the time in the world. They don’t.

The Fed is gearing up for its first rate increase in eight years, a potential killjoy for fixed-income markets. But historically low yields in the U.S. Treasury market suggest investors are betting this won’t happen for many more months. The risk is that nascent inflationary pressures generated by a tighter U.S. labor market will force the central bank into action earlier than many suspect.

Investor complacency isn’t without cause. Countless false starts have turned inflation doomsayers into Chicken Littles. And there hasn’t been a big bond-market selloff since investors were caught out by the rate increases of 1994. Anyone betting on a repeat of that has almost always lost.

It must also seem odd to talk about inflation’s return days after the U.S. consumer price index registered its first annual decline in more than five years.

But January’s fall in headline CPI was entirely explained by the six-month collapse in oil prices. The Fed cares about core CPI, which strips out volatile food and energy prices, and which last month rose 0.2% from December. That’s not a big jump, but it beat forecasts for a 0.1% gain and suggests that nonenergy sectors have been immune from energy-led deflationary contagion.

More importantly, with unemployment near six-year lows, workers in some vital industries are finally pushing for higher wages. Jack Ablin, chief investment officer at Chicago-based BMO Private Bank, highlights a string of developments: strikes at oil refineries and West Coast ports, employees winning significant pay increases at Wal-Mart Stores Inc. and TJX Cos.

This is anecdotal evidence, not statistical proof of broad-based wage inflation. But as Deutsche Bank economist Torsten Slok observes, “We haven’t seen anecdotes like these for six years…worker bargaining power is returning.” Mr. Slok points to an annual survey by the National Association of Home Builders that last year found 46% of builders reporting shortages for nine types of labor, despite the massive layoffs in the sector during the recession. That surpassed the 45% and 44% results posted for 2004 and 2005, respectively, at the height of the precrisis housing boom.

More broadly, the Bureau of Labor Statistics’s January employment report showed a 0.5% month-on-month increase in hourly wages, the biggest jump since the financial crisis, and its quarterly employment cost index hinted at modest acceleration in the latter part of the year.

These increases are small by historical standards. They are also long overdue: Workers’ incomes have seriously lagged behind those of higher-earning sectors of U.S. society. The Fed will want to see more sustained gains. But with a 5.7% jobless rate, which many now view as close to “full employment,” we should recognize that monetary policy is extraordinarily accommodative. The Fed desperately wants to “normalize” policy, to stop the economic distortions created by more than six years of zero interest rates. Wage gains offer justification to start that.

That, in my mind, is what Fed Chairwoman Janet Yellen prepared us for with her congressional testimony last week—even if the market read things differently. Many fixated on a seemingly dovish remark about removing a “forward guidance” phrase from the Fed’s last policy statement—the line that said it could afford to be “patient” before increasing rates—in which she said that doing so wouldn’t necessarily result in policy action within two subsequent meetings as she had previously implied. That comment ensured that federal-funds-futures markets continued pricing in the belief that a rate increase won’t happen until at least September.

But here is what was equally important: the very fact that Ms. Yellen signaled this language change probably occurring at the Fed’s next meeting in March, a “normalization” move in its own right that will end the use of “forward guidance” as an easing tool. Afraid of upsetting the apple cart, Ms. Yellen and her colleagues speak of normalization in gradual terms. But the Fed is also duty bound to act pre-emptively.

John Williams, president of the Federal Reserve Bank of San Francisco, said in an interview with The Wall Street Journal Thursday that doing away with “patient” enhances the Fed’s ability to make “data-dependent decisions.” It restores its traditional readiness to act as soon as the numbers require it. Mr. Williams thinks the Fed could move as soon as June.

Once a rate increase is in play, it is the holders of two- and five-year Treasury notes, “the front end of the curve,” who will face the biggest losses, said Rick Rieder, chief investment officer for fundamental fixed income at Blackrock, which has $4.65 trillion under management. He argues that money unleashed by the European Central Bank’s new bond-buying program and demand from pension funds that need fixed-income returns should keep 10-year note yields— currently just above 2%—anchored below 2.5% this year.

In other words, we aren’t revisiting 1994. But it is fair to say that once wage pressures are upon us, the bond market will have seen its best days for some time.

– Follow Michael J. Casey on Twitter: @mikejcasey.