Cross Purposes

September 30th, 2014 11:43 pm

Larry Summers was Barack Obama’s first choice to be Chairman of the Federal Reserve upon the departure of the late and lamented Ben Bernanke. But Mr Summers in various professional incarnations antagonized both the powerful and those with powerful protectors and was passed over for Ms Yellen.

Mr Summers is still making waves as is evidenced by this article at the NYTimes Upshot. Mr Summers is co author of a paper which holds that the Treasury’s extension of its maturities has partially offset the salutary results of the Fed’s purchases of long term securities and the consequences of the QE are less beneficial than they would have been ceteris paribus.

The article notes that the Administration began this policy while Mr Summers was its chief cook,bottle washer and formulator of economic policy.

Via the NYTimes:

Lawrence Summers, the former chief economic adviser to President Obama, said on Tuesday that the Treasury Department had undermined the Federal Reserve’s stimulus campaign and that doing so was a large and expensive mistake.

The facts are straightforward: The Fed has been trying to reduce the supply of long-term Treasury securities. The Treasury, meanwhile, has been issuing relatively more long-term debt and less short-term debt. In effect, one arm of the government has been draining the bathtub while the other adds water.

In a paper presented Tuesday at the Brookings Institution, Mr. Summers and three co-authors argued that the crosswinds had reduced the Fed’s impact by about a third, slowing growth and leaving more Americans jobless.

Mr. Summers is not the first person to suggest this is a little crazy, but two things set him apart: The administration began the policy in question while he was still its top economic official. Moreover, since leaving the administration, he has campaigned loudly for the government to issue even more long-term debt, to support increased spending on roads, airports and other crumbling infrastructure.

On Tuesday, Mr. Summers, who at one point was widely assumed to be Obama’s top choice to be Fed chairman, brushed aside those apparent contradictions. He embraced the role of a provocateur who was, in effect, criticizing his former colleagues — not least the former Treasury secretary Timothy Geithner. The two old friends have aired several disagreements since leaving the administration.

The Fed has sought to stimulate the economy by purchasing large quantities of long-term Treasury securities. The campaign, which is scheduled to end in October, aims to force investors to buy other kinds of debt and, in the face of increased competition, to accept lower interest rates from the borrowers.

During the same period, the Treasury has greatly increased its issuance of long-term debt. Mary John Miller, until recently the Treasury official responsible for debt issuance, said the average duration of government debt, historically about 58 months, fell to 48 months during the crisis and has risen to 68 months.

Mr. Summers and his co-authors calculate that the Fed’s campaign reduced long-term rates by 1.37 percentage points, but that the Treasury’s debt policies put back 0.48 of those points.

“It seems very odd that the Federal Reserve is taking actions that have the effect of substantially reducing the duration of the debt held by the public at a time when the Treasury is arguing that it is in taxpayers’ interest to extend the duration of the debt at a rapid pace,” the paper said. “Moreover, the Federal Reserve has done so without formally acknowledging any of the considerations invoked by the Treasury. Similarly, the Treasury is taking steps that in the judgment of the Fed are contractionary.”

The Treasury certainly has had its reasons. Issuing long-term debt lets the government lock in low interest rates, which could save taxpayers a lot of money. It also reduces the amount of short-term debt that must be rolled over, potentially at higher rates, during periods of uncertainty about whether Republicans in Congress will vote to raise the debt ceiling.

But Mr. Summers and his colleagues argued that the Treasury and the Fed should coordinate management of the debt, perhaps by issuing an annual report describing a shared strategy.

(Mr. Summers was listed as the fourth author on the paper, which he wrote with three other Harvard economists. But he was the outsize personality; organizers joked they expected him to consume half of the three-hour session.)

Representatives of the Fed and Treasury, on a subsequent panel, rejected both the findings of the Harvard paper and the proposal for more coordination.

Jerome H. Powell, a Fed governor who served as the Treasury official responsible for debt issuance during the George H.W. Bush administration, questioned whether coordination would have meaningfully cut interest rates. “Given the very low level of rates over this period, it is not clear to me that a slightly more negative term premium would have produced materially different real economy results,” he said.

And Mr. Powell said increased coordination was “fraught with risk,” because it could give the Treasury greater influence over the course of monetary policy.

Jason Cummins, chief United States economist at Brevan Howard, said in a response to the paper that the Fed and Treasury had coordinated more closely at various times in the past, and the results were almost always unfortunate. He recounted the story of President Johnson’s summoning the Fed’s chairman, William McChesney Martin, to his Texas ranch, slamming him against the wall and telling him, “Martin, my boys are dying in Vietnam, and you won’t print the money I need.”

Mr. Summers, reliably pugnacious, characterized his opponents in remarks at the Brookings event as “central bank independence freaks” and said it was “at the edge of absurd” to suggest that debt management coordination would substantially erode the Fed’s independence.

He has a point, in the sense that the Fed’s independence has always sounded more impressive than it is.

Indeed, the Fed and the Treasury already coordinate extensively. Mr. Summers recalled that in the 1990s, when he himself was Treasury secretary, the two agencies held a regular “debt management meeting.” Ms. Miller said the meeting still took place under a less descriptive name. The Fed chairwoman, Janet Yellen, and the Treasury secretary, Jacob Lew, have a regular lunch. Their staffers work together on a wide range of issues.

And that raises the question of why Mr. Summers, in his time as an administration official, did not press for more conversations about this issue. On Tuesday, he said only that he had objected lightly, but that he did not pursue the point.

Repo Rates to Zero

September 30th, 2014 11:08 pm

The money markets were awash with too much money chasing too little collateral as the Fed’s cap on its reverse repo facility left a flood of money in the system which forced repo rates to zero. The quarter end balance sheet date exacerbated the problem.

Via the WSJ:

Credit Markets

In Significant Test, Fed Facility Fails to Defend Short-Term Rate Floor

Repo Rate Falls to Zero as Heavy Demand for Facility Exceeds New Caps on Its Use

Sept. 30, 2014 5:24 p.m. ET
NEW YORK—A Federal Reserve tool designed to set a lower boundary on short-term rates didn’t work that way Tuesday, reinforcing concerns that new limits could thwart its effectiveness.

The Fed plans to use the tool, known as overnight reverse repurchase agreements, when it starts raising rates, likely some time next year. Through these trades, the central bank takes in cash from money-market mutual funds and other nonbank financial institutions in exchange for one-day loans of Treasury securities and pays them interest in return. Before Tuesday, the Fed paid a rate of 0.05%.

Fed officials say they expect the so-called reverse repo rate will serve as a floor under short-term interest rates when they start lifting borrowing costs. But on Tuesday, when heavy demand for the facility exceeded new caps on its use, the repo rate fell to zero.

Another short-term rate in the private market fell below zero Tuesday. Called the general collateral repo rate, it is the return firms receive for lending cash overnight in exchange for bonds. A negative rate means firms were paying to make the loans. In recent days, some short-term Treasury yields had also turned negative.

Analysts had warned this could happen after the Fed, wary of putting too much weight on the reverse repo facility, announced in September it would limit its use. The analysts said this could cause short-term rates to periodically drop below the intended floor, perhaps substantially.

The new limits cap the Fed’s total reverse repo activity at $300 billion daily, well above the average of about $120 billion this year. But demand for the repo trades typically surges at the end of a month and end of a quarter.

On Tuesday, the final day of September and the third quarter, participants in the repo trades wanted to park more than $407 billion at the central bank, exceeding the cap, the Federal Reserve Bank of New York said. That invoked new rules that led to the Fed’s repo rate being lowered to zero. On days with less than $300 billion in overall demand, the rate would go back to 0.05%, or wherever the Fed sets it.

The rate on Tuesday’s reverse repo operation was “even lower than what we envisioned,” said Stone & McCarthy Research Associates’ Ray Stone, one of those who had warned this could happen. The program’s overall aim to enforce a lower limit on rates “was not effective,” he said, adding that “this will probably be the situation at most future quarter-end offerings.”

Scott Skyrm, a former repo-market participant and author, said in a commentary that the general collateral repo rate fell to an average of negative 0.015%. “This is the first time” it appears to have happened at quarter end, he said.

Mr. Skyrm also attributed the recent negative Treasury yields to the cap on Fed repos. “With a limit on the facility, hundreds of billions of dollars began looking for a regulatory risk-free home and U.S. Treasury bills yields dipped into the negatives.”

The Fed declined to comment on the outcome of Tuesday’s operation. But Chairwoman Janet Yellen, at a news conference in September, didn’t appear worried about the risk of short-term rates falling below a desired level. She said the Fed expected its benchmark short-term rate could fall below the lower bound of its target range, adding “such movements should have no material effect on financial conditions or the broader economy.”

Fed officials have altered the terms of the reverse repo program before as they experimented with it over the past year, and could adjust it further if they are unhappy with how it works. They announced the new limits amid mounting concerns that if unlimited in size, the trades could distort markets and amplify financial turmoil in times of stress.

Officials have observed that short-term market rates are frequently volatile at the ends of quarters and years, and indicated they are willing to look past these disruptions, even if they result from the reverse repo program. They mostly likely would become concerned if short-term interest rates consistently fell short of their goals.

Mr. Stone said it is likely the money-market funds that are major program participants would like to see a higher overall cap on the reverse repo program, which would increase their odds of getting a better return on cash they park at the Fed. But he said those who got to use the repo facility Tuesday still got a better return than they would have in other parts of the short-term market, where rates for some investments turned negative.

Tuesday’s drop in short-term interest rates is expected to reverse quickly as demand for the repo facility eases. Demand for the Fed’s repo trades peaks at the ends of months and quarters as market participants deal with a variety of issues, including a shortage of places to park cash very short-term and regulatory factors. The Fed’s reverse repo operation on June 30, the end of the second quarter, recorded a record $339 billion in activity.

The reverse repos are one of several tools the Fed will use to raise short-term rates from near zero when the time comes. Many investors expect that to happen around the middle of next year.

The Fed has said it would continue to use a target range for the fed-funds rate, an overnight rate on interbank lending, as its key method of communicating where it wants short-term rates. The range is currently zero to 0.25%. The fed-funds rate influences other borrowing costs throughout the economy, such as on mortgages, credit cards and business loans.

The Fed plans to use the reverse repo rate to set the lower boundary on that range. Its chief tool for managing the fed-funds rate will be the interest rate it pays banks on the reserves they park at the central bank.

Credit Spread Stuff

September 30th, 2014 8:09 pm

Via Merrill Lynch Research:


  • Economy up, risk assets down. As our rates strategists have highlighted, September stands as the month where longer term interest rates finally go up in reaction to stronger than expected economic data, see The long-end mystery. This most likely as strong Treasury demand technicals from the beginning of the year (China, banks, money managers, etc.) have weakened substantially. However, risk assets are troubled by this development – especially credit and especially high yield. Thus, while in September 10-year interest rates rose 16bps, stocks declined 1.4%, IG credit spreads widened 7bps while high yield spreads were as much as 67bps wider (cash indices through 9/29). In contrast, during the first eight months of the year 10-year rates plunged 69bps while stocks rose 9.9% and IG and HY spreads each tightened 16bps. You would think that an improving economy is good for risk assets – and it most certainly is longer term – but there will be periods like September where markets struggle as rate concerns motivate the unwind of crowded trades. How long the current weakness persists depends in no small way on Friday’s employment report. In the short term good news is bad news, bad news is good news. - Hans Mikkelsen (Page 5)
  • Earnings, M&A to drive October supply. As expected, high grade issuance volumes were heavy in September, totaling $121bn. This is the fifth-busiest month on record (going back to 1998, excluding government guaranteed issuance), and the second busiest this year after March, when issuance was $122bn. October, however, is seasonally a slower month due to earnings-related issuance blackouts. Most of the reporting is scheduled during the weeks of October 20 and 27th. As a result, supply volumes will likely be more concentrated during the first week of the month, before blackouts, and in the last week – after enough companies report earnings. There is also risk that a sharp rise in interest rates and corresponding market volatility could lead to significantly less favorable market conditions for supply next month. On the other hand issuance related to acquisitions will likely pick up in 4Q, including potentially in October. This is due to M&A volumes accelerating significantly in 2Q and 3Q of this year (see more details below). Hence M&A related issuance creates upside risk to October (as well as November) supply volumes. Due to these uncertainties we expect October supply in a relatively wide $50 to $100bn range.Yuriy Shchuchinov (Page 6)
  • Increase in CDX IG net longs. Non-dealer investor’s net long-risk positioning in CDX IG increased notably last week, while HY only rose modestly. Hence, the net long positioning in CDX IG rose to $22.5bn last week (as of September 26th) from $17.2bn in the prior week. At the same time, the net long positioning in CDX HY rose to $3.9bn last week from $3.4bn in the prior week. Assuming that the CDX HY is around four times more volatile than CDX IG in terms of returns, the current $3.9bn net long for CDX HY corresponds to about $15.6bn CDX IG net long in terms of risk, which is still somewhat below the current $22.5bn reading for CDX IG


Bank of New York Mellon Exits Derivatives Business

September 30th, 2014 8:06 pm

In another body blow to those in the fixed income trading and sales business (from which I departed one year ago today) Bank of New York Mellon announced that it will exit the business of selling and trading derivatives. The bank will focus on its custody and collateral businesses which are its core businesses.

Via Bloomberg:

Bank of New York Mellon to Shut Derivatives Sales, Trading Group
2014-09-30 20:25:53.0 GMT

By Kelly Bit
Sept. 30 (Bloomberg) — Bank of New York Mellon Corp. told
a group of employees today that it’s shutting its derivatives
sales and trading business.
The decision affects about 50 people, almost all in New
York, according to a person with knowledge of the matter, who
asked not to be named because it’s private. Employees were told
in a meeting earlier this month to expect changes so that BNY
Mellon could focus on its core business of custody and
collateral services, said the person.
“BNY Mellon has decided to exit the derivatives sales and
trading business that operates as part of the company’s Global
Markets group,” spokesman Ron Sommer said in an e-mail.
“Global Markets will offer a modified version of its cash rates
offering to support BNY Mellon’s investment services clients.”
The custody bank, which came under pressure this year from
Trian Fund Management LP to lift its share price, has struggled
as low interest rates have cut income from its investment
portfolio and held down revenue from securities lending. BNY
Mellon Chief Executive Officer Gerald Hassell has been selling
assets and cutting costs to boost profitability.
Trian, the activist investment firm founded by Nelson
Peltz, Peter May, and Ed Garden in 2005, said in June that it
acquired a 2.5 percent stake and was seeking talks with
management. Trian stepped in after BNY Mellon’s pretax margin
was smaller than rivals State Street Corp. and Northern Trust
Corp. in four of the past five fiscal years, according to data
compiled by Bloomberg.


Chat Chief

September 30th, 2014 5:16 pm

The WSJ has posted an article on Perzo the start up founded by David Gurle which is set to be bought by Goldman Sachs and a consortium of other investment banks. The chat function devised by Perzo is seen as a means to the end of breaking Bloomberg’s dominance of the information flow between dealers and clients.

I do not see how that happens unless current Bloomberg users are offered the same analytic capacity which they possess now on the Bloomberg system. In a non legal sense Bloomberg’s holds a monopoly on desktop distribution of information between dealers and clients. In that regard Bloomberg could take the logical path open to any monopolist and slash prices to the point at which the challengers become uncomfortable and hemorrhage capital.

I think the challengers have a difficult task particularly with the former Mayor back in charge of his creation.

Via WSJ:


Wall Street’s Chat Plan Turns to Perzo Chief

David Gurle, CEO of an Instant-Messaging Company That Is Near a Deal to Be Acquired, Is No Stranger on Wall Street

  • Sept. 30, 2014 11:57 a.m. ET

    Perzo Chief Executive David Gurle previously played key roles in developing communications software for big corporations, including banks. UBM Tech

    David Gurle is on the cusp of a deal to sell his two-year-old Silicon Valley startup, Perzo Inc., to 15 of the world’s largest banks and money managers.

    Yet even before executives at Goldman Sachs Group Inc. GS -0.14% zeroed in on his fledging instant-messaging company last year as a possible alternative to the chat service offered by Bloomberg LP, the 47-year-old Mr. Gurle was no stranger on Wall Street.

    At previous career stops at Microsoft Corp. MSFT -0.17% , Thomson Reuters Corp. and Skype, Mr. Gurle played key roles in developing communications software for big corporations, including banks. In time, he got to know trading and technology executives at Goldman and other important clients, people familiar with the matter said.

    Along the way, the France native burnished his reputation as an expert in a narrow field that had generated little buzz—that is, until Wall Street’s hunt for software that allows traders and salespeople to share messages instantly, while loosening Bloomberg’s grip on the way traders communicate, led the industry to Perzo’s Palo Alto, Calif., offices.

    “He knows one thing,” Salman Ullah, a Perzo board member and a partner at Merus Capital, says jokingly. “He’s the enterprise-messaging guy,” referring to the corporate equivalent of consumer “instant message” programs offered by GoogleInc. GOOGL +0.10% “And I think other people have figured it out.”

    “It’s an obscure accolade to have,” Mr. Ullah acknowledges. But it’s one of great value to large companies struggling to find ways for employees to trade instant messages as securely as they might corporate email, he says.

    One of Mr. Gurle’s important allies these days is Darren Cohen, who heads Goldman’s principal strategic investments arm. Mr. Cohen has been the New York firm’s point man on the recent discussions, the people said.

    Goldman and a group of top Wall Street firms are nearing an agreement to buy Perzothrough a holding company called Symphony Communication Services LLC, The Wall Street Journal reported last week. The consortium is in talks to purchase Perzo for $40 million to $50 million, and a deal could be announced as soon as this week, people familiar with the discussions said.

    Mr. Gurle launched Perzo in late 2012, as companies and consumers alike were growing more concerned about privacy online. He didn’t set out to create a messaging platform just for banks, and at first Wall Street’s attention caught some of the Perzo team by surprise, a person familiar with the company said. About a year ago, Goldman had contacted the Perzo chief executive officer to explore whether Perzo’s software would fit well with technology that the Wall Street firm was developing internally, people familiar with the situation said.

    Like many of its peers, Goldman has been searching for a safe way for employees to communicate instantly across different devices—between, say, a smartphone and a desktop computer, the people said. Perzo’s system promised to keep those messages secure and offered an open platform that would allow big corporate customers such as banks to customize for their use.

    Goldman executives came to believe the messaging platform stood a better chance of gaining widespread acceptance on Wall Street if the industry’s biggest players also invested directly in its success.

    Earlier this year, Mr. Gurle called one of his early investors to give an update on the discussions: “These guys want to talk about doing something much closer to us,” Mr. Gurle told the investor, according to a person familiar with the conversation.

    The discussions grew into acquisition talks earlier this year. By September, 14 firms—from BlackRock Inc. BLK -0.70% and Citigroup Inc. C -0.44% to Citadel LLC andWells Fargo WFC +0.35% & Co.—had joined Goldman in the negotiations.

    The new company would blend Perzo’s encrypted messaging software while folding in Goldman’s own back-office messaging components that would make the final product more bank-friendly, people familiar with the plans said.

    The Perzo group is also in talks with one of Mr. Gurle’s old employers, Thomson Reuters, about ways they can integrate the platform into its Eikon system, the Journal reported.

    “While we do not comment on rumor or speculation, Thomson Reuters believes in open, cross-industry collaboration,” Thomson Reuters said. Dow Jones, publisher of The Wall Street Journal, competes with Thomson Reuters and Bloomberg in delivering business news and information.

    Mr. Ullah, who worked with Mr. Gurle at Microsoft, notes that his former colleague created a new business at the tech giant that sought to bring a messaging platform to Microsoft’s business software. Mr. Gurle would work on similar projects at Thomson Reuters and then Skype, which is now owned by Microsoft.

    With the Wall Street companies’ involvement, Perzo could give financial firms’ compliance departments the ability to monitor and limit how employees chat over the messaging system, people familiar with the plans said. That is especially valuable as regulators are watching traders’ words very carefully.

    Mr. Gurle “is very bright and experienced in messaging, and collaboration,” says Charles Giancarlo, a senior adviser at venture-capital firm Silver Lake. “He’s really passionate about this stuff.”

    Mr. Gurle, who is expected by people familiar with the discussions to stay on with the company following its sale, declined to comment.

    Mr. Giancarlo, who was a member of the Silver Lake team that acquired Skype in 2009, helped bring Mr. Gurle to that company. At past jobs, including at Thomson Reuters, Mr. Gurle would frequently attend meetings with executives at Goldman and other clients, people who worked with him said.

    Former colleagues said Mr. Gurle had enjoyed the technology challenges posed by Wall Street and its focus on faster, more-secure data networks; the Perzo deal, one of them said, would mark him “coming home” to a familiar industry.

    Wall Street “knows him,” Mr. Giancarlo says. “Not that they wouldn’t have trusted someone else. But without David or someone of similar stature, it probably wouldn’t get done.”


    End of Day Analysis

    September 30th, 2014 4:58 pm

    Via Richard Gilhooly at TDSecurities :

    The quarter came to and end with selling pressure in long-end Treasuries as the curve steepened 3bp on 5-30s, closing at 144bp. This represented a flattening of nearly 30bp in the quarter, from a June 30 close of 172bp, but was essentially flat on the last month, after closing at 145bp at the end of August. Negative carry for a month is running at around 4.5bp on 5-30s flatteners, while roll down of around 2bp in 5yr notes takes the break-even to around 6bp per month. At 18bp over the quarter, the flattener was still a winning trade, out-performing carry and roll-down by a decent 12bp in the quarter. However, the pace of flattening has waned and in the latest month the flattener has lost around 5bp versus carry and roll-down.

    The big loser in the quarter were commodities, with crude oil dropping around 12% and a bit more for Brent crude, capped by a plunge today to end the quarter, with WTI down over $3 today alone. Gasoline futures fell to a new low for the year but TIPs stopped the bleed and 10yrs break-evens rebounded by 2bp. 30yr Breaks have fallen sharply and hit the lowest levels since 2011, at around 210bp.

    Quarter-end flows can tend to create short term volatility that reflects position adjustment and not necessarily fundamentals, especially when there have been large move sin the quarter. The recent move in the Euro might have been influenced by a need to show less Euro exposure and could have exaggerated the latest decline, in addition to heightened expectations of ECB easing measures via ABS purchases and a possible hint at outright QE. The latest flattening in the yield curve in the past few weeks may have reflected similar pressures, while the unchanged monthly close could possibly indicate exhaustion of this move, especially with the Fed dots becoming more hawkish at mid-month.

    The more interesting question will be investors view of the EM space after the significant FX weakening over the past month, mirrored by the worst performance from EM stocks since 2012. Weakness in Q1 was seen as a buying opportunity and rallied that sector strongly in Q2, as the Fed’s Taper proceeded and Treasury yields eased back. Q4 is normally not a time for investors to ramp up risk, unless there is a very compelling case on valuation and with the Fed being perceived as hawkish and commodities in free-fall we would expect pressure to intensify in coming months rather than move the other way.

    Oil Off 8 Percent in September

    September 30th, 2014 3:20 pm

    Via the FT:

    MARKETSOil’s monthly drop hits 8% as it tumbles below $95

    The euro’s tumble was the most eye-catching move in financial markets early on Tuesday, but it’s since been eclipsed by the slide in oil.

    Brent crude fell 2.6 per cent to trade below $95 a barrel in late afternoon trading in London, taking oil’s drop to just over 8 per cent in September.

    Although there was no obvious trigger for the further leg lower in oil, market watchers pointed to a report signalling a rise in Opec output in September, reports Anjli Raval, oil and gas correspondent.

    Investors closing out positions at the end of the quarter and hedging activities by producing countries, namely Mexico, were noted as other potential reasons for the price falls.

    A combination of oversupply in the North Sea and the Atlantic Basin has coincided with higher production in North America.

    With emerging market economies no longer growing at the heady pace of recent years, both the International Energy Agency and Opec shaved their forecasts for oil demand next year.

    Oil analysts at Commerzbank said:

    There is a clear lack of any impetus to drive any price recovery.

    While bad news for the world’s oil producers, the slide in oil prices will provide a welcome tailwind for US consumers.

    Nice Piece on HY

    September 30th, 2014 2:42 pm

    Via Barrons:

    Junk Bonds Tanking In September, Down 2.4

    The high yield bond market is on track to close September with a 2.47% loss, including a 0.25% loss yesterday and a 1.54% loss over the past week, per a benchmark Bank of America Merrill Lynch index. That’s cut the market’s 2014 return to 3.22% and lifted the market’s average yield to 6.455%. It was barely over three months ago that the market’s average yield fell to an all-time low just under 5%; at that point 2014 returns already totaled 5.34%. In late July, the market saw a brief but intense pullback, but rebounded in August before the latest slide. The current malaise has been enough to cause five companies to postpone planned high-yield bond offerings.

    I’ve gone hoarse in this blog and my Current Yield column warning that the high yield market has been on precarious footing all year, with high valuations, liquidity problems and Federal Reserve rate-hike expectations leaving the market prone to the occasional selloff, even as defaults remain a distant concern. Add to that the recent market volatility after Bill Gross’s exit from Pimco and the high yield market will be happy to see this month end tomorrow.

    Adrian Miller of GMP Securities says the latest stumble has been led by exchange-traded funds, as more big fund managers use ETFs to make bets on the broader market. The iShares iBoxx $ High Yield Corporate Bond Fund (HYG) is down 2.7% this month, and the SPDR Barclays Capital High Yield Bond ETF (JNK) is down 3.1% in September. Here’s Miller:

    The high yield market witnessed a situation where the ETF tail has been effectively wagged the HY dog due to a combination of Fed rate hike speculation, PIMCO headlines and geopolitical tensions. Indeed, last week the HY market dropped -1.35% (YTD: 3.485%) as cash spreads jumped +43bp to 440bp, wider than the recent high of 425bp on August 1st tied to a flare-up in Ukraine and the widest since November 14, 2013. At the same time the market’s yield jumped +57bp to 6.363%…. And while the cash HY market was clearly under duress, HY ETFs underperformed. HYG dropped -1.8% for the week as the JNK fell -1.6%….

    The unfortunate developments for U.S. risk in general and U.S. HY in particular is persistent global macro events and Fed speculation that continues to cloud a near to intermediate term solid fundamental backdrop for credit and to a lesser extent equities. Indeed, we still hold the view that the underlying fundamental backdrop is favorable for credit…. So when the current weakness ends, we look for HY to recover and spreads to narrow. However, given the nature of the current geopolitical concerns, these events are not going away anytime soon and could continue to weigh on the HY market over the near term.

    Treasury Update

    September 30th, 2014 1:19 pm

    The Treasury market is a hotbed of rather pedestrian activity today as clients close their books on Q3.

    The yield curve has manifested a proclivity to steepen with 5s 3s at 142.4 a basis point wider than very early New York AM levels.The 10s 30s curve had flattened between 530AM and 830AM and the subsequent resteepening leaves it a little shy of the 530AM level.Dealers report an average volume day.

    I think there are several reasons for the curve steepening. The World Bank deal was a $4billion deal and the machinations associated with the pricing would remove 5 year paper from the street. I think that with the labor report later in the week winning flatteners are probably being prudently unwound. In addition the next dollop of supply from Jack Lew and his acolytes is long end paper and I think some of this is the beginning of that underwriting process.

    More on ECB and Junk

    September 30th, 2014 11:49 am

    This is also from a fully paid up subscriber across the pond. I do not believe he wrote it but he left no identifying marks regarding the source so take with grain of salt.

    Via a fully paid up subscriber;

    Mario Draghi will push for the European Central Bank to accept bundles of Greek and Cypriot bank loans with “junk” ratings, in an effort to ensure policy makers’ latest attempt to save the eurozone’s economy from economic stagnation is a success.

    Mr Draghi, ECB president, will this week unveil details of a plan to buy hundreds of billions of euros’ worth of loans sliced and diced into packages known as asset-backed securities (ABS), along with covered bonds, to revive the region’s ailing recovery and boost lending to credit-starved smaller businesses in the currency bloc’s periphery.

    As part of the plan, people familiar with the matter say the ECB’s executive board, headed by Mr Draghi, will propose that existing requirements on the quality of assets accepted by the central bank are relaxed to allow the eurozone’s monetary guardian to buy the safer slices, known as senior tranches, of Greek and Cypriot ABSs.

    The move would free up billions of liquidity for banks in two of the eurozone’s weakest economies. A senior Greek banker said: “This would have a significant positive impact for the Greek banking system and the Greek economy.” The ECB’s efforts to ease monetary conditions in the periphery were being hampered by the rules on low credit ratings, the banker argued.

    However, a relaxation of the rules is likely to face staunch opposition in Germany, fraying the increasingly strained relations between the ECB and officials in the eurozone’s largest economy.

    Bundesbank president Jens Weidmann has objected to the plan to buy ABS, which he says leaves the central bank’s balance sheet too exposed to risks. Wolfgang Schäuble, Germany’s finance minister, has also voiced his opposition, saying purchases would strengthen the debate about potential conflicts of interest between the ECB’s role as monetary policymaker and bank supervisor.

    As the assets originated in Greece and Cyprus are potentially riskier than those from banks elsewhere in the eurozone, the ECB would compensate by purchasing smaller proportions of these securitisations, according to a Eurosystem official. The move is aimed at making the programme of ABS purchases as inclusive as possible. If supported by the majority of members of the governing council, it would enable the ECB to buy instruments from banks of all 18 eurozone member states.

    At present, the ECB only accepts ABSs as collateral in exchange for its cheap loans if they hold a minimum rating of at least triple B, the lowest investment grade rating.

    Because the ratings on senior tranches are capped by the sovereign rating of the country where the bank is based, if those rules were to apply to the ECB’s buying plan, the central bank could not accept any securitisations of Greek or Cypriot issuers. Standard & Poor’s rates Greece and Cyprus as single B sovereigns – a sub-investment grade rating. Fitch rates Greece as single B, and Cyprus as single B-minus. Moody’s rates Greece Caa1 and Cyprus as Caa3.

    An ECB official declined to comment on Tuesday, saying proposals made to the governing council are confidential.