IP Dissected

January 18th, 2017 9:46 am

Via Stephen Stanley at Amherst Pierpont Securities:

Industrial production surged in December by 0.8%, mainly driven by a weather-induced 6.6% rebound in utility usage.  In fact, the utility category has been driving the headline figures for several months.  In contrast, manufacturing output has been on a steadier but glacial uptrend.  Factory production rose by 0.2% in December and is up on average by 0.1% per month over the past four months (and by a cumulative 0.2% over the last 12 months).  While this is far from robust, it is a little better than what we saw in 2015 and early 2016, when factory output was being dampened by the steep dollar appreciation that occurred in late 2014/early 2015.  Despite President-elect Trump’s best efforts to keep production on shore, another run-up in the dollar since the election is not going to be helpful for manufacturers.  Once tax and regulatory reform begin to kick in (presumably in the second half of this year), manufacturers may have a lot to cheer about, but, for now, the near-term outlook remains tepid at best.

CPI Dissected

January 18th, 2017 9:20 am

Via TDSecurities:

US: Inflation Breaks 2% On Energy and Core Services


·         December CPI accelerated to 2.1% y/y in line with expectations, boosted by gasoline prices and a solid 0.2% m/m print in the core (ex food & energy) index. The latter pushed up the core inflation rate back to 2.2% y/y.  


·         Most of the core strength was found in services while goods prices remained subdued as USD appreciation continued to weigh on domestic price pressures. A recovery in the latter will be key for a further acceleration in core inflation this year. Accelerating Chinese manufacturing goods inflation is a welcome development but USD appreciation may remain an offsetting factor in the near-term.


Headline CPI rose 0.3% m/m in December, leading the headline inflation rate higher to 2.1% y/y. Energy prices firmed further to 5.4% y/y on higher gasoline prices, while electricity prices were flat and natural gas prices declined. Food prices were flat on the month and remained below year ago levels (-0.2% y/y) though look to have bottomed in our view.  We expect food inflation to firm further this year on the back of higher producer level prices and firming global commodity indexes.

Excluding food and energy, the core CPI rose a solid 0.2% m/m (0.230% m/m). That lead the core inflation rate back to 2.2% y/y. The strength continued to be concentrated in services, with shelter prices accelerating to a new cycle high of 3.6% y/y on hotel prices. Transportation services also contributed due to a bounce in airfares. Elsewhere however, price pressures remained subdued with another soft reading for medical care services (+0.1% m/m). Core goods prices were flat on the month (-0.6% y/y) as USD appreciation continue to weigh. Continued m/m declines were seen in apparel, household furnishings and recreational goods with offsetting modest increases in education/communication categories and medical care goods.


January 17th, 2017 7:13 am

Via Marc Chandler at Brown Brothers Harriman:

Trump’s Comments Send the Dollar Reeling

  • In a WSJ interview, Trump pushes against GOP border adjustment plan and warns the dollar is already too strong.  
  • Details of UK’s May Brexit speech has already been provided via advanced extracts.  Sterling recovers from yesterday’s slide
  • Global equities are heavier and bond yields lower

The US dollar is broadly lower and North American session will begin with the greenback on session lows.  The intraday technicals look stretched and North American operators were more constructive the dollar in the second half of last week than Asia or Europe.  The South African ran, Brazilian real, Russian rouble, and Mexican peso are leading the emerging market currencies higher.  Bonds are rallying, Us 10-year Treasuries off nearly 7 bp to 2.33% and European bond yields are off 4-6 bp.  Equity markets are mixed.  The MSCI Asia Pacific eked out almost 0.2% gain, most markets outside of China, Hong Kong and South Korea were lower.  MSCI Emerging market index has retraced yesterday’s 0.75% loss.  However, European markets are weak, with the Dow Jones Stoxx 60 is off 0.5% with all sectors lower, lead by materials and telecoms.  
The US dollar is broadly lower against major and emerging market currencies.  It has given up yesterday’s gains and more.  The proximate cause appears to be comments by President-elect Trump in a Wall Street Journal interview.

There are two parts of Trump’s comments that would have likely weighed on the dollar separately, and together they seem to be worth between 0.5% and 1.0% for the major currencies.  First, Trump pushed against the “border adjustment” plan from Republicans that would have taxed imports and exempted exports.  He said it was “too complicated.”  Recall, many economics, including Harvard’s Martin Feldstein, argued that the tax would spur an “automatic” 20-25% increase in the dollar.

Second, Trump specifically said the dollar was too strong.  The context was about China, but the remarks seemed to have broader implications.  “Our companies can’t compete with them [China] now because our currency is too strong.  And it is killing us.”  He said the yuan was “dropping like a rock” and the central bank was supported it simply “because they don’t want us to get angry.”

The investment community, like Americans themselves, is grappling with how literal to take the seemingly visceral remarks.  Some of the strident positions taken during the campaign have been softened, including the nomination of at least five men from Goldman Sachs, not pushing for criminal charges against Clinton, and citing China as a currency market manipulator on Day 1 (which, in any event, is now said to be not the day after inauguration but Monday January 23).  It is the uncertainty that is weighing on the greenback today.

In the larger picture, of the numerous factors that impact foreign exchange rates, the wish and desires of officials do not often seem to be particularly salient.  Our long-term bullish outlook for the dollar is based on the divergence of monetary policy, the relative health of the financial system, the anticipated policy mix, and the uncertainty surrounding this year’s elections in Europe.

The highlight of today was supposed to be UK Prime Minister May’s speech on Brexit. Much of what she is going to say is believed to have been largely reported with advanced extracts.  The essence of the approach is a “clean break” with the EU, including the single market.   Also, we expected the time frame for triggering Article 50 remains the same, end of Q1.  That said, recall the Supreme Court ruling on the role of Parliament and the snafu in Northern Ireland pose risks to the plans.

Sterling gapped lower yesterday in Asia, falling below $1.20 briefly after Chancellor of the Exchequer Hammond appeared to threaten sharp cuts in UK corporate tax rates if necessary to remain competitive in post-EU circumstances.  It filled the gap today, which extended a little above $1.2120.  Sterling approached $1.2190, with the help of a firmer CPI (1.6% up from 1.2% in November, and the highest since July 2014, with the core rate also firming.  A break now of $.12080 would suggest the short-squeeze may have run its course.

The ECB meeting in a couple of days is another highlight of the week.  The euro slipped to $1.0580 yesterday and rallied a cent by early European hours today.   It stopped just shy of last week’s high set on January 12 at $1.0685.  Intraday technicals, like for sterling, suggest the North American dealers may be more constructive on the dollar as it was several days last week. Initial support for the euro is seen near $1.0620-$1.6030.

The German ZEW had a little perceptible impact.  The January reading saw improvement, more in the assessment of the current situation (77.3 from 63.5 and 65.0 median guesstimates in the Bloomberg survey) than in expectations (16.6 from 13.8 and 18.4 median).   The final estimate of Germany’s December CPI will be released tomorrow.  It is expected to confirm the 1.7% preliminary estimate, and is a timely reminder ahead of the ECB meeting of the challenges of a one-zone fits all monetary policy.

The dollar’s recent losses against the yen are being extended today.  The greenback fell to almost JPY113.00, its lowest level since December 5.  In addition to the broad dollar decline today, other drivers seem to be also encouraging short-covering of previously sold yen positions.  US 10-year yields are six basis points lower at 2.33%.  The low point last week was almost 2.30%.  Recall that the yield peaked near 2.64% in the middle of December.  Also, US equities are trading lower, with the S&P are called to open around 0.5% lower.   The Nikkei itself gapped lower (gap:19043-19061) and closed off 1.5%, for its biggest loss since the US election.  It closed on its lows, which has not been seen since December 8.

The dollar lost 0.6% against the Chinese yuan.  At a little below CNY6.86, the dollar is at its weakest against the yuan since mid-November.  While this likely reflects the broadly weaker dollar, China’s overnight repo rate jumped 23 bp to 2.40%.  This does not seem to be tied to the short squeeze officials engineered early this month in the offshore yuan.  Instead, the onshore pressure comes from the tightening of conditions ahead of the Lunar New Year holidays.  The PBOC has tried to offset the shortage by injecting a relatively large amount (net CNY270 bln or ~$39 bln) the most since last January.  The Lunar New Year holiday runs from January 27 through February 2.


January 16th, 2017 7:12 am

Via Marc Chandler at Brown Brothers Harriman;

Drivers for the Week Ahead

  • May’s Brexit speech on January 17
  • ECB meeting on January 19
  • Trump’s inauguration as 45th US President on January 20
  • Bank of Canada meets
  • China’s President Xi to address Davos

Sterling’s drop through $1.20 in Asia in response to additional confirmation that the UK government will accept that it no longer will retain access to the single market in exchange for immigration control and not being subject to the European Court of Justice.  This is what investors regard as a hard exit and negative for sterling.  The anxiety that is leading to sterling sales also seemed to weigh on the usually currency sensitive FTSE 100 , which is poised to snap a record 14-day advance.  Sterling’s drop may have helped drag down most of the other major currencies, with the Japanese yen bucking the trend.  The yen found a bid seemingly from the falling equities and benchmark yields in Europe.  Chinese stocks tumbled amid reports suggesting that initial public offerings may be accelerated.  The Shanghai Composite closed fractionally lower after losing more than 2%, while the Shenzhen’s 3.6% decline represents almost half of the loss at its worst today.  Most Asian and European bourses are lower.  European bond yields are lower led by the UK gilts.  Brent oil is firmer, but consolidating within last Thursday’s ranges.  Iron ore prices continue to rally strongly, tacking on another 7.5% to bring the year-to-day rise to almost 20%.  The euro has been sold to $!.0580, roughly a cent down from the pre-weekend high.  Sterling is a drag, but also comments from US President-elect Trump that NATO is obsolete and that more countries will likely follow the UK out of the EU, which is a German project.  Trump also extended his attack auto companies using Mexico as an export platform and specifically mentioned BMW.  Italian assets are underperforming after the DBRS downgrade before the weekend.  After a two day rally on tightening liquidity, the Turkish lira is back on the defensive as is the South African rand.  The Russian rouble is the best performing emerging market currency, following a suggestion by Trump that sanction can be lifted in exchange for a nuclear weapons agreement.  

Like many, we recognize that political factors may overshadow macroeconomic drivers in shaping the investment climate in the period ahead.  We suspect this will be very much the case in the coming days  It is not that the economic data doesn’t matter, but for many investors, the imprecision and quirky nature of the high frequency economic data pale in comparison to the risks emanating from politics and policy.  

Before providing a thumbnail sketch of the five events, we think may shape the investment climate in the week ahead, allow us to briefly preview the economic highlights.  The US and Japan round out the large countries industrial output reports. Europe accelerated.  Japan is will likely confirm the strongest monthly increase since March 2014.  US industrial output is expected to have snapped back from a weak November.  The soft patch the dragged it lower for three of the past four months through November may have ended.  

The US, UK, and Canada report inflation measures.  UK inflation is expected to have stabilized at higher levels, though PPI may continue to trend higher.  US headline CPI is expected to continue to converge with the core rate, as is repeatedly done for the past fifty years.  It is expected to push through 2.0% for the first time since July 2014.  The core rate is expected to tick up to 2.2% from 2.1%.   Canada’s CPI has averaged 1.4% this year and 1.1% in 2015.  It is expected to rebound from 1.2% in November to 1.7% last month.

Investors will get an update the UK labor market, which has lost some momentum in recent months, and average weekly earnings that appear to have steadied.  Australia reports December employment figures.  It created almost 25k jobs a month in 2015 and less than a third of that in 2016. It reported an outsized 39.1k  job growth in November. These were all full-time jobs.  Economists expect a 10k increase in December, which seems optimistic.  Canada reports November retail sales. The 1.1% jump in October (1.4% excluding autos) is obviously unsustainable. The risk seems to be on the downside of the Bloomberg median forecast of 0.5%.   

Now, let’s turn to the five key events:  

5.  Bank of Canada meeting and updated economic assessment:  The overnight rate will remain unchanged at 0.5%, and the anticipation of closing the output gap in mid-2018 also won’t be altered. However, we flag this because we expect a more upbeat tone to the central bank’s neutrality.  Also, we suspect that in the US dollar appreciation that we expect to resume shortly, investors will also look for alternatives to the greenback and the Canadian dollar is a potential candidate.  The Canadian dollar was the strongest of the major currencies against the US dollar in 2016, gaining almost 3%. The US dollar has been sold from CAD1.36 on December 30 to nearly CAD1.30 on January 12.   The US two-year premium has fallen from nearly 48 bp to 39 bp at the end of last week. It is approaching the lower end of a range  (~35 bp) that has been sustained since the middle of November.    The US premium had risen steadily from below six bp last-July.    The US 10-year premium more than doubled from last April’s 32 bp to 81 bp peak in late-November.  It has subsequently pulled back and has not been above 70 bp since January 4.  

4:  China’s President Xi goes to Davos: This will be the first time a Chinese President attends Davos.  It is part of an important and ironic juxtaposition that appears to be unfolding.  It will be Chinese “core” leader that will defend globalization from the populism and protectionism that appears to be on the rise in the United States and Europe.  The shoe has been on the other foot for years.  Chinese nationalism was worrisome for many.  It was China’s reluctance to free-trade rules embodied in the WTO agreements that was the cause of much trade friction.  Meanwhile, the price of stabilizing the economy has been a continued increase in credit extension.  At the same time, capital controls have been tightened stem the outflows.  The painful squeeze inflicted in the offshore yuan market continues to deter speculation as CNH is trading at its largest premium (rather than the more usual discount) for the longest period under this dual currency regime.  

We had argued that just like Bush and Obama backed off their campaign pledges to cite China as a currency manipulator when they assumed office.  Our forecast that Trump would also back off his pledge to cite China on day one was also bluster is coming to pass.  In an interview in the Wall Street Journal, the President-elect says it won’t be day one.  He will talk to them first.  Revealing either his reluctance to take language seriously or a subtle slight to China, Trump referred to President Xi as chairman.  It would be like calling a US president Commander.  It is a title they have but not this purpose. Alternatively, it could be a jab that Xi is not elected.   More antagonistic to the Chinese, Trump said he is not committed to the US traditional one-China policy.  He claimed it was up for negotiations.  

3.  May’s Brexit strategy: When May became Prime Minister there was a small window of opportunity to change the trajectory.  She could have said she was not bound by Cameron’s pledge to adhere to the results of the referendum.  May’s government has not been bound by other policies of the previous Tory government. She could have said that the referendum was non-binding and why pretend otherwise.  It won with the slightest of majorities, which was not to make such an important decision as changing a treaty.  With Labour having inflicted on itself serious injury, she could have won an election if she lost a vote of confidence.  Instead, she went with the “Brexit is Brexit”  slogan that may still prove tantamount to cutting one’s nose to spite one’s face.  

A week ago, May confirmed that she was willing to sacrifice access to the single market in exchange for greater control over immigration and not being subject to the European Court of Justice. Sterling fell in response through the $1.22 area that had served as a base since October and fell to two-month lows against the euro.  She is expected to outline more of her approach in a speech on January 17.  A new wrinkle has emerged, and it may blunt or neutralize the negativity of the hard exit that May appears to be leading the UK.  The Northern Ireland government collapsed at the start of last week. If the UK Supreme Court grants, it is expected to do shortly, a role for the parliament that sits in Westminster, the Parliament in Northern Ireland has joined the suit.  Without a sitting parliament in Northern Ireland, May’s intention on triggering Article 50 at the end of Q1 would likely be frustrated.   

2.  ECB meeting: After having adjustment policy last month, there seems to be practically no chance that the ECB introduces new initiatives.  Draghi’s presentation may be ho-hum. The eurozone economy has evolved in line with the ECB’s expectations.  Investors will be most interested learning Draghi and the ECB’s take on the stronger than expected rise in CPI.  Recall headline CPI jumped to 1.1% in the preliminary estimate in December from 0.6% in November. It is expected to be confirmed the day before the ECB meets. Draghi can be expected to resist ideas such as those suggested by German Finance Minister Schaeuble that it is time to reconsider the thrust of monetary policy.   If it were up to officials like Schaeuble, the policy would not have been implemented in the first place.  

The first inkling that policy is indeed working is not the time to pullback, Draghi may say.  In addition to cautioning against jumping to conclusions based on one month’s data, he may note that the rise in headline measures is primarily the result of energy prices.  The core rate increased to 0.9% in the preliminary estimate for December.  The cyclical low was 0.6%.  Pressure is likely to mount until the updated staff forecasts in March.  Note that the base effect warns of additional gains in CPI. Last January’s 1.4% decline (month-over-month)  will drop out of the year-over-year comparison.  Despite the increase in price pressures, inflation expectations remain deflated.  The German 10-year breakeven is a little below 1.3%.  

1:  Trump’s inauguration:   Donald J Trump will become the 45th President of the United States on January 20.  There is great uncertainty surrounding the policies his administration will pursue, and its priorities.  The only thing we can be confident of is there will be changes in both style and substance. It has already become clear in the confirmation process that many of new cabinet officials disagree with important elements Trump’s campaign rhetoric, and disagree with each other.  Presidents have their own decision-making style, and it is not clear where power will truly lie.  Only infrequently is an org chart particularly helpful.  

Amid the uncertainty, there are a few important constants.  First, the economic team is very pro-growth.  The usual reasons for not pursuing policies that lead to stronger growth, as the effect on the trade deficit, the dollar, or inflation are not acceptable to many in the new economic team.  Second, Trump does not feel bound by American tradition, including resisting sphere of influence claims (including formally recognizing Russia’s annexation of Crimea), opposing nuclear proliferation, defender of free-trade, and the acceptance that Taiwan is part of China (even while opposing a military solution).  Third, the communication style, including the extensive use of Twitter and citing names of specific companies and people, create new uncertainties for investors.  In situations like that, people often find ways to look like they are complying in hopes of deflecting negative attention while pursuing their own agenda.  Fourth, the style and policy substance is likely to lend itself to a heavy volume of misunderstanding, clarifications, and in one word, controversies, that make it all the more important that investors distinguish between noise and signal and focus on the latter.  

Gross Sees 2.60 as Technical Line in Sand

January 9th, 2017 7:07 am

This is an excerpt from a longer Bloomberg story:

“If the 10-year breaks 2.6 percent on a weekly or on a monthly basis, because it’s so strong and so important in terms of technical analysis, that if and when it’s broken on the upside, it’s a bear market,” Gross, who manages the $1.7 billion Janus Global Unconstrained Bond Fund, said Friday in an interview on Bloomberg Television and Bloomberg Radio. “And if it’s not broken on the upside, we just stay where we are.”

Aging Baby Boomer Alert: The Bond Market Version

January 9th, 2017 7:02 am

Via Bloomberg:

Don’t Worry Bond Investors, Baby Boomers Have Got Your Back

  • HSBC report sees aging population supporting demand for bonds
  • Debt already accounts for more than half of pension holdings

Investors mourning the end of a 30-year bull market in U.S. Treasuries can take solace from demographics: thanks to the aging population there’s a limit to how high yields can go.

Over the next decade, as more of those born in the baby-boom period following World War II get closer to drawing their pensions, global demand for bonds and cash will rise and allocations to equities will fall, according to analysts at HSBC Global Research. That’s because people get more risk averse as they get closer to retirement, shifting out of stocks and into fixed-income investments.

The generation now approaching retirement is both bigger and wealthier than all the other age groups in most of the developed world. So even if cyclical factors such as rising inflation in the U.S. boost the mid-term appeal of stocks over bonds, the longer-term demand for fixed income will remain high, according to Fredrik Nerbrand, global head of asset allocation at HSBC Bank Plc in London.

“If you believe in follow the money, you need to follow the baby boomers,” Nerbrand said in a phone interview. “Bond yields may not revert back to their historical averages even if inflation were to rise because the structural story is still there.”

Tremors in the bond market have renewed interest in an argument that the greying of large portions of developed-market populations will help support bond prices. Jim Leaviss at M&G Investments in London argued in a research note in December that while demographics have helped to push down bond yields in the past, the link has been distorted by factors like government stimulus since the financial crisis and globalization changing the shape of the labor force.

The global population aged 60 or over is growing at a rate of 3.3 percent a year and in Europe, that age group already makes up 24 percent of the total, according to the United Nations 2015 World Population Prospects report. As the ranks of those entering retirement age swell, they are taking a larger slice of the economic pie, with baby boomers in the U.S. now holding more than 45 percent of the total wealth pool, HSBC said in a report.

Pension funds in member states are already allocating more than 50 percent of their holdings to bonds, according to an Organisation for Economic Co-operation and Development study released in June. HSBC forecasts that U.S. allocations to equities will drop by about five percentage points by 2030, offset by a small increase in bond holdings and a larger increase in cash.

That doesn’t mean Nerbrand is betting on bonds in the short term. In the current cycle, with the Federal Reserve set to raise interest rates at a faster pace this year and Donald Trump’s spending plans set to fuel inflation, the place to be is equities, he said.

“There are times when you don’t want to be long bonds from an asset allocation perspective,” Nebrand said. “But generally we would suggest that there is still a structural demand over the next five to 10 years that favors bonds rather than equities.”

Corporate Bond Pipeline

January 9th, 2017 6:57 am

Via Bob Elson at Bloomberg:

2017-01-09 10:39:10.53 GMT

By Robert Elson
(Bloomberg) — Set to price today:

* Toronto-Dominion Bank (TD) Aaa/AAA, to price $benchmark
144a/Reg-S 5Y Covered Bond, via managers BMO/BNP/GS/HSBC/TD;
IPT MS +Low-60s

* Added today:
* Kommuninvest (KOMINS) Aaa/AAA, mandates BNP/BAML/Nom/TD
to manage a forthcoming $benchmark 144a/Reg-S 3Y
* Inter-American Development Bank (IADB) Aaa/AAA, mandates
BMO/BAML/HSBC/JPM to lead manage $benchmark Global 5Y

* M&A deals expected in 2017

* Recent updates:
* Empresa de Transporte de Pasajeros Metro S.A. (Metro de
Santiago) (BMETR) na/A+/A, mandates BAML/JPM for
investor calls; 144a/Reg-S 30Y expected to follow
* Fibria Celulose S.A. na/BBB-/BBB-, mandates
BNP/BAML/C/HSBC/JPM for investor meetings from Jan. 6;
10Y Green Bond may follow
* Raizen Fuels Finance na/BBB-/BBB, to hold investor
meeting from Jan.9, via BAML/Bradesco/C/JPM/SANTAN
144a/Reg-S intermediate offering may follow
* PG&E Corp (PCG) Baa1/BBB, filed $350m mixed shelf; last
issued at this level in Feb. 2014
* Republic of Korea (KOREA) Aa2/AA, mandates
BAML/C/GS/HSBC/KDB/Samsung for investor meetings Jan.
9-11; USD deal may follow
* Has not priced a new USD issue since June 2014
* Apple (AAPL) Aa1/AA+, added as possible early 2017
issuers based on history
* United Technologies (UTX) A3/A-, said in Dec. 14
guidance call it will tap the debt markets in early 2017
to complete its share buyback program
* 3M (MMM) A1/AA-, plans to add up to $2.8b of debt in
2017, suggesting another yr of incrementally higher
leverage: BI


* Scentre Group (SCGAU) A1/A; mtgs Dec. 5-8
* ACWA Power; mtgs from Nov. 23
* Adani Ports (ADSEZ) Baa3/BBB-; mtgs from Nov. 13
* Korea Hydro & Nuclear Power (KOHNPW) Aa2/AA; mtgs Oct. 18-20


* Mercury General (MCY) files debt shelf; last seen in 2001
* Puget Sound Energy (PSD) A2/A-; $800m debt shelf (Nov. 8)
* Dow Chemical (DOW) Baa2/BBB; debt shelf; last issued in
Sept. 2014 (Oct. 28)
* Darden Restaurants (DRI) Baa3/BBB; debt shelf, last seen in
2012 (Oct. 6)
* Western Union (WU) Baa2/BBB; debt shelf; last issued Nov.
2013 following Oct. 2013 filing (Oct. 3)


* European Stability Mechanism (ESM) Aa1/–; mandates for
advisement on inaugural USD issuance (Oct. 21)
* ConAgra (CAG) Baa2/BBB-; could borrow up to $2.5b for
acquisitions, BI says (Oct. 19)

Sterling Falls on Prospect of Hard Brexit

January 9th, 2017 6:54 am

Via WSJ:

Sterling Falls on Theresa May’s Brexit Comments

The prime minister said the U.K. would aim for a clean break from the EU

The pound fell sharply against the dollar and euro Monday after U.K. Prime Minister Theresa May said Britain would make a definitive break from the European Union.

The pound fell 1.23% to $1.214 against the greenback, taking sterling to the levels it traded at in October. It was down 1.11% against the euro at €1.154. Sterling was as high as $1.24 Thursday.

On Sunday, Ms. May said in an interview with Sky News that the U.K. would aim for a clean break from the EU, reiterating her intention for Britain to negotiate control over immigration in upcoming Brexit negotiations.

“Often people talk in terms as if somehow we are leaving the EU, but we still want to kind of keep bits of membership of the EU,” Mrs. May said in an interview with Sky News.

“We are leaving. We are coming out,” she added, saying that the U.K. still wanted the “best possible deal” in terms of trade.

The EU’s 27 other heads of government have said that freedom of movement for EU citizens is a requirement for access to the bloc’s single market, with is the biggest destination for British exports.

The pound plunged in October following similar comments from Ms. May at the Conservative Party conference.

On Monday, a spokeswoman for Mrs. May said the Prime Minister hadn’t ruled anything out or in.

​”She’s said she wants the best possible deal for trading with and operating within the single market,” the spokeswoman said.

Though U.K. economic data has surprised on the upside, many analysts believe the pound will continue to head lower.

Sterling is also being hit by the strong dollar, which has gained in recent months on a belief that the U.S. Federal Reserve will raise interest rates at a faster rate in 2017. The WSJ Dollar Index was up 0.24% Monday.

Morgan Stanley sees sterling falling to $1.17 this quarter, because it thinks political uncertainty will impact investment in 2017.

However, some forecasters disagree.

“We think further signs that the government is being forced toward a soft Brexit will emerge, enabling sterling to climb back to about $1.30 and €1.24 by the end of this year,” Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics, said in a research note.

Write to Mike Bird at Mike.Bird@wsj.com

Early FX

January 9th, 2017 6:44 am

Via Marc Chandler at Brown Brothers Harriman:

Drivers in the Week Ahead

  • US retail sales late in the week is the main data feature this week
  • The short squeeze in the Chinese yuan appears to have ended
  • UK Prime Minister May comments suggest hard Brexit, which weighs on sterling
  • Brazil is expected to cut 50 bp in the Selic rate this week

May’ weekend comments indicated a willingness and strategic thrust to abandon the single market in exchange for regaining control over immigration and not being subject the European Court of Justice sent sterling off more than 1% today to lead the major currencies lower.  The Australian and New Zealand dollar’s are slightly firmer, withe most of the other currencies little changed.  Japanese markets were closed for a national holiday, and the dollar is straddling the JPY117 area.  Germany reported a larger than expected jump in November exports (3.9%, best in more than four years), but did little for the year which stalled near $1.0555 only to slip toward $1.05 in the European morning.   Equities are mostly lower, thought the currency-sensitive  FTSE 100 extended its winning streak into a tenth session.   Bonds a recovering following the sell-off before the weekend, with Italian and Spanish 10-year yields seven basis points lower and German yield a single basis point lower.  The yield on 10-year Treasuries is 2.5 bp lower to push slightly through 2.40%.  Lastly, we note that the South Korean won  is more than 1% lower as a dispute with Japan led to the suspension of discussions about a swap line and North Korea threatens the launch of a long-range missile.  

The major US equity indices reached record highs before the weekend even if the Dow 20000 level was just out of reach. Following news of a stronger than expected rise in hourly earnings, US yields rose, and after an initial stumble, the dollar recovered on closed on its highs.

The underlying narrative that explains and justifies these broad trends stands on four legs.  First, that the US economy is expanding at a sufficient clip to spur some price pressures, including, as we saw in the employment report, hourly earnings.   (2.9% year-over-year, a new cyclical high, though below past recoveries and expansion levels).  Second, that the economic policies of the new Administration will be pro-growth in the form of de-regulation, tax changes, and nationalist economic policies.  Third, that other high income countries are expanding at least near-trend, and price pressures appear to have bottomed.  Fourth, populist-nationalist forces will be featured on the European political stage, posing the last expression of the existential threat.

The headwinds on the US economy abated in the middle of last year.  The economy expanded at a 3.5% annualized rate in Q3 16 and, while it likely slowed, with less of a contribution from consumption, and a drag from net exports, recent data prompted upward revisions to the Atlanta Fed GDP tracker to 2.9% for Q4.  The Bloomberg consensus is 2.3%, while the NY Fed’s tracker has it at 1.9%.  Some economists are suggesting there is better than a one in three chance of a Fed hike in March, while the CME estimates that the Fed funds futures currently discounts about a one in four chance.

The December retail sales data that will be reported on January 13 will give no reason to doubt basic scenario.  The headline may be flattered by the better than expected vehicle sales and the increase in gasoline prices.  The GDP should rise around 0.3%, consistent with consumption rising at a slightly than the 3.0% pace in Q3.

In Europe, the main feature is November industrial output reports.   Industrial output in the UK and eurozone is expected to have risen by 0.5%-0.6%.  The main difference is in year-over-year pace. The eurozone’s pace may more than double from the 0.6% clip seen in October.  The UK’s industrial output my turn positive (~0.5%) after contracting (-1.1%) in October.  

Separately the UK reports the November trade figures.  The UK deficit is expected to widen out toward GBP3.5 bln from just below GBP2 bln in October.  The average monthly shortfall this year has been GBP3.44 bln vs. GBP2.66 bln in 2015.  Also, Sweden and Norway report CPI.  Sweden, where the central bank is still pursuing very aggressive unorthodox monetary policy is likely to see a further rise in inflation.  It is expected to rise 0.4%-0.5% on the month for a 1.6% year-over-year pace, the fastest in four years.  Even with a 0.1% decline in the Norway’s monthly consumer prices, the year-over-year rate may still rise to 3.8% from 3.5%.

Japan reports its November balance of payments.  It typically deteriorates in November compared with October.  This has been the case without exception since 2006. Before then, it had often improved.  Many observers focus the yen’s impact through the trade channel, but given Japan’s large holdings of foreign assets, the pullback in the yen will boost the investment income balance, arguably more directly than the trade balance.

In 2015 and early 2016, Chinese developments rattled the investors; now considerably less so. However, the powerful short squeeze engineered by PBOC officials does not appear aimed at reversing the yuan’s decline as much creating a powerful disincentive for speculators to think it is a one-way bet.  In the larger picture, the same fundamental considerations that we think will underpin the dollar against the major and emerging market currencies are at work with the yuan as well.  That means that we expect the yuan to move lower on a trend basis.

Nevertheless, the near-term outlook is a bit of cat-and-mouse with Chinese officials and how persistent it wants to be.  As painful as it was for some players last week, the second that officials appeared to back off, they jumped right back into the fray.  On Monday the money market rates eased and the yuan, especially the offshore variant fell.  

China reported that reserves fell by a little more than $41 bln in December to $3.01 trillion.  It is the smallest in decline in three months, and in line with market expectations.  Interestingly, the debate about China’s reserves has transformed from it having too much to wondering if it has a sufficient level of reserves.  Also, because the opaqueness of China’s intervention, in the derivatives market or forward market, forward market, for example, more reserves may be encumbered (committed).  

China is expected to report inflation figures and the December trade surplus.  China’s CPI has gradually firmed.  The 24-month average in November was 1.7%, while the 12-month average 2.0% and the three-month average may tick up to 2.2% in December.  It is the PPI that is surging.  Recall it was negative (deflationary) for five years through late Q3 16.  After turning positive in September (0.1%) it jumped to 1.2% in October and 3.3% in November.  It is expected to rise toward 4.6% in December.    Often when producer prices rise faster than consumer prices, investors get concerned about profit margins.  Some economists also talk about pipeline inflation, but this seems to be more an exception than the rule.

China’s trade surplus is expected to edge toward $47.5 bln from $44.6 bln in November.  Exports likely deteriorated after edging 0.1% higher year-over-year in November.  The improvement likely stems from a slowing in imports.  China’s monthly trade surplus is fairly stable.  The three, 12, and 24-month averages converge between $44.3 and $46.5 bln.   Separately China may also report that credit expansion slow, but remains elevated.  Consider that this year’s monthly average of aggregate social financing is CNY1.46 trillion compared with CNY1.27 in 2015.

Brazil’s central bank began its easing cycle last October and had a follow-up rate cut in November. The consensus calls for a 50 bp cut in the 13.75% Selic rate.  The US dollar has been trending lower against the real since early December and by the end of last week had returned to near where it was trading before the US election.  We suspect the move is exhausted or nearly so.  Just as a year ago, the market may have exaggerated the negatives, it seems that the positives may be exaggerated now.  The dollar finished last week near BRL3.2225.  We see risk in the coming week or two toward BRL3.30.  

Lastly, we note three political issues that may become talking points in the days ahead.  First, the tensions between Greece and the EU has eased since the middle of December, and a new tranche of aid is expected shortly.  Greece’s 10-year bond yield fell 25 bp last week to bring the decline to about 45 bp since Christmas Eve.  Note that investors will likely learn in the days ahead that Greece is still experiencing deflation.  Greece will also report November industrial output (6.8% year-over-year in October) and October unemployment (23.1% in September).  Meanwhile, Greece’s privatization efforts appear to be progressing with the sale of a 51% stake in the Piraeus ports to a Chinese company while has been managing a couple of piers.  

Second, a decision by the UK Supreme Court on the royal prerogative regarding triggering Article 50 to begin the formal negotiations for leaving the EU is expected over the next couple of weeks.  Prime Minister May confirmed two things many investors have suspects:  that there were not plans for Brexit before the referendum and that the UK will leave the single market.   This may weigh on sterling, which lost more than 1% before the weekend to fall for the fourth week in the past five.  Separately, we note that a 24-hour London Underground strike will make for difficult commutes on Monday.  

Third, the US Senate is set to begin taking up the President-elect’s nominations.  Although it is widely recognized Presidents’ prerogative to pick their own advisers and cabinet, many of the nominees are particularly contentious for Democrats, and some Republicans may challenge a couple of the nominees as well.  The process begins in earnest with a Senator Sessions (Republican from Alabama) nomination for Attorney General.  Sessions’ views on civil rights, including voting rights, same-sex marriage, and immigration, as well as Trump’s proposal to establishing a registry of Muslims and imposing a ban on their immigration, will make for a particularly heated hearing.   

Can the Epic Junk Bond Rally Continue?

January 9th, 2017 12:14 am

Via WSJ:

Investors Betting Strongest Junk-Bond Rally in Years Has Legs

Better earnings among risky companies and a slowdown of defaults have given junk-bond investors cause for optimism despite a big decline in yields


An uptick in earnings among riskier U.S. companies is bolstering investor confidence that an epic rally in junk bonds can last a little longer.

After six straight quarters of year-over-year declines, earnings of low-rated companies increased 14% in the second quarter and 72% in the third quarter, according to Bank of America Merrill Lynch. At the same time, defaults slowed following a wave of bankruptcies in the energy sector.

Because of those factors, some investors and analysts say junk bonds— issued by companies that are often small and burdened by debt—could do much better than might be expected after such a strong year.

“From my vantage point, fundamentals are the most important thing” and “they’ve modestly improved,” said Michael Contopoulos, head of high-yield strategy at Bank of America, noting stronger earnings and steady oil prices have reduced risks.

The average junk bond yield was 5.86% Thursday, a two-year low but above the sub-5% levels it reached in 2014. Despite the low yields, many investors still view junk bonds as attractive at a time when the 10-year Treasury note yield is below 2.5% and stock valuations are widely seen as inflated.

Among the many junk-rated companies that had better earnings was Sprint Corp., which reported a 17% increase in adjusted earnings before interest, taxes, depreciation and amortization in the quarter ended Sept. 30 from a year earlier. Its 7.625% bonds due 2025 last traded at around 107 cents on the dollar, up from 75 cents on the dollar in June, according to MarketAxess.

The Bloomberg Barclays U.S. Corporate High Yield Index returned 17.1% in 2016. That was its best total return since 2009 and better than those produced by all three major stock indexes, as well as investment-grade corporate bonds and U.S. Treasurys.

Such a performance almost certainly can’t be replicated in 2017. Unlike stocks, there is a limit to how much bonds can rally because they mature at 100 cents on the dollar.

As bond prices rise, their yields decline. Before last year, junk bonds had produced double-digit returns four times in the previous 10 years and each time returns were much lower the following year.

Still, many investors and analysts are fairly optimistic about how junk bonds will perform.

Of six large banks surveyed by The Wall Street Journal, four project positive returns for junk bonds in 2017. J.P. Morgan Chase & Co. is the most bullish, predicting an 8% return. Wells Fargo & Co. is projecting 5% to 6%, while Bank of America Merrill Lynch is estimating 4% to 5% and Goldman Sachs Group Inc. is expecting 3.2%.

“High yield is a pretty resilient asset class,” said John McClain, a high-yield bond portfolio manager at Diamond Hill Capital Management in Columbus, Ohio. Though the market hit a rough patch in early 2016 as recession fears increased and sellers had trouble finding buyers, “that got fixed very quickly,” he added.

Of course, junk bonds still face risks. They are especially sensitive to economic downturns, sometimes picking up signs of stress before the stock market.

Though they aren’t as vulnerable to rising Treasury yields as investment-grade corporate bonds, junk bonds likely would decline in price if the Federal Reserve raises interest rates more quickly than expected and government bond yields increase sharply. That is especially true for higher-rated bonds with lower yields.

One wild card is the volume of new bonds added to the market. While bond sales tend to drop off during times of market stress, robust issuance can also depress prices of outstanding debt due to supply-demand dynamics.

Unlike the investment grade bonds, which set a record for issuance in 2015 and nearly matched that total last year, the volume of new high-yield bonds has declined in recent years, totaling $261 billion in 2016 compared with $269 billion in 2015 and a record $359 billion in 2013, according to Dealogic.