Hedge Fund Longs

August 1st, 2015 5:50 pm

A fully paid up subscriber who had an urge to write on the weekend pointed out that hedge funds have their largest long positions in the 10 year note contract since April 2013. At that time I was still plying my trade as a bond salesman and preparing for the fruits of retirement but if memory serves me well I believe than in late April 2013 or early May the 10 year note traded as low as 1.60. Shortly thereafter the taper tantrum ensued and its fury took 10 year rates to 3 percent by Labor Day 2013. I was always a better bear so it was nice to begin my September 30 2013 retirement with that ferocious ursus major as a happy memory.

Via Bloomberg:

As oil prices tanked, hedge-fund managers and other large speculators increased bullish bets on Treasury securities to the most in two years, even as the Federal Reserve moves closer to raising interest rates.

“It’s a low-inflation environment,” said Larry Milstein, managing director in New York of government-debt trading at R.W. Pressprich & Co. There’s no “gangbusters growth here and there’s slow growth overseas.”

Speculative positions, or bets prices will rise, outnumbered short positions by 65,642 contracts as of July 28, according to data from the Commodity Futures Trading Commission released Friday. The figure was the most net-long positions since April 2013. Last week, traders were net-long 27,400 contracts, reversing a short position they held since September.

Biden Weighs Challenge to Hilary Clinton

August 1st, 2015 4:43 pm

Vice President Biden has been mute on the topic of a challenge to Hilary Clinton for the right to be the Democratic nominee in 2016. The New York Times reports that he and staff are in active discussion with potential donors and supporters on the possibility that he might seek the nomination. The article intimates that one of the dying wishes of Biden’s son Beau was that his father should seek the nomination and his other son also supports the endeavor. The process has picked up steam as Ms Clinton’s vulnerabilities have become apparent. The lady has been around for a quarter century and carries what the Romans referred to as impedimenta (extra baggage). She has become an easy target and she is wooden on the stump.

Via the NYTimes:

Vice President Joseph R. Biden Jr. and his associates have begun to actively explore a possible presidential campaign, an entry that would upend the Democratic field and deliver a direct threat to Hillary Rodham Clinton, say several people who have spoken to Mr. Biden or his closest advisers.

Mr. Biden’s advisers have started to reach out to Democratic leaders and donors who have not yet committed to Mrs. Clinton or who have grown concerned about what they see as her increasingly visible vulnerabilities as a candidate.

The conversations, often fielded by Mr. Biden’s chief of staff, Steve Ricchetti, have taken place in hushed phone calls and over quiet lunches. In most cases they have grown out of an outpouring of sympathy for the vice president since the death of his 46-year-old son, Beau, in May.

On Saturday, Maureen Dowd, the New York Times columnist, reported that Mr. Biden had been holding meetings at his residence, “talking to friends, family and donors about jumping in” to challenge Mrs. Clinton in Iowa and New Hampshire, the first two nominating states.

One longtime Biden supporter said the vice president has been deeply moved by his son’s desire for him to run.

“He was so close to Beau and it was so heartbreaking that, frankly, I thought initially he wouldn’t have the heart,” Michael Thornton, a Boston lawyer who is a Biden supporter, said in an interview. “But I’ve had indications that maybe he does want to — and ‘that’s what Beau would have wanted me to do.’ ”

Mr. Biden’s path, should he decide to run, would not be easy. Mrs. Clinton has enormous support among Democrats inspired by the idea of electing a woman as president and her campaign has already raised millions of dollars. Mr. Biden, who is 72, has in the past proven prone to embarrassing gaffes on the campaign trail, and he would also face the critical task of building a field operation.

One Democrat with direct knowledge of the conversations described the outreach as a heady combination of donors and friends of Mr. Biden’s wanting to prop up the vice president in his darkest hours, combined with recent polls showing Mrs. Clinton’s support declining, suggesting there could be a path to the nomination for the vice president.

Ms. Dowd reported that as Beau Biden lay dying, he “tried to make his father promise to run, arguing that the White House should not revert to the Clintons and that the country would be better off with Biden values.” Mr. Biden’s other son, Hunter, also encouraged him to run, she wrote.

The support Mr. Biden has garnered speaks to growing concerns among Democrats that Mrs. Clinton could lose in Iowa and New Hampshire, as the populist message of one of her opponents, Senator Bernie Sanders of Vermont, draws swelling crowds.

“The reality is it’s going to be a tough, even-Steven kind of race, and there’s that moment when a lot of party establishment would start exactly this kind of rumble: ‘Is there anybody else?’ ” said Joe Trippi, a Democratic strategist.

At the same time, the slow trickle of news about Mrs. Clinton’s use of private email when she was secretary of state and the coming Benghazi hearings may be distracting some voters from the core message of her campaign: the need to lift the middle class.

“It’s not that we dislike Hillary, it’s that we want to win the White House,” said Richard A. Harpootlian, a lawyer and Democratic donor in Columbia, S.C. who met with Mr. Ricchetti before Beau Biden died. “We have a better chance of doing that with somebody who is not going to have all the distractions of a Clinton campaign.”

A spokeswoman for the Clinton campaign declined to comment.

In a July 30 Quinnipiac poll, 57 percent of voters said Mrs. Clinton was not honest and trustworthy and 52 percent said she did not care about their needs or problems. The same poll showed Mr. Biden with his highest favorability rating — 49 percent — in seven years, with 58 percent saying he is honest and trustworthy and 57 percent saying he cares about them. But Mrs. Clinton’s numbers are still strong, especially among likely Democratic primary voters.

“The No. 1 thing voters want is a candidate who is honest and trustworthy, and the veep is leading in those polls,” said William Pierce, executive director of Draft Biden, a “super PAC” that is trying to build enthusiasm for his possible candidacy.

Mr. Biden could still decide not to run. Confidants say that he has not made up his mind, but that they expect him to make something official by the end of the summer or early September. Other than by not ruling out a run and by holding preliminary meetings, Mr. Biden has not openly fueled the speculation about his candidacy. As of Saturday he had no trips planned to Iowa or New Hampshire in the coming weeks. But an intermediary recruited by the vice president’s office has been in touch with potential staffers who have not yet signed on to the Clinton campaign.

Kendra Barkoff, a spokeswoman for Mr. Biden, said, “As the Biden family continues to go through this difficult time, the vice president is focused on his family and immersed in his work.”

A 2016 campaign would be the third time Mr. Biden, a longtime senator from Delaware, has sought the presidency, which friends describe as his ultimate dream.

Mr. Biden’s first campaign in 1988 ended in heartbreak after news reports that he plagiarized parts of a speech and exaggerated his academic record forced him to drop out. In 2008, Mr. Biden received less than 1 percent of the vote in the Iowa caucuses and dropped out after making controversial comments about Barack Obama, then seeking his first term in the White House. Mr. Biden said he was “the first mainstream African-American who is articulate and bright and clean.”

Mr. Obama later chose Mr. Biden as his running mate. In the early months of the 2016 campaign, the president has been careful not to undermine or wholeheartedly endorse either his former secretary of state or his vice president.

“The president has said that the best political decision he’s ever made in his career has been to ask Joe Biden to run as his vice president,” Eric Schultz, a White House spokesman said last week.

Friends described Mr. Biden’s relationship with Mrs. Clinton in the Senate as cordial and warm. But Mr. Biden has in his long career in Democratic politics clashed with former President Bill Clinton, and his relationship with Mrs. Clinton has not been without awkwardness. One close Biden confidant, Ron Klain, has been in contact with Mrs. Clinton’s campaign about helping her prepare for the Democratic debates, a sign some people interpreted as proof Mr. Biden may decide against a run.

Mr. Ricchetti, a former White House aide in the Clinton administration who is now Mr. Biden’s chief of staff, began talking to donors and supporters in the months before Beau Biden died.

In recent weeks those conversations, with local elected officials and party leaders, started again, mostly because well-wishers called to check on the Biden family. The conversation inevitably drifted to 2016, and many of these Democrats urged Mr. Biden to seriously consider getting into the race, according to people with knowledge of the talks who agreed to discuss private conversations only without attribution.

Mr. Ricchetti declined to comment.

The speculation intensified on Thursday when friends of Mrs. Clinton’s spotted Mr. Ricchetti having breakfast at the Four Seasons in Washington with Louis B. Susman, a major Democratic donor and former ambassador to the United Kingdom. Fox News reported on the meeting.

Mr. Susman, who has already made the maximum donation allowed in the primary, of $2,700, to Mrs. Clinton’s campaign, and who is a longtime friend of the Biden family, dismissed any implication that he was discussing the vice president’s plans. “He wasn’t testing the waters with me,” Mr. Susman said of Mr. Ricchetti. “There was never any discussion of the presidential campaign or money.”

Mr. Biden is by no means a virtuoso campaigner. But his entry into the race would add an unbridled — and often unscripted — passion for the presidency that some Democrats say the ever-cautious Mrs. Clinton at times lacks.

One Democratic donor with direct knowledge of the overtures from the Biden camp said Mr. Biden had already thought about how he would position himself in the race, delivering an economic message to the left of Mrs. Clinton’s while embracing the policies of the Obama administration, like health care reform, that are widely popular among Democrats.

Energy Defaults Weigh on Junk

July 31st, 2015 11:04 pm

Via Barron’s:

3-Year High in Junk Bond Defaults in Second Quarter


The number of defaults among companies rated below investment grade jumped to 15 in the second quarter, a three-year high, according to Moody’s Investors Service. There were just 10 in the first quarter of 2015 as well as in the second quarter of 2014.

This 50% jump doesn’t change the overall default rate, which remains at just 2%. Moody’s believes the default rate will reach a high of 3.2% in February of 2016.

More than half of the second quarter defaults came from the  energy sector, which has suffered from lower prices. Defaults included Alpha Natural Resources (ANRZ), a coal company which did a distressed debt exchange, Warren Resources (WRES), an oil and gas exploration and production company, which also did a distressed debt exchange, and firearms maker Colt Defense, which went bankrupt.

Moody’s senior vice president John Puchalla wrote in the report:

The fallout from the sharp drop in energy prices continues to create operating and liquidity challenges in the oil & gas (O&G) sector, but the resulting upward pressure on defaults is not spreading broadly to other sectors.

On the bright side, the total amount of debt that went into default was far smaller than in the first quarter — just $6.4 billion compared to $27.8 billion. The first quarter included a $20.5 billion default in Caesars Entertainment (CZR) debt.

Equity Market Leverage

July 31st, 2015 9:01 pm

The FT has an excellent piece on leverage in the equity market. The author note that at current levels it approaches levels attained in 2000 and 2007 before markets began to decline. If you are sanguine on stocks this article should make you cautious.

Via the FT:

The Chinese stock markets have delivered a reminder — perhaps most of all to the leadership in Beijing — that markets bolstered by leverage are built on sand.

There were lots of reasons why the raging bull market in China came to an end but one of the principal ones was the extent of margin financing involved. Unofficial calculations overheard in the corridors of the glass towers of Hong Kong suggest that the number could exceed Rmb5.5tn, or more than twice official estimates.

But perhaps US investors similarly need reminding of this truth. Growth in margin financing is on the rise on the other side of the Pacific as well, amounting to some $505bn in June. “Margin debt has risen 11 per cent since the start of the year to reach a record high even as the rally in stocks has become increasingly narrowly based,” note analysts at research boutique Gavekal Dragonomics.

“Although high margin debt will not trigger an equity market collapse, it could exacerbate the downside move should any external shock trigger a sell-off, especially as the ratio of margin debt to total market capitalisation is approaching historical danger levels.” Moreover, “the negative wealth effect of an abrupt decline in the stock market could tip the US economy into recession”, Gavekal suggests.

It is not exactly reassuring that the last time margin debt was at comparable levels was in 2000 and 2007, according to BofA Merrill Lynch Global Research. “We see it as a yellow flag,” Merrill’s technical analyst Steve Suttmeier notes.

The probability that the yellow flag can turn red has risen after the Federal Reserve’s midweek meeting. In the words of Citigroup strategists, the central bank’s utterances imply that the beginning of the end of almost-zero interest rate policies will come “sooner rather than later”.

Of course, there is much more transparency in the US, and margin financing can be measured far more precisely than in China, where most of the margin lending took place in the shadow market. But even though the extent of such financing is known, there remains an element of at least potential instability in the US market as well.

Moreover, there are other sources of leverage in the stock market today that add to such concern, and these factors come at a time when the backdrop is one of deteriorating fundamentals and less liquidity — always a dangerous combination.

For example, stock buybacks have been a big contributing factor to the rise in share prices generally this cycle. Many of these buybacks have been financed with borrowed money. Share buybacks are a byproduct of the possibly perverse incentive structure arising from the Fed’s easy money policies.

In the short term, they are a positive for investors, but in the long term the message is: ‘We have nothing better to do with our money, certainly not to invest in our core business.’ The problem with share buybacks is that they can’t continue indefinitely. In retrospect, investors may realise that managements undertook these programmes at peak prices.

Even with the support of share buybacks, the spring quarter may be the first for the S&P 500 to see negative earnings growth since 2009, according to analysts at the Merrill Lynch arm of Bank of America.

There may also be other, less visible forms of leverage and strains on liquidity In July, investors in China tried to redeem holdings from exchange traded equity funds, expecting to receive the shares on a pro-rata basis. In some cases they could not because the firms involved didn’t have the shares in the first place, because of inadequate quotas. It is difficult – but not impossible – to imagine the same thing happening in some US ETFs.

ETFs and high-frequency trading firms are relatively young features of the US financial landscape. Many analysts fear that ETFs, with their promise of instant redemption, and high-frequency trading firms contribute to an illusion of liquidity when markets are rising that may not be there when the markets turn.

It is also not clear how much leverage both hedge funds and their investors have. One consequence of quantitative easing is that markets are more one-sided today than in the past, and that hedge funds are increasingly forced to use leverage to garner returns.

When rates do finally creep up, vulnerabilities will begin to appear as well. Count on it.

Eclectic Stuff

July 31st, 2015 8:54 pm

Via Merrill Lynch Research:

  • Full on bonds. Not surprisingly after another record breaking month in the primary market (July=$129bn) the high grade bond market feels satiated with paper. We see this as secondary credit spreads continue to widen, new issue concessions increase, although there was some month-end buying in July it seemed slow to pick up, and the CDS-cash basis turns more negative. What this market needs is a break either in the form of a slowdown in supply volumes or some healthy inflows. We expect two more somewhat busy weeks in the primary market before investors head to the beach for total August volumes of $60bn. Unless interest stabilize at lower levels and prompt retail inflows our continued underweight stance on high grade credit will work.
  • ECI vs. PCE. Judged by the reaction in the rates market the disappointing 2Q Employment Cost Index (ECI) of just +0.2% vs. +0.6% expected has the potential to generate a rebound in retail inflows as a representative HG ETF rose about 1/2pt on the same day. Recall that the recovering ECI was the lone bright spot on the US inflation front. However, we would not pay too much attention to one number especially as this one seems a poor reflection of the generally very strong labor market. Moreover, the Fed‘s preferred inflation gauge – PCE – rebounded nicely in 2Q.
  • Accelerating M&A activity. M&A volumes are clearly accelerating as we estimate $404bn in July for North America – the fourth busiest on record (since 2003) after June at $415bn had nearly tied July last year for the busiest month ever. In fact all five months March-Jul this year individually rank in the all-time top-8 busiest months. M&A volumes are heavy because the equity market continues a historically rare pattern of fairly consistently rewarding acquiring companies for takeovers. Unless that changes we can expect more M&A and, while conditions in the high grade primary market permit, that leads to supply.  (Page 7)
  • Remain in curve flatteners. High grade spread curve performance in July was characterized by weakness in the belly of the curve (10-year), as with the lack of retail inflows there are few natural buyers of the 10-year sector. We estimate that 5s/10s spread curves steepened by 8bps in July, while 10s/30s flattened 2bps. Our outlook for a flatter 10s/30s spread curve is intimately related to our underweight stance on HG, as we expect retail outflows and eventually increasing buying in the long end by yield sensitive investors. We expect the 5s/10s curve to flatten as well, as the front end has most “tourist” money and rising short term interest rates into the Feds rate hiking cycle lead to re-accelerating outflows there. The big risk to our curve call is that long term interest rates stabilize at lower levels in which case retail inflows will lead to outperformance in the 10-year sector and a steeper 10s/30s curve. The risk to a 5s/10s flattener is that long rates go up while the front end remains anchored.  (Page 18)
  • Retrench in standard tranches. We recommend that investors sell non-standard maturities issued this year (7-year, 20-year, etc.) and move into the on-the-runs, as off-the-runs stand to underperform significantly as we head into the rate hiking cycle and liquidity suffers.  (Page 19)

Weekend Data Preview

July 31st, 2015 2:34 pm

Via Robert Sinche at Amherst Pierpont Securities:

AUSTRALIA: Manufacturing PMI index for July, following sub-50 readings in 17 of the last 20 months, with a particularly low June reading at 44.2.

CHINA: The “official” Manufacturing and Non-Manufacturing PMIs will be released FRIDAY EVENING at 9:00pm , with the BBerg consensus at 50.1 for the Manufacturing index, down from 50.2 in June. The Markit measured Manufacturing PMI will be released Sunday evening, with a BBerg consensus at 48.3 from 48.2 in June.

S. KOREA: The Manufacturing PMI has plunged in recent months, having fallen to a 2 ½-year low of 46.1 in June, will little prospect of a strong rebound for July. The BBerg consensus expects the Trade data for July to be released Friday night to show a sharp -6.8% YOY drop in exports.

INDIA: The Manufacturing PMI was near its recovery low of 51.3 in June, with the July report due early Monday morning.

JAPAN: The final Manufacturing PMI will be released, with the 51.4 preliminary reading a 5-month high.

RUSSIA: The BBerg consensus expects the Manufacturing PMI to inch up to 48.8 in July from 48.7 in June, which would be the 8th consecutive reading below 50.

EURO ZONE: The EZ Manufacturing PMI is expected to be confirmed at 52.2, the 5th consecutive reading above 52, with the German Manufacturing PMI expected to be confirmed at 51.5 and the French PMI at 49.6. The BBerg consensus expects the Italy Manufacturing PMI at a solid 53.9 (54.1 in June) and Spain at54.3 (vs. 54.5 in June).

UK: The BBerg consensus expects the Manufacturing PMI to inch up to 51.5 from 51.4 in June; the 51.4 reading was the lowest since April 2013.

BRAZIL: The BBerg July Manufacturing PMI will follow a June reading of 46.5; the index has been below 50since February as the economy sinks into recession.

MEXICO: With the MXN reaching record lows versus the USD and CNY, the Manufacturing sector has been expanding, with the 52.0 reading for June the lowest since last July, but still sharply outperforming manufacturing in Brazil.

Bullard OK With September Rate Hike

July 31st, 2015 2:31 pm

Via Bloomberg:

Fed’s Bullard: ‘We Are in Good Shape’ to Raise Rates in Sept:WSJ
2015-07-31 18:19:32.99 GMT

By Libby Sallaberry McGowan
(Bloomberg) — Fed’s Bullard tells Wall Street Journal in
interview GDP data supports case to boost rates soon, cleared
away worries over outlook.

* “The outlook remains fairly good for the economy”
* Fed policy outlook remains data dependent
* 25bps rate rise likely will be nonevent for economy
* Confident inflation will begin rising back to 2%, will get
there by 2016
* NOTE: July 29 FOMC Policy Statement

Guest Post on the Month End Trade

July 31st, 2015 11:40 am

Via Steve Liddy and I apologize for the charts being difficult to read:

I’ve pointed this chart out the last couple of months. Month end has provided a great opportunity to get short. Over the previous 6 month ends, LB yields have risen an average of 36+bp, before seeing any significant support (yes, where I call the top is subjective, but the pictures are fairly clear). Last month’s ‘mere 17.6bp’ move is nearly ½ of the next lowest move-following the Feb m/e.

The LB ‘death cross’ (cue scary music) took place on 6/12, with the 50d registering 2.8407 that day (v 2.8387 on the 200d). That lines up nicely with this ascending trend channel. The 200d is also right below that at 2.822; and if you believe in the ‘death cross’ that should be fairly significant yield support. For today, I think you sell against the 2.89 level, which is Fibo support for the 2014-15 bond rally. I appreciate the flows that have gone on, but history tells me (from the picture above) that come month end, the buying is generally done. In 8/9 days, they’ll have all the 10s and LBs they want.

Deeper Dive into the ECI

July 31st, 2015 10:23 am

This is a second piece from TDSecurities by Millan Mulraine. He conversed with the BLS and he thinks the softness is a result of one off type items and he suggests fading the strength derived from the data surprise.

Via Millan Mulraine at TDSecurities:

In addition to the earlier note sent out by Eric Green, I wanted to make a few observations on the ECI report following our conversation with the BLS. The key findings reinforce our earlier view that this anomalous performance in both wages and benefits has been driven by one-off factors that should unwind. As such, we believe that this report does not reflect a germane deterioration in underlying inflation dynamics, and will have little bearing on the Fed’s deliberation on policy.
1. The sharp deceleration in the growth rate of the wages and salaries component (which accounts for about 70% of total compensation) was driven by a sharp falloff in incentive pay this quarter versus Q1. This accounted in the sharp drop in the growth rate of private industry wages (on an NSA basis) from 0.8% q/q in Q1 to 0.2% q/q in Q2. Excluding commission sale incentives, wages and salaries were unchanged at a solid 0.6% q/q pace in both quarters.
2. Benefits were also affected by special factors, and the key driver was the redefinition to retirement benefits in Q2, perhaps caused by the underfunding of some retirement pension plans. The 0.8% q/q drop in unionized workers benefits was a big part of this. Here is a link of various stories highlighting this fact earlier this year ({http://bit.ly/1Df9WML}). In comparison, non-unionized benefits was unchanged.
Bottom-line: Fade the ECI weakness. Next week’s employment report will give a better picture on the outlook for inflation, and we look for a 0.2% m/m rebound in AHE in July after essentially stalling in June.

Another Take on ECI

July 31st, 2015 9:19 am

This one is by Eric Green at TDSecurities. He is also a bit flummoxed but does not think that this will dissuade the FOMC from hiking rates in September.

Via Eric Green at TDSecurities:

The Q2 ECI was dismal. Total compensation rose only 0.2%, well below the expected gain of 0.6%, and well off the average 0.7% gain over the past four quarters. The rise in wages was the smallest since 1982. The details of the report were no less encouraging. This will be good for stocks (margin compression may be slower than presumed), good for bonds (non inflationary and not constructive for Fed), and bad for the dollar owing to combination of the above. Curve should bull steepen on this.

Total compensation rising only 0.2% was driven by a combination of weak wage growth (0.2%) and spectacularly weak benefit gains (0.1%). All the weakness was centered on the private sector. Wages and salaries there rose 0.2%, but total compensation was 0.0% owing to a -0.2% (that is a decline) in benefits. That is very curious. Unionized benefits led this decline (-0.8%) while unionized benefits fared better (0.0%). Part of this unusual pattern may be attributed to the adjustment to Obamacare, but that is just a suspicion and if so then it looks marginally better than it looks. However, that does not change the tone of this report. It was ugly.
This does not mean the odds of a September rate hike have fallen below even. This data has periodically proved to be very lumpy (seasonal issues, timing issues etc) and the sharp decline is inconsistent with other measures of wage inflation that is trending higher, not falling off a cliff. Moreover, labor market fundamentals are improving, job openings at record highs, and slack on a steady downtrend. This is precisely how the Fed will interpret this report, even if the numbers here are atrocious. The broader trends are still unquestionably favorable.
Yellen has disassociated rising compensation with the timing of lift-off (link to inflation nebulous at best), but we know she wants to see more not less. Still there are two clear implications from this report—one is that it will put more attention on other data as confirmation of sustained economic strength—another is that it simply reinforces a low and slow hiking cycle in which the guts of a normal recovery remain too elusive for comfort.
September rate hikes still on.