October 18th, 2016 6:51 am

Via Marc Chandler at Brown Brothers Harriman:

Dollar Slips Broadly but not Deeply

  • UK and New Zealand inflation was stronger than expected.  Will the US CPI follow suit?
  • China’s credit expansion continues, and faster than economists anticipated
  • Can EU trade ministers ensure that the trade agreement with Canada stays on track?
  • Equity markets and bonds are mostly firmer

The US dollar is trading with a distinct heavier bias today and the retracement of its recent gains may have more room to run.  Part of the move seems technical and one of the key props for the dollar, interest rates,  have pulled back.   Asian shares were mostly higher and the MSCI Asia-Pacific Index gained nearly 1%, while the MSCI Emerging Market equities are 1.3% higher.   The Dow Jones Stoxx 600 was up 1.2% near midday in London, led by materials and information technology.  Financials are doing a little better than the market.  Deutsche Bank shares are 2% higher, while the Italian bank index is up over 2% to extend its winning streak into the third sessions.  The euro has scope to rise toward $1.1050 and be consistent with corrective forces.   Sterling’s cap may extend from $1.2300 toward $1.2350-$1.2370.   The greenback is losing ground to the dollar-bloc.  It appears headed toward CAD1.3000, while the Australian dollar is testing its formidable ceiling around $0.7700.  

The US dollar’s upside momentum eased yesterday in North America, and follow-through selling was seen in Asia and the European morning. The dollar is lower against nearly all the major and emerging market currencies.   The yen is the chief exception, and only barely, as the greenback straddles the JPY104 area.  

Last week’s US retail sales and yesterday’s industrial output figures are disappointed.  What looked to be such a promising quarter in terms of growth appears to have fizzled, and economists are no longer confident that the three-quarter streak of sub-2% GDP prints will be snapped.  

It is tempting to attribute this disappointment to the dollar’s pullback, but such logic needs a middle term, and that is changed expectations of Fed policy.  That is the missing link, so far.  Net-net, and with little volatility, the December Fed funds futures contract is unchanged since October 4, and implies a slightly higher chance of a hike than at the end of September.  Still, US yields have softened somewhat.  The two-year note yield is seven basis points off last week’s high.  The 10-year yield is five basis points below yesterday’s four-month high.    

Sterling was posting corrective upticks before news that prices rose more than expected in September.  Sterling made a marginal new high near $1.2275, but progress quickly stalled.  Comments from the UK government attorney (Eadie)  that seemed to recognize parliament’s right to ratify the Brexit Treaty was understood by the market as making a hard exit marginally less gave a fresh boost to sterling that made new highs on near midday in London.    

Headline CPI rose 0.2% on the month for a 1.0% year-over-year pace.  This was slightly more than expected and compares with a 0.6% pace in August.  The core rate rose to 1.5% from 1.3%, which is also a little more than expected.  

One of the reasons that higher inflation is not good for sterling is that the middle terms are lacking here. Bank of England Governor Carney has made it clear that the higher inflation readings will be accepted and will not trigger a tightening of monetary policy.  There are at least two chains of reasoning.  First, the currency impact is transitory.  Second, higher inflation may offer some cushion to the economic headwinds that are prudent to expect.  

The main news from Asia was China’s continued credit expansion.  It continues at a stronger pace than economists expected.  Aggregate financing rose CNY1.72 trillion (~$255 bln), up from CNY!.47 trillion in August.  The median forecast on Bloomberg was for a modest decline.  The increase in the aggregate figure took place in the traditional banking sector as opposed to shadow banking.  This is evident in the increase of yuan loans to CNY1.22 trillion from CNY949 bln.  The Bloomberg survey showed that economists had expected the shadow banks to have taken a greater market share.  

Although China has not exhausted monetary policy, it appears to be having a similar experience in terms of its money supply as high income countries.  While M1 is expecting rapidly (24.7% year-over-year in September, slowing slightly from 25.3% in August), what is actually getting into the economy is growing much slower (6.6% in September, the slowest pace in three months).  The immediate focus of Chinese policymakers is on reining in the housing market.  This will also encourage a stand pat monetary policy.

The Australian and New Zealand dollars are leading the move against the US dollar today (up to ~0.7% and 0.8% respectively).  Th driving force is not Fed expectations, but a greater sense that the RBA is in no hurry to cut interest rates and that an RBNZ rate cut next month is near a done deal that had been discounted.  The Aussie is having another run at its nemesis near $0.7700 that has blocked the upside over for several months.  Slightly stronger than expected CPI helped the Kiwi has come up to test the 20-day moving average (~$0.7200) and a retracement objective of the nearly five-cent decline since early-September ($0.7210).  A break could spur a move toward $0.7260-$0.7300.  Consumer prices rose 0.2% in Q3.  The median guesstimate was flat after a 0.4% rise in Q2.  The year-over-year rate also stands at 0.2%.  It was expected to ease to 0.1%.  Kiwi is sitting just below its highs ahead of the dairy auction.  

The UK and New Zealand reported higher than expected CPI figures.  This gives more evidence of our macroeconomic views:  Deflationary pressures, outside of Japan have bottomed.  Price pressures will gradually increase.  This is an important turn for investors.    Attention is turning to the US CPI report.  The pace is also expected to increase.  At the headline level, a 0.3% increase will lift the year-over-year pace to 1.5%, while the core rate may be steady at 2.3%.  Remember, the Fed targets the core PCE deflator, which lags behind the CPI.  

The European trade ministers meet to see if there is a compromise to be found to ensure that free-trade agreement with Canada remains on track.  Objections from part of Belgium threaten to gum up the works.  A breakthrough does not seem particularly likely at this level, and it may require a solution from the heads of state who hold a summit at the weekend.  

Some Corporate Bond Stuff

October 18th, 2016 6:49 am

Via Bloomberg:

IG CREDIT: Volume Higher; Rarely Seen Issues Are Most Active
2016-10-18 10:17:06.485 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $13.9b vs $11.7b Friday. 10-DMA $14.1b; 10-Monday
moving avg $12.8b.

* 144a trading added $2b of IG volume vs $1.9b Friday

* Trace most active issues:
* CF 4.95% 2043 was 1st with evenly-weighted client flows
accounting for 100% of volume
* TEVA 4.10% 2046 was next with client trades taking 63%
of volume; client buying twice selling
* F 4.389% 2026 was 3rd with client trades sharing volume
with trades between dealers near 50/50
* HPE 3.60% 2020 was the most active 144a issue with client
trades taking 89% of volume; client selling 2x buying

* Bloomberg Barclays US IG Corporate Bond Index OAS at 130, a
new YTD tight and tightest level since May 2015, vs 131
* 2016 wide/tight: 215 (a new wide since Jan. 2012)/130
* 2015 wide/tight: 171/122
* 2014 wide/tight: 137/97
* All time wide/tight back to 1989: 555 (Dec. 2008)/54
(March 1997)

* Current market levels vs early Monday, Friday levels:
* 2Y 0.815% vs 0.831% vs 0.855%
* 10Y 1.763% vs 1.798% vs 1.775%
* Dow futures +60 vs -58 vs +59
* Oil $50.39 vs $50.23 vs $50.92
* ¥en 103.91 vs 104.12 vs 104.36

* IG issuance totaled $8.35b Monday
* IG issuance topped $30b last week
* October total now $57.105b; YTD $1.39t

Credit Pipeline

October 18th, 2016 6:00 am

Via Bloomberg:

IG CREDIT PIPELINE: Yankees, SSAs and Bank of America to Price
2016-10-18 09:50:45.428 GMT

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

* Japan Finance Organization for Municipalities (JFM) A1/A+,
to price $1b 144a/Reg-S 7Y, via managers BAML/C/Daiwa/Miz;
guidance MS +87 area
* Turkiye Ihracat Kredi Bankasi AS (EXCRTU) Ba1/na/BBB-, to
price $500m 144a/Reg-S 7Y, via C/HSBC/ING/Miz/MUFG/SCB; IPT
MS +420 area
* European Investment Bank (EIB) Aaa/AAA, to price $benchmark
Global 3Y, via C/GS/HSBC; guidance MS +17 area
* Bank of America Corporation (BAC) Baa1/BBB+, to price
$benchmark 3-part self-led deal
* 6/NC5 FRN
* 6/NC5 fixed
* 11/NC10 fixed


* Mondelez International Holdings Netherlands (MDLZ) Baa1/BBB,
hires BAML/CS/HSBC/Miz for investor calls from Oct. 18;
$benchmark 144a/Reg-S 3Y, 5Y expected to follow
* EQUATE Petrochemical Baa2/BBB+, mandates C/HSBC/JPM/NBK for
investor meetings Oct. 20-26; debut 144a/Reg-S 5Y, 10Y deal
may follow
* Province of Nova Scotia (NS Gov) Aa2/A+ , filed Friday a
$1.25b debt shelf; last issued in USD in 2010, has $500m
maturing January
* Korea Hydro & Nuclear Power (KOHNPW) Aa2/AA, mandates BNP/C
for investor meetings Oct. 18-20
* Enersis Americas (ENRSIS) Baa3/BBB, mandates
BBVA/C/JPM/MS/SANTAN for roadshow Oct. 17-19; intermediate
maturity deal expected to follow
* International Finance Corp (IFC) Aaa/AAA, to market 5Y
inaugural Forest Bond, via BNP/BAML/JPM; at least $75m may
price week of Oct. 24
* Hyundai Capital Services (HYUCAP) Baa1/A-, to hold investor
meetings from Oct.17, via C/HSBC/Nom
* Kingdom of Saudi Arabia (SAUDI), to hold investor meetings
Oct. 12-18, via C/HSBC/JPM along with BoC/BNP/DB/GS/MS/MUFG;
144a/Reg-S 5Y/10Y/30Y deal expected to follow
* Sirius International Group (SIRINT) na/BBB/BBB-, has
mandated AMTD/BoC/C/JPM/WFS for 144a/Reg-S USD bond; last
issued in 2007
* Honeywell (HON) A2/A,announced a possible 4Q debt
refinancing in its guidance release Oct. 6
* May consider refinancing 2018, 2021 bonds, BI says
* Darden Restaurants (DRI) Baa3/BBB, filed debt shelf, last
seen in 2012
* Darden announced a new $500m share buyback program in
its 1Q earnings release
* Yes Bank (YESIN) Baa3/na, plans to raise $500m by year’s end
* Republic of Namibia (REPNAM) Baa3/BBB-, to hold non-deal
investor meetings Oct. 7-13, via Barc/JPM/StanBk
* Asciano (AIOAU) Baa3/BBB-, names ANZ/BNP/Miz for investor
meetings Oct. 10-28; it is a non-deal roadshow; last priced
a USD deal in 2011
* Western Union (WU) Baa2/BBB, filed debt shelf; last issued
Nov. 2013 following Oct. 2013 filing
* Nafin (NAFIN) A3/BBB+; mandates BofAML, HSBC for investor
meetings Sept. 27-28; USD-denominated deal may follow
* Analog Devices (ADI) A3/BBB; ~$13.1b Linear Technology acq
* $5b loan received after $11.6b bridge (Sept. 26)


* HollyFrontier (HFC) Baa3/BBB-; investor calls Sept. 15-16
* Banco Inbursa (BINBUR) –/BBB+/BBB+; mtgs Sept. 7-12
* Woolworths (WOWAU) Baa2/BBB; investor call Sept. 7
* Sydney Airport (SYDAU) Baa2/BBB; investor calls Sept. 6-7
* Industrial Bank of Korea (INDKOR) Aa2/AA-; mtgs from Aug. 22
* Sumitomo Life (SUMILF) A3/BBB+; investor mtg July 19


* Bayer (BAYNGR) A3/A-; ~$66b Monsanto acq
* Hybrid bond sales planned; part of $57b bridge (Sept.
* Danaher (DHR) A2/A; ~$4b Cepheid acq
* Sees financing deal via cash, debt issuance (Sept. 6)
* Couche-Tard (ATDBCN) Baa2/BBB; ~$4.4b CST Brands acq
* Expects to sell USD bonds (Aug. 22)
* Pfizer (PFE) A1/AA; ~$14b Medivation acq;
* Expects to finance deal with existing cash (Aug. 22)
* Danone (BNFP) Baa1/BBB+; ~$12.1b WhiteWave (WWAV) Ba2/BB
* Co. Says deal 100% debt-financed, expects to keep IG
profile (July 7)
* Zimmer Biomet (ZBH) Baa3/BBB; ~$1b LDR acq
* Plans $750m issuance post-completion (June 7)
* Great Plains Energy (GXP) Baa2/BBB+; ~$12.1b Westar acq
* $8b committed debt secured for deal (May 31)
* Abbott (ABT) A2/A+; ~$5.7b St. Jude buy, ~$3.1b Alere buy
* $17.2b bridge loan commitment (April 28)
* Sherwin-Williams (SHW) A2/A; ~$9.3b Valspar buy
* $8.3b debt financing expected (March 20)


* Starbucks (SBUX) A2/A-; debt shelf; has $400m maturing Dec.
5 (Sept. 15)
* Brunswick (BC) Baa3/BBB-; automatic mixed shelf; last issued
in 2013 (Sept. 6)
* Enbridge (ENBCN) Baa2/BBB+; $7b mixed shelf (Aug. 22)
* IBM (IBM) Aa3/AA-; automatic mixed shelf (July 26)
* Nike (NKE) A1/AA-; automatic debt shelf (July 21)
* Potash Corp (POT) A3/BBB+; debt shelf; last issued March
2015 (June 29)
* Tesla Motors (TSLA); automatic debt, common stk shelf (May
* Reynolds American (RAI) Baa3/BBB; automatic debt shelf; sold
$9b last June (May 13)
* Statoil (STLNO) Aa3/A+; debt shelf; last issued USD Nov.
2014 (May 9)
* Corporate Office (OFC) Baa3/BBB-; debt shelf (April 12)


* GE (GE) A1/AA-; Ratings cut by S&P on assumption of
increased debt for next couple of yrs on possible
acquisitions (Sept. 23)
* Israel Electric (ISRELE) Baa2/BBB-; said to hire C, JPM for
at least $500m bond sale in 4Q (Aug. 8)
* Visa (V) A1/A+; CFO says will issue $2b debt for buybacks by
yr end (July 21)
* Investment Corp of Dubai (INVCOR); weighs bond sale (July 4)
* Alcoa (AA) Ba1/BBB-; upstream entity to borrow $1b (June 29)
* Discovery Communications (DISCA) Baa3/BBB-; may revisit bond
market this yr, BI says (May 18)
* American Express (AXP) A3/BBB+; plans ~$3b-$7b term debt
issuance (April)

Short Rate at Two Year High in China

October 18th, 2016 5:41 am

Via Bloomberg:
China Money Rate Climbs Most in Two Years as PBOC Drains Funds
Bloomberg News
October 18, 2016 — 5:17 AM EDT


China’s two-week money-market rate climbed the most in almost two years as the central bank drained funds from the financial system and a weakening yuan reduced the possibility of monetary easing.

The 14-day repurchase rate, a gauge of interbank funding availability, surged 52 basis points, the most since December 2014, to a two-week high of 3.03 percent, according to weighted average prices. The overnight cost climbed 10 basis points, while the seven-day rate rose 12 basis points.

The People’s Bank of China pulled a net 184.5 billion yuan ($27.3 billion) via open-market operations on Monday and Tuesday, bringing total withdrawals since Sept. 26 to 959.6 billion yuan, data compiled by Bloomberg show. The yuan has declined about 1 percent since mainland markets reopened on Oct. 10 after a week-long holiday, cramping the central bank’s room to ease policy.

“The PBOC pulled more funds than we expected, and the post-holiday market is tighter than we thought,” said Song Qiuhong, an analyst at Shunde Rural Commercial Bank Co. in Foshan in Guangdong province. “Given the falling yuan and the authorities’ intention to control risks in the real estate sector, it’s very unlikely to see interest rates falling.”

Policy makers have extended the tenors of money-market lending tools recently, spurring speculation that it wants to curb excessive use of leverage in bond investments and cool an overheated property market. China’s financial regulators plan to tighten control on funds flowing into the property market, according to people familiar with the matter. Authorities including the central bank aim to tighten control on speculative real-estate investments and money involved in land transactions, the people said.

The cost of one-year interest-rate swaps, the fixed payment to receive the floating seven-day repo rate, rose one basis point to a four-month high of 2.57 percent in Shanghai, data compiled by Bloomberg show. Government bonds declined, with the 10-year yield climbing one basis point to 2.70 percent, National Interbank Funding Center prices show.

David Challenges Goliath (Bloomberg)

October 18th, 2016 5:25 am

Via NYTimes DealBook:

A start-up looking to take on the financial information behemoth Bloomberg L.P. is hiring a former Bloomberg executive to begin a new financial news service.

Norman Pearlstine, a former top editor at Bloomberg, The Wall Street Journal and Time, is joining Money.net, which has been building a low-cost alternative to the data terminals that sit at the core of Michael R. Bloomberg’s business empire.

Mr. Pearlstine is tasked with building a news feed for Money.net that will be based on machine-generated news bulletins and stories. He will be hiring journalists to help guide the computers and potentially supplement them with reporting — part of a broader move toward the automation of journalism.

“I think I know what the customer is looking for, and I think I know where smart developers and journalists working together can add value,” Mr. Pearlstine said in an interview. “My bias is toward not spending a lot of time duplicating things that everybody else is doing — trying to think about what timely, usable information is for a professional investor.”

Mr. Pearlstine was the chief content officer at Bloomberg until 2013, shortly before Mr. Bloomberg ended his final term as New York City’s mayor and rejoined the company he founded in the 1980s. Mr. Pearlstine is currently the vice chairman of Time Inc. and will remain in that role.

Money.net was founded by another former top executive at Bloomberg, Morgan Downey, who got to know Mr. Pearlstine when they were both at the company.

Mr. Downey has been outspoken about his belief that Money.net can win over Bloomberg customers who are unhappy with the high price of the terminals, which generally cost around $21,000 a year. A Money.net subscription costs about $1,500 annually.

Mr. Downey said that Money.net now had about 50,000 paying subscribers, up from fewer than 10,000 a year ago. Over the same time period, the number of Bloomberg subscribers has remained steady at around 325,000.

Mr. Downey has been trying to capitalize on the fact that revenue is down in the financial industry, leading many banks and asset managers to look for lower-cost service providers.

“The industry is at this inflection point,” he said. “They know that the ecosystem of Bloomberg and Thomson Reuters can’t continue.”

A Bloomberg spokesman said the company had no comment on Mr. Pearlstine’s hiring.

Money.net began as a platform for basic financial data, but Mr. Downey has been trying to add tools that can compete with other parts of the Bloomberg terminal.

Recently, Money.net announced a partnership with the Wall Street messaging service Symphony, which is mostly owned by a consortium of banks. Symphony has been described as an effort by the banks to create an alternative to Bloomberg’s messaging system, which is often cited as a main reason to have the terminals.

Professional investors also choose Bloomberg because of the huge journalistic operation it has built, focusing in particular on market-moving news.

But Mr. Downey sees another opportunity to take on Bloomberg at a lower cost.

He contends that much of the information that investors need is freely available in news releases, government statements and social media.

Mr. Downey already has a team of developers working on software that can scan the web for news releases and stories from other publications to generate headlines for Money.net customers.

Last week, for instance, Money.net generated a headline from a Department of Transportation release. It read: “D.O.T. issues emergency order banning all Samsung Galaxy 7 phones from air transportation in the U.S.”

High-powered computers are crucial to processing more news and doing so faster than Bloomberg’s human-based system, Mr. Downey said.

Bloomberg does provide its customers with a stream of headlines from other major publications and social media. Earlier this year, Bloomberg’s editor in chief, John Micklethwait, announced that the company was creating a team to use more automation in its editorial offerings and that it already had a news tool called Project Cyborg.

Several other technology companies are already working to automate journalism, using software that can take raw data and turn it into proper sentences. But this strategy has run into obstacles. When Facebook recently moved to make its trending stories feature more automated, fake news stories crept in unnoticed.

Mr. Downey is hoping that Mr. Pearlstine can bring in a team of journalists to help guide the machines toward accuracy. Mr. Downey says that he wants Mr. Pearlstine to hire about 25 journalists to work with around 75 programmers.

Mr. Pearlstine is more measured than Mr. Downey in his ambitions to immediately take on Bloomberg. He says that for now the data giant still has a big lead in many areas.

But Mr. Pearlstine says there is an opportunity to do things in a smarter way given the current state of technology. He said that Bloomberg News began more than three decades ago as a small team of people aggregating news from other publications.

“Technology has given you the opportunity to revisit that model in ways that could be better, faster and smarter,” he said.

Bond Market Angst

October 18th, 2016 4:34 am

Via WSJ:

Markets Heard on the Street
By Justin Lahart
Updated Oct. 17, 2016 3:41 p.m. ET

There is a little bit of fear creeping into government bond markets. It is about time, even if investors are still underestimating how much long-term Treasury rates could rise from here.

Government bonds are no longer the can’t-lose market, as a steady drop in prices sends rates higher. The 10-year Treasury carries a yield of 1.79% versus the 1.36% it plumbed in early July in the aftermath of the Brexit shock. With global worries easing and central banks rethinking tactics and inflation picking up, yields could go higher still.

Get financial insights and commentary on global investing from The Wall Street Journal’s Heard on the Street team. Subscribe to the podcast.

Fears that the world risked slipping into a deflationary spiral have eased. Higher oil prices have taken pressure off many energy-producing countries, and China’s efforts to stabilize its economy have had positive effects on other emerging markets.

One sign of this is the increase in term premiums—the extra compensation investors ask for holding a longer-term bond to maturity versus what they estimate they could earn on a series of short-term securities over the same time frame. Historically, term premiums have been positive, since investors have worried they were underestimating how high rates would go in the future. But this year they went deeply negative across developed-world bond markets.

Investors are still worried about lower rates, but not as much. The Federal Reserve Bank of New York’s measure of the term premium on the 10-year Treasury, for example, has gone from a low of minus-0.76 percentage point to minus-0.38 percentage point.

Changes in central-bank policy also are playing a role. The Bank of Japan ’s move last month to target the yield on 10-year bonds at 0%, with an aim to keep even longer-term rates in positive territory, reduced the relative attractiveness of Treasurys for Japanese investors. Expectations that the European Central Bank will alter its rules so it can buy more short-term, and fewer long-term, bonds are having a similar effect. Federal Reserve Bank of Boston President Eric Rosengren suggested over the weekend that the Federal Reserve replace long-term securities in its portfolio with short-term ones. The goal would be to tighten monetary policy by driving up long-term rates.

But perhaps biggest reason investors should worry about higher Treasury yields is an old one: inflation. The inflation expectations embedded in Treasury inflation-protected securities imply that inflation will average 1.52% over the next five years—more than 1.24% implied at the start of September, but still very low.

And probably too low. With oil no longer pulling prices lower, Barclays calculates that the inflation measure TIPS are priced off of will be running 2.4% by the end of the year. Seeing that sort of figure would force a lot of investors to rethink their view on rates.

Skirting the Dodd Frank Rules on Risk Retention

October 18th, 2016 4:30 am

Via WSJ:

A major postcrisis rule taking effect in December will force Blackstone Group LP and other creators of complex securities to eat some of their own cooking. Many of them are already engineering ways to keep it to a nibble.

Starting Christmas Eve, the 2010 Dodd-Frank regulatory overhaul will require companies that package most types of loans into bonds to keep at least 5% of the securities they create. The intent is to prevent a repeat of crisis-era behavior, in which loan quality fell dramatically as lenders passed all of the risk along to investors.

But in the market for so-called collateralized loan obligations, which are backed by junk-rated corporate loans, many issuers don’t plan to use their own money to retain the whole 5%. Firms including J.P. Morgan Chase & Co. spinoff HPS Investment Partners LLC have moved instead to set up affiliated companies that would buy the stakes. HPS and some others would own roughly 51% of the new firms, and outside investors would own the rest, according to market participants. That means their effective exposure would be halved.

The move is allowed by the rules, which say issuers can hold the securities via majority-owned affiliates. Blackstone is one company weighing whether to push that boundary further by setting up an affiliate in which it holds as little as 20%, people familiar with the matter said.

The private-equity firm thinks that could work, because the rules don’t define “majority-owned” in purely mathematical terms, the people said. They include affiliates in which issuers have a “controlling financial interest” under U.S. accounting standards. As long as companies are in charge of the operations of their affiliates, they arguably could meet that test with stakes as small as 10%, accounting experts said—leaving them exposed to just 0.5% of the securities they create.

Regulators have remained largely silent on the question of what exactly it will take for an affiliate to qualify as majority-owned and on the penalty for noncompliance, adding to the uncertainty that debt-market participants continue to face more than six years after the regulatory overhaul was passed.

“Simpler is always better,” said Brian Juliano, co-head of Prudential Fixed Income’s CLO business, explaining his view on how to manage the new regulations. The money manager, a unit of insurance company Prudential Financial Inc., decided not to use an affiliate and instead took a 5% stake directly in one of its offerings last year.

Pushing the envelope is “potentially dangerous,” Mr. Juliano said.

Asset-backed securities are arcane, but they play a crucial role in the financial system, underpinning everything from credit-card debt to auto loans. CLOs in particular are a major source of credit for indebted companies with limited alternatives. Some $270 billion worth have been issued in the U.S. since 2014, according to LCD, a unit of S&P Global Market Intelligence, pooling together loans made to junk-rated companies like Valeant Pharmaceuticals, Charter Communications and American Airlines.

Issuers buy loans arranged by banks and package them into bonds with varying degrees of risk and return.

Issuance of U.S. CLOs is down 40% from this point last year at $48.3 billion in 2016, according to data from LCD. Market turmoil earlier this year was a big factor, but so is the risk-retention rule. Money managers that oversee CLOs earn fees around 0.5% of the size of the deal. Many of them say retaining a 5% stake would make managing the CLOs far less profitable.

“We got out of the business, because it didn’t make sense to stay in it,” said Brett Jefferson, the founder and president of hedge-fund firm Hildene Capital Management LLC. A Hildene affiliate issued $1.4 billion in CLOs between 2013 and 2015. It sold its rights to manage the CLOs to an affiliate of Fortress Investment Group LLC earlier this year.

Former Rep. Barney Frank, an architect of Dodd-Frank, has called the risk-retention section the most important part of the legislation. Securitization was widely viewed as one of the culprits of the 2008-2009 financial crisis, after scores of bonds backed by subprime mortgages soured. During the housing boom, many mortgage lenders and banks that bundled loans into securities passed all the risk on to others, a practice critics believe limited their incentives to ensure the loans would hold up.

The risk-retention rule isn’t having a major impact on nonprime residential mortgages because private lenders largely abandoned the market after the crisis.

From the start, many CLO originators argued that they shouldn’t be subject to risk-retention rules. They point out that the securities held up relatively well during the chaos of the financial crisis and that the fee structure already typically includes incentives for good performance over time.

An option being pursued by some managers as an alternative to setting up an affiliate is to spin off their CLO businesses entirely. Those new companies are funded by outside investors and do everything the original firms used to do—including buying loans and issuing CLO securities—while also holding 5% of the structures they create.

Dallas-based Triumph Capital Advisors LLC recently spun off its CLO-management business into a new company called Trinitas Capital Management LLC. The firms share several employees, including Triumph Chief Investment Officer Gibran Mahmud, and Trinitas plans to send 60% to 80% of the management fees it earns back to Triumph as compensation for its staff and services, a person familiar with the matter said. Trinitas also has a three-person board of directors that includes Mr. Mahmud and two people unaffiliated with Triumph.

Legal experts said regulators will have to decide whether such companies are truly independent or simply a workaround.

Write to Sam Goldfarb at sam.goldfarb@wsj.com and Serena Ng at serena.ng@wsj.com

China Credit Surge

October 18th, 2016 4:21 am

Via Bloomberg:
October 18, 2016 — 3:09 AM EDT
Updated on October 18, 2016 — 4:03 AM EDT


China’s broadest measure of new credit exceeded estimates in September to fuel the economy’s continued stabilization and at the same time underscore escalating concerns over a property binge and the pace of debt expansion.

Aggregate financing was 1.72 trillion yuan ($255 billion) last month, compared with median estimate of 1.39 trillion yuan in a Bloomberg survey
New yuan loans stood at 1.22 trillion yuan
Broad M2 money supply rose 11.5 percent from a year earlier

Big Picture

With a credit-binge having succeeded in stabilizing the economy, policy makers are switching focus to reining in soaring home price gains that cheap borrowing costs have spurred. China urgently needs a plan to address a build up of corporate debt that’s manageable but with a window to address it “closing quickly,” according to an International Monetary Fund working paper.
Economist Takeaways

“The government is in a dilemma: if they tighten the real estate sector too much, the economy could turn down sharply; but if they don’t control it, they’ll allow the bubble to expand,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. He expects a sharp slowdown in credit expansion in October.

“It’s more of the same: more yuan lending, more debt, no real increase in M2 growth and a much larger rise in M1 growth,” said Michael Every, head of financial markets research at Rabobank in Hong Kong. “It screams ’Liquidity trap!”

“The property frenzy will certainly limit the PBOC’s appetite for further easing,” said Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong. “While it is too early to call for tightening, deleveraging is certainly an ongoing theme” in the fourth quarter.

“While credit growth remains rapid relative to a couple of years ago, it has been slowing in recent months,” Julian Evans-Pritchard, economist at Capital Economics in Singapore, wrote in an e-mail. “Broader worries about credit risks means further monetary easing is unlikely. It will take time for this more cautious policy stance to impact economic growth.”

“Beijing talks about controlling credit but allows the banks to increase loans,” said Andrew Collier, an independent analyst in Hong Kong and former president of Bank of China International USA. “The official message is not the same as the reality. Pressure from the banks for profits, from corporates for loans, and from local governments for revenue from the property sector is driving the Chinese economic bus more than the policy makers in Beijing.”
The Details

Gross domestic product data due tomorrow is likely to show the economy expanded 6.7 percent in the three months through September, the third straight quarter at that pace, according to economists surveyed by Bloomberg
Entrusted loans, trust loans and undiscounted bankers’ acceptance bills — which collectively give a glimpse of shadow financing — remained subdued
Foreign currency loans growth declined 9 percent from year earlier, with 26.3 billion in new foreign currency loans

— With assistance by Yinan Zhao, and Kevin Hamlin

Early FX

October 18th, 2016 4:12 am

Via Kit Juckes at SocGen:


Working out how important central bank indepdence has been in building the economic prosperity major economies ahve enjoyed since the end of the 1970s wouldn’t be easy, but getting rid of independence and seeing what happens next seems to be on the minds of some politicians, on both sides of the Atlantic. personally, I find this desire to go back to the 70s a really bizarre form of nostalgia. But it’s something to watch…
The rise in bond yields has paused, the dollar rally has paused, Asian equities and currencies are stronger. A stronger dollar as well as higher US yields are a drag on global asset prices and on global growth but today we have cheerful markets, with the dollar and the yen at the bottom of the FX pile while the won, rand, New Zealand and Australian dollars bask in the sun. Even the pound is up! None of this fits the market’s central narrative. I’m watching to see if the US data and the brighter equity mood put a spark under Treasury yields again and if/when that happens, I expect the dollar rally to resume.

Yesterday’s pause in the bond bear market was helped by a soft Empire State Manufacturing survey, which is a reminder that this economic recovery can’t get out of third gear, rather than a reason to look for it to stop altogether. I’m not sure bond dip-buyers are going to get any help from today’s data. The ECB’s bank lending survey will probably show continued, albeit modest improvement. The UK inflation rate is likely to edge up from 0.6% to 0.8% (with more rises to come in the months ahead, of course) and the US CPI data is likely to show headline inflation edging up to 1.5% from 1.1% with the core steady at 2.3%.None of that’s too scary but nor is it designed to derail the gradual rise in yields that have taken 10year Treasuries up by 41bp since early July (the 2016 low), in turn dragging gilt yields up by 39bp, Bunds by 24bp and JGBs by 22bp. Upward yield trundle is likely to continue. If nothing else, William Hague’s article in the Telegraph this morning (Central bankers have collectively lost the plot. They must raise interest rates or face their doom) reflects the mood change that sees more and more critics of low rates and QE, even outside hard money bastions like Germany.

A pause but not an end to the rise in yields


Most of today then, will be spent watching bond yields. Oil and commodity prices are trundling higher too however. Brent needs to get above USD 54/bbl to get chart drawers properly excited, but NOK, and CAD are both benefitting, the latter (along with the Mexican Peso) also helped by Hilary Clinton’s widening opinion poll lead in the US election.

Commodity price uptrend – slow but steady


There’s no real new news in the UK. With positioning and sentiment so extreme, corrections can feed on themselves as sterling bears lighten up. I’d rather be short gilts than short pounds in the next few days. But our medium-term bearish GBP stance is unchanged.

Duration Time Bomb

October 17th, 2016 3:09 pm

I have long thought the next market calamity would be in the corporate bond world. This Bloomberg  story reports on a Goldman Sachs research piece which posits that a 1 percent increase in yields would lead to more than $1 trillion in losses in corporate bond portfolios. The more interesting angle is in a world of sparse balance sheets and risk aversion at dealers what will happen when clients ask for bids and find them light years from what they expected.

Via Bloomberg:
October 17, 2016 — 11:30 AM EDT
Updated on October 17, 2016 — 11:51 AM EDT
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First they came for the yield, then they came for the duration.

A Goldman Sachs Group Inc analysis says investors could be mired in a world of pain if yields on long-dated assets snap higher. Just a modest backup in rates could inflict outsized losses on bond portfolios — a sobering prospect in light of the recent jump in longer-dated bond yields that’s already eating into bondholders’ capital returns.

A 1 percent increase in interest rates could inflict a $1.1 trillion loss to the Bloomberg Barclays U.S. Aggregate Index, analysts at Goldman calculate, representing a larger loss for bondholders than at any other point in history. With the bank predicting the selloff in bonds has further to run, that remains “far from a tail scenario,” its analysts write.

Bets on longer-maturity obligations had paid off handsomely for most of the year amid a global bond rally triggered by expectations that weak economic activity will persuade central banks in advanced economies to postpone tightening monetary policy. Asset purchases by the Bank of Japan, Bank of England and the European Central Bank helped the average maturity of new U.S. corporate bonds climb to a peak of 11.3 years in August.

With average bond maturities worldwide now more than double the inflation-adjusted level of 2009, and three times that of 1994, Goldman says there’s an elevated risk of losses if rates spike higher.

“We see potential for the rates market to continue to sell off, and the notional amount of duration dollars at risk is unprecedentedly large,” Goldman fixed-income analysts, led by Marty Young, wrote in the report on Monday.

The effective average duration of the global bond market, as measured by the Bloomberg Barclays Global Aggregate Index, has risen to 6.98 years, as of mid-October, compared with 6.60 years in January. Goldman’s $1 trillion estimate reflects potential losses on dollar-denominated investment-grade cash bonds, and therefore may form a conservative estimate of the risks facing money markets. It excludes a whole gamut of duration risks facing the U.S. interest-rate swap market; from junk obligations, to the trillion-dollar pile of fixed-rate mortgages, and corporate loans held on bank balance sheets.

A tug-of-war between valuation concerns and dovish central banks will drive the near-term outlook for yields on long-dated securities. Bond guru Bill Gross — who’s also warned that minor interest-rate moves have the potential to wipe out capital gains on bond portfolios — said last month the timing for any “bond bear market” had been “delayed” thanks to dovish central-bank pronouncements which provide a fillip for longer-dated debt. Goldman last month, however, downgraded bonds to underweight on a three-month time horizon, while maintaining its overweight position for cash, partly due to selloff pressure it said valuation and monetary-policy concerns pose to U.S. sovereign debt.

In their Monday note, Young and team restate their view that U.S. long-dated notes could snap higher in the coming months, noting that 10-year U.S. Treasury yields appear expensive relative to fundamentals to the tune of 1.5 standard deviations.

Fed-tightening cycles in the 1990s and in 2006 caused longer-dated bond prices to fall more relative to shorter-dated obligations. Investors typically demand greater compensation for longer-duration bonds, since there’s a greater probability interest rates will change over their lifetime.


Still, the ownership of long-dated debt provides a modicum of solace. “Duration risk is more widely owned today, especially by global central banks and sovereign wealth funds which can more readily absorb such a shock,” the analysts conclude. Foreign central banks and sovereign wealth funds — who this year have shunned new U.S. government debt purchases — face the biggest mark-to-market losses in the event of an interest-rate shock, the Goldman analysts conclude, since they are large buyers of such securities. Meanwhile, pension funds, the natural buyers of bond obligations with longer maturities, would see a corresponding reduction in their liabilities, offsetting, to some extent, the impact of rising rates.

So while Goldman doesn’t necessarily foresee a systematic shock if interest rates snap higher, price-sensitive long-duration investors are swimming in uncharted waters.