TIPS Commentary

March 21st, 2017 5:53 pm

This is an interesting (to me) bit of commentary from ian Lyngen and Aaron Kohli at RBC. This is a amll excerpt from their end of day note:

The other big move on the day was the failed attempt by breakevens to improve and the fact that almost all major breakeven benchmarks (i.e. 5s and 10s), save the 30-year, cracked 2%. As seasonals and crude have both turned and the 10-year TIPS auction lies just ahead, we’re watching these levels because they could give us some sign of where market sentiment is ultimately headed.

Still at only around 2%, breakevens were reinforcing the broader narrative that the market may have started to pull a few chips off the reflation bet, but if Thursday’s vote results in failure for the passage of healthcare, we could see more material pressures show up in forward inflation expectations. Aside from political events, flows into TIPS have been very solid and we’d expect good sponsorship at high real yield levels and sub-2% breakevens at Thursday’s auction. To be clear, we do believe that the markets could eventually price out the reflation trade, but even if we start to see the market forecast the end of the Trump honeymoon with Congress, it could be some time before markets remove the risk of stimulus entirely and take Treasury yields much lower.

Liquidity Issues in China?

March 21st, 2017 7:44 am

Via Bloomberg:

PBOC Said to Inject Liquidity After Interbank Payments Missed
2017-03-21 10:33:19.211 GMT

By Bloomberg News
(Bloomberg) — China’s central bank injected hundreds of
billions of yuan into the financial system after some smaller
lenders failed to repay borrowings in the interbank market,
according to people familiar with the matter.
Tuesday’s injections followed missed interbank payments on
Monday, the people said, asking not to be identified because the
matter isn’t public. The institutions that missed payments
included rural commercial banks, according to three traders who
asked not to be identified because they aren’t authorized to
speak publicly. One said a borrower failed to repay an overnight
repo of less than 50 million yuan ($7.3 million).
China’s smaller lenders have been squeezed by a rise in
money market rates this week, with the benchmark seven-day
repurchase rate jumping to the highest level since April 2015 on
Tuesday. While the tightening of liquidity reflects factors
including quarter-end regulatory checks and a wall of maturing
certificates of deposit, Banco Bilbao Vizcaya Argentaria SA said
the People’s Bank of China may also be sending a message to
over-leveraged firms to rein in borrowing.
“The PBOC wants to warn the smaller lenders not to play the
leverage game excessively,” said Xia Le, chief economist at BBVA
in Hong Kong. “It’s a tug of war between the central bank and
the financial institutions.”
The PBOC declined to comment on the operations.

FX

March 20th, 2017 7:23 am

Via Marc Chandler at Brown Brothers Harriman;

Drivers for the Week Ahead

  • Recent developments have given rise to doubts over the divergence theme, which we suggested have shaped the investment climate
  • The G20 statement diluted the commitment to avoid protectionist trade measures
  • Both German members on the ECB talk in the week ahead
  • The newfound threat of a BOE rate hike is unlikely to subside, and this may see sterling post additional corrective gains
  • There are two highlights from the Asia-Pacific in the week ahead:  RBNZ meeting and Japan trade data

The dollar is mostly softer against the majors.  The Antipodeans and euro are outperforming, while the Loonie and yen are underperforming.  EM currencies are mostly firmer.  THB and KRW are outperforming, while RUB and MXN are underperforming.  MSCI Asia Pacific ex-Japan was up 0.4%, with Japan markets on holiday.  MSCI EM is up 0.5%, with China shares rising 0.1%.  Euro Stoxx 600 is down 0.2% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is flat at 2.50%.  Commodity prices are mixed, with WTI oil down 1.6%, copper up 0.5%, and gold up 0.3%.

Recent developments have given rise to doubts over the divergence theme, which we suggested have shaped the investment climate.  There are some at the ECB who suggest rates can rise before the asset purchases end.  The Bank of England left rates on hold, but it was a hawkish hold as there was a dissent in favor of an immediate rate hike.  Furthermore, the rest of the Monetary Policy Committee showed that their patience with both rising price prices and the resilient economy was limited.  The Bank of Japan has already modified its aggressive balance sheet growth and reduced slightly the amount of funds deposited with it that are subject to negative interest rates.  

Federal Reserve officials sounded considerably more confident about the US economy’s underlying strength and rising prices, but this seemed now to be mostly an attempt to ensure that last week’s hike was not a surprise.  The FOMC statement and the forecasts simply confirmed the pace of normalization that had been previously signaled.  

Moreover, the Federal Reserve has been unable to rebuild its credibility in the sense that investors still doubt that the central bank will deliver the rate hikes that it thinks will be appropriate.  If investors took seriously that the Federal Reserve would hike rates five more times by the end of next year, the two-year note would not be yielding around 1.30%.  

Following the FOMC meeting, the market downgraded the chances of a follow-up hike in June.  Judging by the Fed Funds futures strip, about one in nine think the Fed will not hike again.  About a third thinks there may be one more hike, and one third accepts the dots that indicate two hikes may be appropriate before the end of the year.  

Five of the regional Fed presidents speak in the week ahead.  Leaving aside Bullard, who seems to be still developing the new approach unveiled last year, and Evans, who leans to the dovish side, most of the other regional president will likely continue to press their case for quicker normalization.  However, we again suggest putting more weight on the guidance from the Fed’s leadership, and in the week ahead that means Yellen and Dudley.  They may offer a less dovish interpretation of the Fed’s recent decision than the market seems to believe.

Investors may also be concerned that US fiscal policy may not be what they expected.  The draft budget proposed by President Trump expressed little of the populist sentiment seen on the campaign trail and subsequent rhetoric.  In many ways, the budget was an expression of longstanding Republican aspirations.  Rather than boost infrastructure spending, numerous domestic social programs and foreign aid were cut to make room for increased defense and security spending, including a down payment for the wall that is to be erected on the border with Mexico.  

Funds to the Department of Transportation, which would seem to play an important role in the revitalization of America’s infrastructure, would see a 13% (nearly $2.5 bln) cut under the president’s plan.  The Federal Aviation Administration (FAA) would be privatized.  Amtrak funding would also be cut, and several new transit projects would have to be canceled.  

Meanwhile, the Republican health care plan as an alternative to the current Affordable Health Care Act (a.k.a. Obamacare) may be voted on before the end of the week ahead.  At stake is not only health care, but it is a keystone to the Republican’s larger tax reform efforts.  Specifically, the repealing of the taxes that financed the current scheme would free up around $1 trillion over the next decade.  

Of course, as most observers recognize, the Senate has other ideas and will likely pass a different bill.  The differences will be hammered out in the reconciliation process, which requires a simple majority that the Republicans possess.  It is integral to the GOP strategy to use the reconciliation process to overcome the limitations posed by its slim majority in the Senate.  

The reassertion of US interests, as understood by President Trump, is already being felt on the world stage.  The G20 statement diluted the commitment to avoid protectionist trade measures.  It is a warning sign of the likelihood of future conflict.  The Eurogroup meeting at the start of the week will also have to take seriously the possibility that the US prevents the IMF from participating in the aid package to Greece.  Recall, that the German and Dutch parliaments require IMF participation in order to secure their approval.  The ability to compromise may be limited by the German election that is six months away, and for which polls warn of a resurging SPD party that may make Merkel’s fourth contest here more difficult.  

The eurozone PMIs have been running ahead of actual data.  We expect the flash PMI, the main economic report for the week, to soften slightly.  However, more attention may be paid to the price components and the official comments.  If the macro divergence is being re-considered, the divergence in the euro area between creditor and debtor appears to becoming more pronounced again.  Even though the ECB agreed at the end of last year to extend its asset purchases through the end of the year, albeit as modestly slower pace (60 bln euros vs. 80 bln euros) starting next month, the hawks (creditors) are emphasizing a move to the exit.  In particular, they have been emphasizing that the sequence may differ than the Fed’s exit.  

Recall that the Fed tapered the asset purchases until ending them.  Then, after several months, raised rates (December 2015).  The ECB has a deposit rate of negative 40 bp.  It seems clear that the ECB is talking about its exit strategy, but the creditors appear to have pushed the issue into the public space.  Both German members on the ECB talk in the week ahead and the possibility that the deposit rate is increased before the asset purchase program are complete may be underscored.  This may continue to spur upward pressure on yields in the eurozone.  In turn, this may see the euro-sensitive two-year interest rate differential narrow, allowing the position is squaring the foreign exchange market to allow the euro to continue the correction from the sell-off since the US election.  

Similarly, the newfound threat of a BOE rate hike is unlikely to subside, and this may see sterling post additional corrective gains.  The main economic report is the February CPI.  Price pressures have not peaked in the UK, and an uptick will keep investors cautious about the BOE taking back the rate cut delivered amid much uncertainty after last June’s referendum.  

Officials will draw attention to the measure of consumer inflation that also includes owner-occupied housing costs, like the United States, using a rental equivalence measure.  The Office of National Statistics (ONS) says this will be it preferred measure going forward.  Like other inflation measures, it is trending higher and is expected to breach the 2.0% threshold for the first time since late-2013.

February UK retail sales also will be reported.  A small rise is expected after declines in both December and January.  The last time British retail sales fell in three consecutive months was late 2009 and early 2010.  We suspect it is not coincidental that wage growth slowed in December and January.  We suspect that the weakening wage pressure give the majority at the BOE time to see how the economy evolves before deciding if it needs to take back some of its accommodation.  

Within a few days of the EU’s celebration of the 60th anniversary of the Treaty of Rome (Match 25), which founded the European Economic Community, UK Prime Minister May is widely expected to formally trigger Article 50 to begin negotiations of its exit from the EU.  Since the referendum, the initiative has been the UK’s.  It did not have to turn the non-binding resolution into law.  It did not have to accept the small (52% to 48%) majority to be sufficient to pursue such a fundamental change.  However, once Article 50 is triggered, the initiative shifts to the EU.  Investors should be prepared for some jockeying for position and advantage in the coming weeks.  

UK Chancellor of the Exchequer Hammond quickly reversed himself on a tax increase on self-employed, and reflects the weakened state of May’s government.  The reversal was in the face of a revolt, not of Labour, which is struggling to be more than obstructionist, but among the Tories themselves.  It makes the government look weak.  The power struggle within the Tory Party is one of the factors encouraging speculation, despite denials from 10 Downing Street, that an early election will be called.  There have been some rule changes that make the early election scenario more difficult, but not impossible.  

There are two highlights from the Asia-Pacific in the week ahead.  The Reserve Bank of New Zealand meets.  It is widely expected to keep rates on hold.  The most recent data warned that the economy slowed more than expected, but it will take more than that to get the RBNZ to consider cutting rates.  The other highlight is Japan’s trade balance.  The February trade balance always (without fail for more than 30 years) improves over January.  Although Japan exports around 15% of GDP (compared with over 40% for some European countries), the external sector plays an important role in capex plans and industrial output.  

Japan had generally run trade deficits from early 2011 through early 2016.  However, Japan returned to surplus.  Although Japan reported a large deficit in January (over JPY1 trillion), seasonal factors were the main culprits, and it is expected to return to surplus.  There has been a strong improvement in Japan’s broader external measures, its current account.  Last year the average monthly surplus was JPY1.72 trillion, the highest since 2007.

At the same time that Japan’s external account has improved, Japanese investors have turned sour on foreign bonds.  In the last 18 weeks through March 10, Japan sold about JPY6.05 trillion (~$57 bln) of foreign bonds.  Consider that in the previous 18 weeks, Japanese investors bought JPY7.76 trillion of foreign bonds.  

There had not been as much doubt about the outcome of the Dutch election as there is with the French election next month.  Although the Dutch populists-nationalists did worse than the polls had suggested, they still picked up seats, and its anti-Islamic rhetoric may have influenced the government’s choices regarding the Turkish ministers recently.  Unless something big happens, like Juppe jumping into the race, Le Pen’s support is sufficiently solid to put her into the second round.  

Barring a poll showing any candidate getting a majority, the key for medium-term investors is not the poll outcome of the first round, but the second round.  There Le Pen loses handily.  Of course, things can change, but this is the base case.  Perhaps it will be Japanese investors who return to the French bond market.  They had been substantial buyers (higher yielding bunds?) but in recent months were featured sellers.

EM FX continues to firm.  While we have been concerned about the negative impact of the Fed tightening cycle, EM continues to digest higher US rates with little difficulty.  It would seem that until investors start believing the Fed more with regards to future rate hikes, EM FX can continue to gain.  We warn, however, that a more protectionist global trade environment can hardly be supportive for EM.   

FX

March 16th, 2017 6:42 am

Via Marc Chandler at Brown Brothers Harriman:

Greenback Consolidates Losses as Yields Stabilize

  • The Fed hike and Dutch election were not very surprising; the surprise of the day was China
  • The BOJ, SNB, and Norges Bank stood pat; the focus shifts to the BOE
  • AUD and NZD are under some pressure after both reported poor data
  • Turkey is expected to tighten policy with a 75 bp hike in the late liquidity window rate; Chile is expected to cut rates 25 bp to 3.0%

The dollar is mostly firmer against the majors, recouping some of its post-FOMC losses.  The Swiss franc and the Loonie are outperforming, while Nokkie and Kiwi are underperforming.  EM currencies are mixed.  KRW and RUB are outperforming, while the CEE currencies and TRY are underperforming.  MSCI Asia Pacific was up 1.5%, with the Nikkei rising 0.1%.  MSCI EM is up 2%, with China shares rising 0.5%.  Euro Stoxx 600 is up 0.6% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is up 3 bp at 2.53%.  Commodity prices are mostly higher, with oil up 1.2%, copper up 1.1%, and gold up 0.4%.

The US dollar remained under pressure in Asia following the disappointment that the FOMC did not signal a more aggressive stance, even though it delivered the nearly universally expected 25 bp rate hike.  News that the populist-nationalist Freedom Party did worse than expected in the Dutch elections also helped underpin the euro, which rose to nearly $1.0750 from a low close to $1.06 yesterday.  European activity has seen the dollar recover a little, but the tone still seems fragile, even though US interest rates have stabilized and the 10-year Treasury yield is back above the 2.50% level.

The US premium over Germany on two-year money peaked a week ago near 2.23.  After the US yield had fallen in response to the Fed’s move, the spread finished near 2.12%, from which it has not moved far.  Initial euro support has been found a little above $1.07.  The first retracement target of the run-up is a little below there at $1.0690.  The other retracement targets are seen near $1.0675 and $1.0655.

Few expected Wilders in the Netherlands to have a say in the next Dutch government.  He drew about 13% of the vote and will hold about 20 seats, which is five more than currently.  Prime Minister Rutte’s party appears to have received the most votes and won 33 seats, down from 41.  The other coalition partners did worse.  In particular, the disastrous showing of Labor means that Dijsselbloem, the current finance minister and head of the Eurogroup of finance ministers, is unlikely to hold his post.  Labor may have less than 10 seats in the new parliament, down from 38.  The other coalition partner, Liberals, lost eight seats.

The new parliament will sit in a week and negotiations for a new government will begin.  It will take some time.  The last election (2012) took 54 days to sort out, while in 1977 it took more than 200 days to form a new government.

The Fed hike and Dutch election were not very surprising; the surprise of the day was China.  The PBOC announced a 10 bp increase in its medium lending facility loans and open market operation reports.  Its statement did try to temper the surprise by noting that these increases were not the same as an increase in the benchmark rates.  This seems to suggest that the increase in rates is unlikely to be passed on to households or business.

Three other central banks have met today, and as expected, did not change policy.  The Bank of Japan, the Swiss National Bank, and Norway’s Norges Bank stood pat.  The focus shifts to the Bank of England.  It too is widely expected to maintain its neutral stance.

The Australian and New Zealand dollars are under some pressure independent of the US dollar.  Both reported poor data.  Australia reported a 6.4k drop in employment.  The Bloomberg survey’s median forecast was for a 16k increase after 13.5k in January.  The unemployment rate ticked up to 5.9% from 5.7%, while the participation rate was unchanged at 64.6%.  One positive aspect of the report was the mix of full and part-time jobs.  Full-time positions increased by 27.1k after a 44.1k decline previously, while there were 33.5k less part-time jobs after a 57.5k surge in January.

New Zealand reported Q4 GDP expanded by 0.4%, not the 0.7% expected.  Q3 growth was revised to 0.8% from 1.1%.  This puts the year-over-year rate at 2.7% down from a revised 3.3% (was 3.5%) in Q3.

The Australian dollar pushed back from the nearly $0.7720 high seen in the US to a little below $0.7680 in Asia.  However, it has been better supported in the European morning, perhaps helped by the reports of a large foreign acquisition in the energy space.

The drop in US yields weighed on the dollar against the yen.  It fell from the upper end of its two-month range toward the middle of it.  It was near JPY114.50 before the Fed announcement and was pushed a little through JPY113 in early European activity.  It managed to recover to around JPY113.50 before stalling, seemingly awaiting fresh cues from the US session.

Risk appetites like the confluence of political and economic developments.  European peripheral bonds are firmer, while core bonds are mostly heavier.  MSCI Emerging Market equity index is extending its rally into a sixth consecutive session and the nearly 2% gain thus far today is the most since last July.  The MSCI Asia-Pacific Index rose nearly 1.5%, for a five-day streak.  European markets are following suit.  The Dow Jones Stoxx 600 is up 0.6%, after a gap higher opening.  It is the second advance in a row, and six of the past seven sessions.  

Materials are up the most, followed by energy and financials.  Iron ore prices edged higher to bring this week’s rise to 11%.  Rebar steel eased after yesterday’s rally lifted it its highest closing level since December 2013.  Oil prices are up about 1%, helped by the first decline in US inventories this year and the heavier dollar tone.

The US session features February housing starts and permits, weekly jobless claims, JOLTS, and the March Philadelphia Fed.  Given the Fed’s move, we suspect the market will not be particularly sensitive to the data.  Attention may shift to a fiscal policy where President Trump has provided an outline for the budget for the remainder of the year.  It looks to increase defense and security spending (and a little for education) whilst cutting other programs, such as the State Department and Environment Protection Agency, deeply.  The opposition from the Republican Party appears to be based more in the Senate than the House.

Central Bank of Turkey is expected to tighten policy with a 75 bp hike in the late liquidity window rate to 11.75%.  Lately, the central bank has tightened by forcing banks to borrow at this window rather than at the overnight rate of 9.25%.  We still think reliance on back door tightening reflects Erdogan’s heavy-handed tactics to prevent outright rate hikes.  

Chile central bank is expected to cut rates 25 bp to 3.0%.  CPI inflation eased to 2.7% y/y in February, below the 3% target for the fifth straight month.  After the easing cycle started with a 25 bp cut to 3.25% in January, the central bank then stood pat in February.  As such, we think it will cut again today.

 

Debt Ceiling Primer

March 15th, 2017 1:53 pm

Via Stephen Stanley at Amherst Pierpont Securities:

In addition to the Ides of March and Fed day, today is also the day that the current debt ceiling “expires.”  Here’s a brief explanation of what is happening today and what it means.  This might be worth filing away somewhere because this will come up again.  I promise.

Back in the day, when Congress raised the debt ceiling, they would just add some amount, say $1 trillion, to the existing debt ceiling, a relatively simple move (though certainly easier said than voted for!).  However, during the crisis, when deficits were surging out of control, federal debt was rising so fast that the debt ceiling issue was coming up too frequently.  In addition, under that structure, Congress and the Administration had limited control over when the debt ceiling would become a binding problem, leading to the prickly political issue rearing its head at inconvenient times.  So, someone figured out that it would be better to just put a time deadline on the debt ceiling, which is how Congress and the Obama Administration handled the issue over the past several years.

Here’s how it works: a law is passed that says the debt ceiling is suspended until a certain date.  The last such legislation established March 15 as the deadline, so here we are.  Republicans in Congress did not trust the Democratic Administration to avoid playing games with this new approach, so the legislation also stipulates that Treasury has to get the cash balance down to a specific level (otherwise, Treasury could manipulate the debt ceiling up by borrowing more than necessary).  That level happens to be $23 billion.

Back when this new debt ceiling arrangement was first established, that level of cash balance was low but not egregiously so.  Since then, however, Treasury has decided that prudent cash management requires a much larger cash balance, in the neighborhood of $300 billion on average.  As a result, every time the debt ceiling deadline arises, Treasury has to spend months winding the cash balance down from its normal run rate all the way to $23 billion.  Thus, every time the debt ceiling deadline approaches, Treasury bill supply has to be slashed to get the cash balance down.

In any case, what happens now is that a level is set for the debt ceiling.  Then, Treasury will unleash its quiver of “extraordinary measures” to create additional room to borrow.  These are a variety of things, mostly “defunding” several different trust funds, i.e. replacing one type of IOU (nonmarketable Treasury debt) that counts against the debt ceiling for a different type (a literal IOU) that does not.  Then, it is just a matter of how long Treasury can hold out using these extraordinary measures before the debt ceiling actually begins to bind.

This time around, the timing is fortuitous (not a coincidence).  Federal government cash flows are quite seasonal, and the biggest inflow of cash all year happens to be coming up (April 15 tax date).  So, once we get over that hump, inflows will carry the Treasury for quite a while, probably through the summer and into the fall based on current estimates.  Thus, from a market perspective, nothing happens today.  Then, starting tomorrow, bill supply will begin to normalize and the cash balance will rise.  And then, nothing for several months until the extraordinary measures near exhaustion.  And then the political war over raising the debt ceiling kicks in and the Treasury market starts to get nervous.

Firm PPI Dissected

March 14th, 2017 9:47 am

Via Stephen Stanley at Amherst Pierpont Securities:

The PPI was firmer than expected in February, rising by 0.3% for both the total and core indices.  This comes on top of a +0.6%/+0.4% performance in January.  Energy prices were somewhat firmer than I had anticipated at the wholesale level, rising by 0.6%, but the main surprise relative to my forecast was broad-based firmness in the core.  After January’s outsized gain, I had looked for a bit of a breather.  However, price pressures continued to build.  While there is very little in the core PPI that passes through directly, even roughly, to the CPI in the same month, I find these PPI results to be ominous for the near- and medium term inflation outlook.  The bulk of the firmness in the PPI came once again in the services categories.  While even the concept of a “producer” or wholesale price for a service product is often questionable, the BLS is certainly measuring something, and what statisticians are finding is that a variety of services are becoming more expensive.  In January, it was mainly airfares and banking and investment services.  Last month, it was banking services (again), insurance, legal fees, architectural and engineering services, hotel rates, restaurants, and the infamous wholesale and retail trade margins.  Again, none of this will feed through directly into the February CPI, but the evidence is building to support my argument that a tight labor market will eventually show itself in services price inflation.  A broad-based rise in the core PPI driven by an array of services categories should be viewed as much more impactful than a scenario where a handful of goods categories drove the advance.

Today’s results are especially troubling because I had drawn up a similar scenario for the February CPI as for the corresponding PPI.  After both releases showed big advances in January, I had anticipated a pullback to, if anything, below-trend advances in February.  Clearly, I am 0-for-1 on that count.  As for the February CPI, I am going to stick to my guns.  I am not making any dramatic changes to my estimates, though I do feel more comfortable with my numbers.  I look for a 0.1% rise for the headline, held down somewhat by a fall in energy prices, and a 0.2% increase for the core.  Before today, my estimates for both were closer to rounding down than up, so the small tweaks that I made to the CPI forecast (predominantly to the headline) make me feel better at the margin about my point estimates.

Meanwhile, the handful of PPI categories that are used in calculating the corresponding components of the PCE deflator were not particularly high.  A quick perusal of those numbers suggests nothing out of the ordinary in terms of how the core CPI and core PCE deflator will compare for February.

More broadly, even if I am right, and the February CPI is reasonably well-behaved, the specter of services prices creeping higher for two months in a row (the PPI for services rose by 0.3% in January and 0.4% in February) should send a chill up the spines of Chair Yellen and others at the Fed.  Labor markets are not going to ease up for a long time; they are only going to get tighter.  The FOMC’s Goldilocks inflation projections are looking increasingly unrealistic.  Yes, we will reach 2% (and sooner than the Fed thinks), but that will be no more than a quick bathroom break on this inflation road trip, not the final destination.

Subprime Auto Losses

March 10th, 2017 3:25 pm

Via Blooomberg:

U.S. Subprime Auto Loan Losses Reach Highest Level Since Crisis
2017-03-10 19:55:03.994 GMT

By Matt Scully
(Bloomberg) — U.S. subprime auto lenders are losing money
on car loans at the highest rate since the aftermath of the 2008
financial crisis as more borrowers fall behind on payments,
according to S&P Global Ratings.
Losses for the loans, annualized, were 9.1 percent in
January from 8.5 percent in December and 7.9 percent a year ago,
S&P data released on Thursday show, based on car loans bundled
into bonds. The rate is the worst since January 2010 and is
largely driven by worsening recoveries after borrowers default,
S&P said.
Those losses are rising in part because when lenders
repossess cars from defaulted borrowers and sell them, they are
getting back less money. A flood of used cars has hit the market
after manufacturers offered generous lease terms. Recoveries on
subprime loans fell to 34.8 percent in January, the worst since
early 2010, S&P data show.
With losses increasing, investors in bonds backed by car
loans are demanding higher returns, as reflected by yields, on
their securities. That increases borrowing costs for finance
companies, with those that depend on asset-backed securities the
most getting hit hardest.
American Credit Acceptance, one of nearly two dozen
subprime lenders to securitize their loans in recent years, had
one of the highest cost of funds last year with yields on its
securitizations as high as 4.6 percent, even as the two-year
swap rate benchmark hovered around 1 percent, according to a
report from Wells Fargo & Co. American Credit Acceptance didn’t
respond to a request for comment.
Lenders’ profits are eroding amid steep competition to win
new borrowers, S&P analysts said in February.
Performance of prime credit bonds has also worsened to
levels last seen in 2010. S&P blamed the weakening on “a couple
of regional banks whose auto loan ABS transactions we began
rating in 2014.”
Longer-term loans to finance the purchase of new and used-
cars, sometimes stretched to as many as 84 months, have also
hurt lender recoveries by putting borrowers underwater faster,
and leaving lenders with an asset worth far less after
repossession.

FX

March 10th, 2017 6:45 am

Via Marc Chandler at Brown Brothers Harriman:

US Jobs Data – Deja Vu All Over Again?

  • Many seem to recognize the risks of long dollar positions today going into the jobs report
  • Euro short covering spark came from Draghi, who made it clear that the ECB’s risk assessment was shifting toward a more balanced view
  • While we recognize the dollar has scope to weaken a bit more, we suspect it will not be a repeat of last week
  • Brazil reports IPCA inflation, which is expected to rise 4.86% y/y vs. 5.35% in January
  • Korea’s Constitutional Court upheld parliament’s motion to impeach President Park

The dollar is mostly softer against the majors ahead of the jobs report.  The euro and Swedish krona are outperforming, while Nokkie and the yen are underperforming.  EM currencies are mostly firmer.  TRY and ZAR are outperforming, while THB and TWD are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei rising 1.5%.  MSCI EM is up 0.2%, with China shares flat.  Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a higher open.  The 10-year UST yield is flat at 2.60%, the high from last December.  Commodity prices are mostly higher, with oil up 0.4%, copper up 0.6%, and gold down 0.4%.

A week ago, after nine Fed officials had spoken, the market widely expected Yellen and Fischer to confirm that the table was set for a rate hike later this month.  They did, and the dollar and US interest rates rose.  Now, after a strong ADP jobs report (298k), everyone recognizes upside risk to today’s national report, and the dollar has lost its upside momentum against most major currencies except the Japanese yen.  

Many seem to recognize the risks of long dollar positions today.  There are three sets of possibilities.  First, the US jobs report is seen as strong, and the dollar sells off, as last week on “buy the rumor, sell the fact” activity.  Second, the jobs report could be strong, and the market sees the pace of Fed tightening accelerating, and the dollar rallies.  Third, the jobs report could be disappointing, and the dollar sells off.  In two of the three scenarios, the dollar weakens.  

On the other hand, what is different now compared with last week is that the dollar is softer before the event.  The US dollar’s momentum stalled yesterday, helped by a bout of euro short covering that helped trigger a broader short-covering advance in many of the major currencies.  The spark came from the ECB’s Draghi, who made it clear that the central bank’s risk assessment was shifting toward a more balanced view as the downside risks eased.  Nevertheless, the fact that the staff’s forecast that inflation next year will be lower than this year warns against over-emphasizing a subtle change in signaling.  

Most participants did not expect another rate cut from the ECB.  Most did not expect a new long-term loan facility, especially given that the current ones are still open.  Although Draghi said that asset purchases could be accelerated if needed, investors recognize that a gradual winding down is more likely than a fresh expansion.  With the negative deposit rate of 40 bp, there are some that think that the ECB could reduce the negativity before completely ending is asset purchase program.  But this does not appear particularly likely in the next several months, and, moreover, it may look a bit different if inflation peaks, as we expect, in Q2.  

While we recognize the dollar has scope to weaken a bit more, we suspect it will not be a repeat of last week.  Those that want to pick a near-term dollar top may be reluctant to make much of stand when it may be easier to do so after next week’s FOMC meeting.  This view still can see the euro moving toward $1.0640-$1.0680, and sterling testing the $1.22 area.  The Australian dollar can push toward $0.7545-$0.7560, while the US dollar can ease back to the CAD1.3430-CAD1.3450 area.  Such price action would leave the technical tone intact.  

At stake today is also the nine-day drop in US 10-year Treasury prices, which pushed the yield back to 2.62%, the highest since the Fed hiked in mid-December.  The nine-day move saw the yield rise by 30 basis points.  The yield is slightly lower now.  If there were a single factor to explain why the dollar is above JPY115, making a two-month high, we would suggest it is the rise in US yields, which drives the 10-year interest rate differential.  The dollar has not closed above JPY115 since January 11.

There are large option expiries today at JPY115 (~$1.3 bln) and JPY116 (~$1.3 bln).  We note that the January 19 high was set near JPY115.60 and the 61.8% of the dollar’s decline since the early January high is a touch below JPY116.  The dollar’s advance has also lifted it through a trendline drawn from the highs beginning at the JPY115.60 area.  That trendline, which some see as the top of a larger wedge, comes in now near JPY114.60.  This also corresponds with the 38.2% retracement of the dollar’s leg up since the mid-week low near JPY113.60.  

Both the UK and France reported disappointing January manufacturing data.  In France, manufacturing output fell 1.0%.  The market expected an increase of around 0.5%, while the December series was revised to show a 1.0% decline rather than a 0.8% fall.  The broader measure of industrial output fell 0.3% compared with expectations of a 0.5% gain.  

In the UK, manufacturing output fell 0.9%, which was a little more than the market expected.  A pullback had been expected after the heady rise in December which was revised to 2.2% from 2.1%.  Headline industrial output fell 0.4%, a tad less than the market expected.   Construction spending also disappointed.  It fell 0.4% in January; twice the loss the median forecast anticipated but also follows a strong December gain (1.8%).  Lastly, helped by the 1.6% rise in exports and a smaller 0.9% rise in imports, the UK reported a GBP1.966 bln trade deficit.  The median expectation in the Bloomberg survey was for a GBP3.1 bln shortfall after GBP2.026 bln deficit in December (which was initially reported as a GBP3.304 bln deficit).  

Canada also reports February jobs data.  A small decline is expected by the median forecast, as the market looks for some mean reversion after two months of more than 45k job gains.  In the past two months, Canada has grown 86k net new full-time jobs.  Given that Canada is roughly one-tenth the size of the US, it would be as if the US created 860k new jobs in December-January instead of the 385k it did.  

In summary, look for next week’s events (FOMC meeting, Dutch election, and G20 meeting) to limit the dollar’s downside, barring a significant disappointment that makes participants doubt the certainty of a hike next week.  Rather than a repeat of last week’s “buy the rumor, sell the fact”, we suspect the opposite will happen, with most of the dollar’s decline already likely seen since yesterday’s ECB meeting.  The two weeks of rising US yields (a tenth day of rising 10-year yields would be longest such streak since the mid-1970s) warns of a potential turning point in the market.

Korea’s Constitutional Court upheld Parliament’s motion to impeach President Park.  This was our base case and the best possible outcome, since it removes one big source of political uncertainty.  A new election will be held within 60 days.  The three leading contenders (according to the most recent Gallup poll) to replace Park are Moon Jae-in and Ahn Hee-jung of the largest opposition Democratic Party of Korea, and Ahn Cheol-soo of the smaller opposition People’s Party.  Macro policy will remain prudent whoever is elected, but there are likely to be positive micro changes (with regards to how the chaebol operate) in the next administration.  

Brazil reports IPCA inflation, which is expected to rise 4.86% y/y vs. 5.35% in January.  Disinflation continues, which should allow the easing cycle to continue.  In light of the weak economic data, markets appear to be leaning towards a 100 bp cut to 11.25% at the next COPOM meeting April 12.  However, we lean toward a 75 bp cut to 11.50%.  Much will depend on the external environment then.  BRL is finally succumbing to overall EM weakness.  Retracement objectives from the December-February drop in USD/BRL come in near 3.2135 (38%), 3.2665 (50%), and 3.3200 (62%).  The 200-day MA comes in near 3.2650, so that area will be key.    

 

FX

March 9th, 2017 7:22 am

Via Marc Chandler at Brown Brothers Harriman:

Pre-ECB Squaring Lifts Euro in a Strong USD Context

  • Sandwiched in between the ADP estimate and the US jobs data, the ECB meets today
  • Falling commodity prices and rising US rates have helped take the shine off the Australian dollar
  • Chinese producer prices jumped but consumer price inflation slowed markedly
  • We note that the BOJ tweaked its negative deposit rate regime today
  • Czech February CPI rose 2.5% y/y; Mexico February CPI is expected to rise 4.82% y/y; Peru central bank is expected to keep rates steady at 4.25%

The dollar is mostly firmer against the majors.  The euro and Swiss franc are outperforming, while Nokkie and the dollar bloc are underperforming.  EM currencies are mostly weaker.  The CEE currencies are outperforming, while RUB and KRW are underperforming.  MSCI Asia Pacific was down 0.5%, even with the Nikkei rising 0.3%.  MSCI EM is down 1.2%, with China shares falling 0.6%.  Euro Stoxx 600 is down 0.3% near midday, while S&P futures are pointing to a flat open.  The 10-year UST yield is flat at 2.56%, the highest since late December.  Commodity prices are mostly lower, with oil down nearly 3%, copper down 1.4%, and gold down 0.3%.

The euro tested the lower of its range near $1.05 in Asia before short covering in Europe lifted it back toward yesterday’s highs near $1.0575.  However, buoyed by the upside surprise in the ADP estimate of private sector jobs growth, the dollar is firmer against most other currencies today.  The US 10-year yield is up 20 bp this week.  Including today’s move, the US 10-year yield is up for the ninth consecutive session.  At 2.57%, it has convincingly broken the downtrend in place since the middle of last December when the yield peaked near 2.64%.

Sandwiched in between the ADP estimate and the US jobs data, the ECB meets today.  With the euro near the lower end of its range, falling for four of the past five weeks, the pain trade is that the ECB will be somewhat less dovish.  The signal could be a change in the forward guidance about rates remaining at current levels or lower.  The phrase “or lower” could be dropped, some believe, in recognition of the solid growth (above trend) and rising price pressures.

However, this does not appear to us to be the more likely scenario.  Core inflation is stable in the trough (now 0.9%, after bottoming at 0.6%).  However, the ECB cannot be confident that energy prices, and to a lesser extent some weather-related increase in some fresh vegetable prices, will fade in the coming months, leaving a return to disinflation in its wake.  This idea may deter the ECB’s staff from lifting their inflation forecasts very much.

Also, the ECB will be loath to take measures in the presently charged environment that could be destabilizing.  Comments from officials show no strong urgency.  The market is doing some of that work already in the sense that outside of a few exceptions, like Germany and the Netherlands, have seen short-term interest rates over the past month.

Moreover, it seems that the pressures spurred by higher commodity prices may be peaking.  It is true that China’s PPI jumped to 7.8% year-over-year, which is the fastest pace since 2008 and is seen reflecting commodity prices.  However, this is partly a base effect as in the month of February producer prices actually fell (by 0.6%).  Oil prices have fallen, and today, the US WTI is below $50 a barrel for the first time this year.  Copper prices are lower for the sixth session and iron ore prices, off over 1% today, also appear to have rolled over.  Gold is falling as its down draft enters its fourth session (it has fallen in seven of the past nine sessions).

Falling commodity prices and rising US rates have helped take the shine off the Australian dollar, which is the strongest of the major currencies so far this year (up 4% even after this week’s 1% drop).  The Australian dollar broke out of the $0.7600-$0.7700 range last week.  It whipsawed back to into the range on Tuesday, but the slide resumed yesterday, and further losses are seen today.  The objective of the range breakout was $0.7500, and that has been taken out today.

Speculators in the futures market had shifted and taken a net long Aussie position, and the loss of $0.7500-$0.7520 warns that not only will longs have to be cut but momentum players may look to establish shorts.  The next target is near $0.7450, and then $0.7380.  The note of caution is that the Aussie is through the lower Bollinger Band (~$0.7525 today)

Falling oil prices and rising US yields have taken a toll on the Canadian dollar.  Recall the US dollar was testing support near CAD1.30 last month and is above CAD1.35 now, and looks poised to test the nemesis from the end of last year near CAD1.3600.

While Chinese producer prices jumped, consumer price inflation slowed markedly.  Economists had expected a slowing from the 2.5% year-over-year pace seen in January, but the 0.8% m/m pace was what they anticipated.  It is the slowest pace since January 2015.  It appears to be skewed by an early spring and good vegetable crop.  The Lunar New Year may have also distorted.  

Separately, China reported stronger bank lending in February than expected, but still a marked slowing from January.  The broader measures of aggregate financing, which also picks up the shadow banking activity, rose less than expected.  The CNY1.15 trillion increased compares with a median expectation of CNY1.45 trillion and the CNY3.737 trillion rise in January.

The yuan was weaker, falling to its lowest level since mid-January but recovering late.  The offshore yuan (CNH) fell below the onshore yuan (CNY), and the PBOC may have helped spur the recovery of both.  The offshore yuan has been stronger than the onshore yuan most of the year so far.  It was seen as a sign that the PBOC was trying to break the bearish speculation that helped create a troubling cycle of a weaker currency and capital outflows.

Rising yields appear to have forced the Bank of Japan’s hands as well.  The 10-year yield almost reached the BOJ 10 bp threshold after a poor reception to the MOF’s five-year bond auction.  The US 10-year yield premium over Japan reached 2.48 percentage points yesterday, the most in nearly three months.  This helped the greenback to test the JPY115 level that has largely capped the dollar since mid-January.

We note that the BOJ tweaked its negative deposit rate regime today.  It made a small change in the portion of the current account balances at the BOJ to which are exempt from negative rates (“macro add-on balances”) to 17% from 13%.

The softer yen helped Japanese equities edge higher and buck the regional trend that saw the MSCI Asia Pacific Index fall 0.5%, which is now at its lowest level in a month.  European stocks are also heavy.  The Dow Jones Stoxx 600 rose yesterday and snapped a four-day losing streak, but it is back on the downside today.  A close today below 371.80 would be the first below the 20-day moving average since February 7.  As one might expect, energy and materials are leading the push lower.  On the other hand, rising interest rates is seen as favorable for financials, which coupled with the real estate sector are leading the winners.

Sterling’s downside momentum appears to be stalling in front of $1.21.  Sterling is marginally lower today, for the fourth consecutive session.  It fell in the first four sessions of last week as well.  It has had only one advancing session in the past 10.  The Brexit drama over amendments to the bill allowing May to trigger Article 50 has weighed on sentiment, but it is likely a short-lived factor.  Interest rate differentials are also taking a toll.

The main focus is on the ECB and Draghi’s press conference.  Tomorrow’s US jobs data may deter aggressive profit-taking on the dollar today.  The US reports import/export prices, and weekly jobless claims.  Claims may bounce after falling to new cyclical lows.

Czech February CPI rose 2.5% y/y vs. 2.4% expected.  Inflation is the highest since November 2012, though still within the 1-3% target range.   Next policy meeting is March 30, and no change in policy or forward guidance is likely.  With inflation rising and the economic recovery intact, we think the CNB is on track to exit the koruna floor around mid-year.  When it does, we expect appreciation of the koruna on the order of 10-15%, which would in turn help limit inflation.

Mexico February CPI is expected to rise 4.82% y/y vs. 4.72% in January.  Banxico warned of above-target inflation for 2017 in its quarterly inflation report.  It also cut its 2017 growth forecast to 1.3-2.3% from 1.5-2.5% previously and its 2018 growth forecast to 1.7-2.7% from 2.2-3.2% previously.  As such, we do not think it will tighten further over the near-term.  Next policy meeting is March 30, and no move is likely if the peso remains somewhat stable.

Peru central bank is expected to keep rates steady at 4.25%.  Price pressures remain elevated, with CPI accelerating to 3.3% y/y in February from 3.1% in January.  This remains above the 1-3% target range.  Indeed, with the exception of a month or two here and there, inflation has remains above this range since mid-2013.  We believe further disinflation is needed to support the case for the first 25 bp rate cut.    

Morning Musings

March 8th, 2017 9:07 am

Via Stephen Stanley at Amherst Pierpont Securities: