Commercial Mortgages at Risk

April 5th, 2017 9:24 am

Via Bloomberg:


April 5th, 2017 7:19 am

Via Marc Chandler at Brown Brothers Harriman:

Dollar Mixed on Hump Day

  • The US reports weekly mortgage applications, ADP employment, Markit services and composite PMI readings, and the ISM non-manufacturing PMI
  • FOMC minutes will be released
  • Eurozone and UK services and composite PMIs were reported
  • Polls suggest that Le Pen fared poorly in last night’s French debate
  • ZAR is weaker on reports that Zuma will cling to power; Colombia reports March CPI

The dollar is mixed against the majors in choppy trading.  Stockie and sterling are outperforming, while the yen and Kiwi are underperforming.  EM currencies are mostly weaker.  INR and MXN are outperforming, while ZAR and TRY are underperforming.  MSCI Asia Pacific was up 0.2%, with the Nikkei rising 0.3%.  MSCI EM is up 0.4%, with China markets rising 1.4% after returning from a two-day holiday.  Euro Stoxx 600 is up 0.2% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is flat at 2.36%.  Commodity prices are mixed, with oil up 1.1%, copper up 1.3%, and gold down 0.3%.

The dollar is mixed as markets remain choppy and uninspired.  US yields remains soft, with the 2-year yield at 1.26% and the 10-year at 2.36%.  The 2-year US-German differential stands at 203 bp, down a tick from yesterday and still well below the 223 bp peak in early March.  

Yesterday, markets got a surprise with Richmond Fed President Lacker’s immediate resignation over leaking of confidential information.  Back in January, Lacker had said he would resign in October.  Now, the resignation is effective immediately.  Lacker was one of the most hawkish at the Fed.  While the Richmond Fed was not a voting member of the FOMC in 2017, it will be in 2018.  

It’s worth noting that the regional Fed presidents are picked by the board of directors of each regional Fed.  On the other hand, Fed Governors are picked by the President of the US.   Two governorships remain vacant, while Tarullo’s resignation takes effect today.  Next year, both Yellen’s and Fischer’s terms as Chair and Vice Chair are up, and neither is likely to be reappointed.  Filling these posts will allow President Trump to significantly shape US monetary policy in the coming years.    

During the North American session, the US reports weekly mortgage applications, ADP employment, Markit services and composite PMI readings, and the ISM non-manufacturing PMI.  The main focus data-wise will be ADP, with Bloomberg consensus at 185k currently.  More important may be the FOMC minutes that will be released in the afternoon.

There will be two important aspects of the FOMC minutes that will attract attention.  First, the Fed will introduce confidence cones around its forecasts.  This may help investors have a better appreciation for the forecasts, and surely why they are not point-specific promises.  Second, the FOMC likely had its first formal discussion of the balance sheet.  The key issue for the market is when and how it will be addressed.  

The modification of the rolling maturing issues into new issues is expected to take place very late this year or early next year.  It is not clear whether the Fed will focus on the MBS or Treasury portfolio or both.  There are a couple of caveats.  These discussions are still early in the process and there will likely be a wide spectrum of views which later will coalesce around two or three.  

Final March services and composite PMI readings for the Eurozone were reported.  The services PMI came in at 56.0 vs. 56.5 expected, while the composite came in at 56.4 vs. 56.7 expected.  Looking at the country breakdown, German services and composite came in close to expectations at 55.6 and 57.1, respectively, while French services and composite were softer than expected and came in at 57.5 and 56.8, respectively.  Spain was close to expectations, while Italy was weaker than expected at 52.9 and 54.2, respectively.

Polls suggest that Le Pen fared poorly in last night’s French debate.  An Elabe poll showed that 25% viewed Melenchon as the most convincing, followed by Macron with 21% and Fillon with 15%. Le Pen registered 11%.  In a separate poll, Melenchon, Fillon and Macron were all tied for most convincing at 18%, followed by Le Pen again with 11%.  With the unexpected surge of Melenchon, these numbers call into question whether Le Pen will even make it into the second round of voting.    

Although the euro slipped through $1.0650, it was not sustained, and on Monday and Tuesday, the euro finished near its highs. Barring a surprise, the euro can firm a cent over the next few sessions. The technicals look constructive.  The dollar looks better technically against the yen.  Buying emerges as JPY110 is approached.  Initial resistance is seen near JPY111.20.  Elsewhere, the $1.2350-$1.2400 may deter a deeper pullback in sterling.  

UK reported March services and composite PMIs too.  After weaker than expected manufacturing and construction PMI readings, services bucked that trend and came in at 55.0 vs. 53.4 expected.  UK composite PMI came in at 54.9 vs. 53.8 expected.

Japan’s service and composite PMI’s rose to 52.9 (from 51.3 and 52.2 respectively).  Data confirms what we (and others) have recognized, namely that Japanese growth strengthened in the first part the year, and begin Q2 on a solid note.    

Sweden reported February industrial production and orders.  Instead of the expected 0.1% m/m gain, IP rose 0.2%% while orders jumped 7.9% m/m%.  The Riksbank meets April 27, but no change in policy is expected then.  Indeed, despite headline CPI inflation at 1.8% y/y (underlying at 2.0% y/y) and the economy humming along, most expect the first hike from the Riksbank in 2018.    

The rand is on its back foot again on reports that Zuma will likely hang on to power.  That has been and will remain our base case, as he has survived numerous attempts during his two terms.  Reports suggest Zuma has retained the support of key ANC officials, despite the chorus of public calls for his resignation.  USD/ZAR is back above the key 13.75 area, which sets up a test of the November high near 14.65.

Colombia reports March CPI, which is expected to rise 4.74% y/y vs. 5.18% in February.  If so, this would move inflation closer to the 2-4% target range.  The central bank has cut rates several times already, and appears likely to cut 25 bp again to 6.75% at the next policy meeting April 28.  



April 4th, 2017 6:26 am

Via Marc Chandler at Brown Brothers Harriman:

  • US PMI report yesterday certainly supports the notion that price pressures are rising and the labor market is tightening
  • During the North American session, the US reports February trade and factory orders
  • RBA kept policy steady overnight, as expected; its statement was dovish
  • S&P cut South Africa one notch yesterday to sub-investment grade BB+; more downgrades are expected

The dollar is mostly firmer against the majors as risk off sentiment seems to be taking hold.  The yen and Swiss franc are outperforming, while the Antipodeans and Scandies are underperforming.  EM currencies are broadly weaker.  PHP and TRY are outperforming, while MXN and RUB are underperforming.  MSCI Asia Pacific was down 0.3%, with the Nikkei falling 0.9%.  MSCI EM is down 0.2%, with China markets closed for holiday.  Euro Stoxx 600 is down 0.1% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is flat at 2.33%.  Commodity prices are mixed, with oil flat, copper up 0.1%, and gold up 0.5%.

US PMI report yesterday certainly supports the notion that price pressures are rising and the labor market is tightening.  Signs are pointing to a good NFP reading Friday, where Bloomberg consensus is currently at 175k.  After the PMI data, one would think that the 10-year yield would be closer to 2.5% than to 2.3%, and yet here we are at 2.33%, the lowest since February 24.

Yet the 2-year differential with Germany has widened out to 207 bp, the highest since March 17.  This has helped push the euro lower, though support is still holding around the $1.0650 area.   Most of this move has been from the German side, with yields falling as political concerns in France have risen.  The second televised debate between the candidates will be held tonight.

Eurozone reported February retail sales.  Instead of rising the expected 0.5% m/m, sales rose 0.7%, pushing the y/y rate up to 1.8% vs. 1.0% expected.  This has had little impact on the euro today, as the markets continue to reassess their hawkish take on the March ECB meeting.

Furthermore, the mood in the markets today seems to be “risk off.”  This has helped the yen, with dollar/yen about to test the 110 area once again.  The pair has not been below 110 since mid-November, and a break below would set up a test of the 200-day MA near 108.50 currently.  

During the North American session, the US reports February trade and factory orders.  Fed Governor Tarullo speaks at 430 PM ET.  Fed officials continue to make a case for at least three hikes total in 2017.  Other central bank speakers of note include Norges Bank Governor Olsen (8 AM ET) and ECB President Draghi (930 AM ET).

Canada also reports February trade.  The Loonie was the worst performing major yesterday, due in part to lower oil prices and some reported M&A flows.  Further losses today saw the Loonie break above the $1.3430 area, which sets up a test of the March high near $1.3535.  The BOC meets next week and is likely to maintain its extremely dovish stance from last month.  

UK reported March construction PMI at 52.2 vs. 52.5 expected.  This was also lower than the revised 54.5 (was 54.6) in February.  Yesterday, manufacturing PMI came in at 54.2 vs. 55.0 expected.  Sterling’s rally against the dollar ran out of steam above the $1.26 area last month, and it continues to trade heavily as economic concerns mount. A break of the $1.23 area is needed to set up a test of the March low near $1.2110.

RBA kept policy steady overnight, as expected.  The statement was seen as dovish, however, as the central bank noted a deteriorating labor market and expressed concern about a strong currency.  Governor Lowe also criticized the nation’s banks for having lax lending practices, adding that regulators are prepared to take more macro prudential measures to limit this.  In other words, the bank is in no hurry to hike rates.  This helped negate an earlier AUD bid on the back of better than expected February trade data.  

AUD is testing its 200-day MA near .7550.  Break below sets up a test of the March low near .7490.  A break below .7455 and then .7385 is needed for a more bearish scenario to unfold.  Lower iron ore prices aren’t helping, falling below $80 for the first time since January.

Brazil reports February IP, which is expected to rise 0.3% y/y vs. 1.4% in January.  March IPCA inflation will be reported Friday, which is expected to rise 4.57% y/y vs. 4.76% in February.  Inflation continues to move closer to the 4.5% target, and remains well within the 2.5-6.5% target range.  With the economy so weak, markets are looking for a 100 bp cut to 11.25% at the next COPOM meeting April 12.

S&P was the first of the agencies to move, cutting South Africa one notch yesterday to sub-investment grade BB+.  This should not come as a big surprise, as it has been long overdue.  We also agree with S&P’s decision to keep the outlook at negative, as our own sovereign ratings model shows South Africa’s implied ratings at BB/Ba2/BB.  Break of the 13.7575 area sets up a test of the November high near 14.65.

Moody’s gives its review this Friday, and we believe a one notch cut to Baa3 is a done deal.  However, there is a small chance of a two notch cut to Ba1.  Note that many investment grade bond indices require an investment grade rating from at least two of the three major agencies, and so the next cut to sub-investment (likely by Fitch) would lead to forced selling.  

Corporate Bond Stuff

April 4th, 2017 6:00 am

Via Bloomberg:

Lowest IG Trading Volume in 6 Weeks; Spreads Steady
2017-04-04 09:55:47.330 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $13.5b vs $19.5b Friday, $13.9b last Monday. It was the
lowest trading volume since $13.46b on Feb. 17.

* 10-DMA $17.7b; 10-Monday moving avg $16.3b
* 144a trading added $2b of IG volume vs $2.4b Friday, $1.9b
last Monday

* Top 3 most active issues:
* CS 2.30% 2019 was 1st with 2-way client flows accounting
for 97% of volume
* VZ 5.15% 2023 was next with client and affiliate trades
taking 92% of volume; selling 1.6x buying
* F 3.339% 2022 was 3rd; near even client flows took 100%
of volume
* BMW 1.50% 2019 was most active 144a issue with client flows
taking 100% of volume

* Bloomberg Barclays US IG Corporate Bond Index OAS unchanged
at 118
* 2017 wide/tight: 122/111
* 2016 wide/tight: 215 (a new wide since Jan. 2012)/122
* 2015 wide/tight: 171/122
* 2014 wide/tight: 137/97
* All time wide/tight back to 1989: 555 (Dec. 2008)/54
(March 1997)

* BofAML US Corporate IG Index at +124, unchanged; +118, the
tight YTD and the tightest level since Sept. 2014 was seen
Mar. 2-6

* Standard & Poor’s Global Fixed Income Research IG Index at
+165 vs +164; +161, the tightest spread back to at least
2015 was seen March 2-8

* Current market levels vs early Monday:
* 2Y 1.246% vs 1.262%
* 10Y 2.328% vs 2.384%
* DOW futures -54 vs +26
* Oil $50.11 vs $50.62

* No IG issuance totaled just $2.75b Monday
* March Issuance Stats ~$167b
* YTD volume ~$512b; Ex SSAa ~$399b

* Pipeline: GMKNR to Price; Glaxo Files, SANTAN Mandate
* Note: subscribe bar in upper left corner

Credit Pipeline

April 4th, 2017 5:58 am

Via Bloomberg:

Credit Pipeline

March 27th, 2017 5:44 am

Via Bloomberg:

IG CREDIT PIPELINE: KEB to Price, Solid Issuance Week Expected
2017-03-27 09:33:48.225 GMT

By Robert Elson
(Bloomberg) — 84% of dealers and clients in a Bloomberg
News poll expect IG issuance to total at least $20b this week.
50% think it will be over $25b; 16% over $30b. At least 2
industrial deals were held back last week and may come forward
as soon as today. Stocks, however, may be a drag as futures are
currently -133.

Expected to price today:

* KEB Hana Bank (KEBHNB) A1/A+, to price $benchmark 144a/Reg-S
3Y FRN, via managers BAML/BNP/Cmmrzbk/HSBC/ING/KEB/SG: IPT
3ML +90 area

Recent updates:

* CMPC (CMPCCI) Baa3/BBB-, to hold investor meetings March
27-29 via BofAML/JPM/Santander; USD-denominated,
intermediate maturity deal may follow
* It priced a $500m 144a/Reg-S 10Y in 2014 at +225
* Airbus (AIRFP) A2/A+, mandated C/GS/JPM/MS for investor
meetings March 28-30.
* Benchmark USD 144A/RegS sr unsecured notes offering
targeting intermediate and/or long tenors may follow
* Its last USD issuance was a 10Y in 2013 at +98
* Amphenol (APH) Baa1/BBB+, filed senior debt shelf
* Has not issued since 2014; has $375m maturing in Sept.
* Mitsubishi UFJ Lease & Finance (MUFJLF) A3/A, to hold
investor meetings March 13-14, via MS
* Woori Bank (WOORIB) A2/A, mandates BNP/C/HSBC/JPM/Nom to
hold investor meetings March 6-9
* 3M (MMM) A1/AA-; filed mixed shelf
* Plans up to $2.8b debt in 2017, suggesting another yr of
incrementally higher leverage, BI says (Dec. 14)
* Texas Instruments (TXN) A1/A+, has history of March, April
* Mosaic (MOS) Baa2/BBB-, filed automatic mixed shelf; has not
issued since 2013
* $2.5b deal for Vale fertilizer ops; to fund purchase via
$1.25b cash and debt issuance
* Allergan (AGN) Baa3/BBB, exits blackout; last issued in 2015
* Has $1b maturing March 1
* General Motors Company Files Shelf; Parent Last Issued Feb.
* CNA Financial (CNAFNL) Baa2/BBB, Exits Blackout, Has History
of Feb. 10Y Issuance
* Exxon Mobil (XOM) Aaa/AA+, has a history of Q1 issuance
* Feb. 29, 2016: $12b in 8-tranches
* March 3, 2015: $8b in 7-tranches
* March 17, 2014: $5.5b in 5 parts
* Has $2.25b maturing March 15
* Filed debt shelf March 10

* M&A deals expected in 2017, updated
* List grows with the addition of RBLN, BATSLN, FOXA
* MARS, the privately help candy behemoth of M&M fame has
a $5b loan outstanding for its VCA purchase; a private
place or debut bond sale to support the acquisition is


* Panama; debt shelf amended to offer up to $3b debt, warrants
(Jan. 9)
* PG&E Corp (PCG) Baa1/BBB; $350m mixed shelf; Feb. 2014 was
last issuance at this level (Jan. 4)


* United Technologies (UTX) A3/A-; plans to tap debt markets
in early 2017 to complete share buyback (Dec. 14)
* European Stability Mechanism (ESM) Aa1/–; mandates for
advisement on inaugural USD issuance (Oct. 21)
* Conagra Brands (CAG) Baa2/BBB; could add up to $2.5b debt
for M&A, BI said
* CAG was raised to BBB by S&P in Nov. on the expectation
co. will maintain debt leverage ~3x and below


March 27th, 2017 5:34 am

Via Marc Chandler at Brown Brothers Harriman:

Macro Drivers as Q1 Winds Down

  • Trump’s economic agenda is called into question following the inability to replace the national health care
  • The eurozone may report the first slowing in headline CPI in seven months.  Core CPI languishes a little above the 0.6% trough
  • Triggering Brexit is simply a formality for investors
  • There was little evidence that the new SPD leader in Germany has reinvigorated the party’s fortunes, as the CDU expand its votes in Saarland state election

The dollar  was marked down in Asia, and Europe is pushing through an open door to extend the greenback’s losses.   With US rates falling and equities trading heavily, the yen is easily the strongest of the majors.  The dollar is approaching the JPY110 area.  A convincing break would likely trigger stops and options that could see losses accelerate.  The euro is bid near $!.0875,  and a break of it could quickly see $1.0935, a retracement objective of the euro’s losses since the US election.  The Australian dollar, which is the strongest major currency this year, is lagging, perhaps as the crosses adjust and the sell-off in industrial metals takes a toll.  Equity markets are down across the board as the reflation story is questioned and quarter-end position adjustments take a toll.  The US 10-year yield is off 5 bp to 2.35%,  Core European benchmark 10-year bonds are 3-4 bp lower.  Peripheral yields are off 1-2 bp.  

The first quarter winds down.  The dollar moved lower against all the major currencies.  The best performer in the first three months of the year has been the Australian dollar’s whose 5.8% rally includes last week’s 1% drop.  The worst performing major currency has been the Canadian dollar.  It often underperforms in a weak US dollar environment.  It’s almost 0.5.% gain is less than half the appreciation of the sterling, the second worse performing major currency here in Q1.

Although there are conflicting impulses, interest rate differentials continue to appear to be the single most important factor in considering currency movement presently. The question of the dollar is in good measure a question of the direction of interest rates.   US rates have fallen since the Federal Reserve hiked rates in the middle of the month, as they did following last December’s rate hike.

There are three considerations in the week ahead:  economic data, Fed comments, and an initial assessment of the implications of the failure to repeal and replace the Affordable Care Act.   Although Q4 GDP may be tweaked higher to 2%, the most important piece of economic data will be the February personal consumption figures.  The pullback in the consumer is weighing on Q1 growth estimates, while the rise in business investment does not appear sufficient to counter it.  Although February retail sales (~40% of PCE) was soft, the January figure was revised sharply higher.  This means that the February PCE report should catch these developments.  The targeted core PCE deflator is expected to be unchanged at 1.7%.

We note the contrasting projections by the Atlanta and New York Federal Reserve’s GDP trackers.  The Atlanta Fed’s model has the US economy slowing to a 1.0% annualized pace in Q1. This would be just below the average Q1 pace beginning in 2010.  However, the New York Fed’s model has the economy tracking 3.0%.   The market (Bloomberg median) is smack in between.

It is another busy week for Fed officials.  Ten different officials speak, including  Chair Yellen, Governor Powell, and NY Fed’s Dudley.  Outside of Bullard, it does not appear that anyone has downplayed the possibility of a June hike, to the extent that the issue was addressed.  There is no reason for the Fed to be too direct now.  The decision is not imminent.  The Bloomberg calculation puts the odds at 44.6%, while the CME’s interpolation is 50.7%.

Like some Fed officials, many investors have made assumptions about fiscal policy in their economic forecasts and investment strategies.  The inability to agree on the alternative national health care insurance raises questions about much of the administration’s economic program.  The markets may have held up well in the face of the news before the weekend as some positions had already been pared and there is some hope that the next priority, tax reform, will be more successful.

We are skeptical.  First, on practical grounds, the savings from abolishing taxes associated with the Affordable Care Act was going to be an important source to fund tax reform.  That is why it was embraced first.  Second, on political grounds, the inclusion of the border adjustment tax, which is the other major source of funding for the anticipated tax cuts remains highly controversial.  In fact, the same Republican group that sank the Trump/Ryan alternative, the Freedom Caucus, is opposed to the border adjustment tax.

Third, there is a question of timing.  Tax reform cannot be taken up meaningfully over the next couple of months  This also the assessment of the chairman of the House Ways and Means Committee, which is its purvue.  There are some more immediate issues that must be dealt with first. They include approving a budget for the remainder of the fiscal year.  The one that President Trump first proposed which included several controversial cuts, including of substantial cut of the State Department, while funding a large increase in defense and security, including infamous Wall, will be another fight.

In the coming weeks, Congress will also have to agree to extend the federal government’s spending authority.  It runs out at the end of April.  The Treasury is already taking measures to honor the debt ceiling, which also needs to be lifted.  There is also a two-week recess in April, and what looks to be a fight (and possible Democrat filibuster) over the Supreme Court nomination.  A third vacancy on the Fed’s Board of Governors will be exposed when Tarullo steps down next month.

There is some talk that the Republicans could force a rule change to allow a simple majority to confirm Gorsuch for the Supreme Court.  Doing so, however, would make it harder to reach out to Democrats on other issues.  The Republican Party, like other modern political parties, are coalitions. To be successful, Trump has to forge a majority coalition with the Republicans or find a rump of Democrats with whom to deal.  It is questionable whether the requisite skills for either strategy currently exist.  And even if they do, are they ten-times better?  Consider that the Affordable Care Act was over a year in the making.  The new plan about five-weeks-old, and changing at the last minute. A test for Democratic leadership is whether they can regain the initiative and propose their own reforms to the Affordable Care Act.

One of the factors that helped the euro recover in recent weeks is speculation that the ECB could hike rates this year before ending the asset purchase operations.  The speculation was fanned by comments from some officials and the steady increase in inflation.  At the end of the week, investors will likely learn that the six-month rise in CPI was snapped February.  The year-over-year pace may slow to 1.8% from 2.0% on softer energy prices.  The core rate may have eased to 0.8% (from 0.9%) and remains stuck in the trough after having bottomed at 0.6%. 

Merkel’s CDU did better than expected in the state election of Saarland.  Although it is one of the smallest German states, there were ideas that the  SPD, under new management was going to give the CDU a formidable challenge.   The CDU did a few percentag epoints better than last time.  The status quo under which it leads a coalition with the SPD, will likely continue.  Of note, the  anti-euro and anti-immigration AfD appears to have seen its support slip. .  That said there are two more state elections next month ahead of the natinoal election in late September.    

In Japan, industrial output is improving with the help of better exports.  Despite firm labor market, household spending remains depressed.  Since August 2015, it has only risen on a year-over-year basis once (February 2016).   Meanwhile, core inflation (excludes fresh food) is expected to rise to 0.2% from 0.1%.  While this may not sound impressive, it would be the highest core reading since April 2015.   BOJ policy is set, and the immediate interest has shifted to a scandal involving a conservative school’s ability to get a sweetheart deal and whether the Prime Minister or is wife gave a modest sum of money to it.  Although support for the cabinet has fallen, it is not (yet) a significant factor that is offsetting the other economic drivers, like interest rate differentials.  

In the UK, May will trigger Article 50 of the Maastricht Treaty to begin the dissolution of its EU membership.  In so doing, the UK will be subject to rules designed to discourage a country leaving. It will lose the initiative.  In any event, the actual trigger is a formality for investors.  The BOE’s Financial Policy Committee meets and there is an expectation for an update of the counter-cyclical capital buffer (currently set at zero) that is set to expire in June.  Sterling’s correlation with the 10-year interest rate differential between the US and UK is among the strongest since the late 1990s.  

Lastly, we note that OPEC continues to report high compliance and the drop in prices make it increasingly likely it will continue at reduced output.  That said, it seems to be relying on demand catching up to supply.     US rig count and output are still increasing.  Still, after declining nearly 14% this month, the downward momentum seems to be exhausted.   More stable oil prices, and possibly return to $50 a barrel,  also may help ease the weight on US rates.   

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.


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.