Some Corporate Bond Stuff

October 13th, 2016 6:10 am

Via Bloomberg:

IG CREDIT: PSX 30Y, 10Y Led Trading Volume
2016-10-13 09:56:10.959 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $16.7b vs $15.4b Tuesday, $18.7b the previous
Wednesday. 10-DMA $15.9b.

* 144a trading added $3.2b of IG volume vs $2.7b Tuesday,
$3.2b last Wednesday

* Trace most active issues:
* PSX 4.90% 2046 was 1st with client and affiliate flows
accounting for 97% of volume; client buying 2.4x selling
* PSX 3.55% 2026 was next with client and affiliate trades
taking 87% of volume, client buying 5:4 over selling
* GILD 2.55% 2020 was 3rd with evenly weighted client
trades taking 100% of volume; 1 large ticket on each
side
* Forest Labs (AGN) 4.375% 2019 was the most active 144a issue
with client trades taking 81% of volume

* Bloomberg Barclays US IG Corporate Bond Index OAS at 132, a
new YTD tight, vs 133
* 2016 wide/tight: 215 (a new wide since Jan. 2012)/132
* 2015 wide/tight: 171/122
* 2014 wide/tight: 137/97
* All time wide/tight back to 1989: 555 (Dec. 2008)/54
(March 1997)

* Standard & Poor’s Global Fixed Income Research IG Index
unchanged at +183, a new tight for 2016
* +262, the new wide going back to 2013, was seen
2/11/2016

* Current market levels:
* 2Y 0.843%
* 10Y 1.739%
* Dow futures -86
* Oil $50.18
* ¥en 103.94

* IG issuance totaled $6b Tuesday
* October total now $34.5b; YTD $1.37t
* Pipeline – SWED, EIBKOR to Price; Mandates Added
* Note: subscribe bar in upper left corner

Replacing Humans

October 13th, 2016 6:05 am

Via Bloomberg:
This Bank-Beating Trading Powerhouse Doesn’t Use Human Traders
John Detrixhe
johndetrixhe
October 13, 2016 — 12:00 AM EDT

One of the world’s fastest-growing trading shops doesn’t have any traders.

XTX Markets Ltd. has emerged as a foreign-exchange powerhouse, relying on programmers and mathematicians to fuel its rise into the global top five earlier this year. Now, after becoming a formidable player in currencies, XTX has its sights set on growing in stocks, commodities and bonds markets.

But in a world where the difference between profit and loss can be tiny fractions of a second, XTX says it relies more on smarts than speed. Instead of building microwave networks to ferret out prices a microsecond before anyone else, XTX uses mathematical models that are tuned with massive data sets. It says its technology has computing power comparable to some of the world’s top supercomputers.

XTX’s rise comes amid a market shift: In an arms race where just about anyone can lease ultra-fast trading systems, it’s harder than ever to get an advantage simply by being fast. That may have opened up an opportunity for firms with sophisticated statistical models, says Greenwich Associates. As XTX co-chief Zar Amrolia sees it, a key trial for the London-based firm comes when it competes in even more markets that are dominated by high-frequency traders, particularly in the U.S.
Speed vs. Smarts

“Can a smart, machine-learning approach beat probably a less sophisticated algo which is faster?” Amrolia said. “That’ll be a really exciting test.”

XTX’s other Co-Chief Executive Officer Alex Gerko, 36, points out that some of its 74 employees would still call themselves traders. But their jobs aren’t really recognizable to the humans who used to fill football-field-sized trading floors.

“We don’t have any human decision making in trading,” said Amrolia. “We do have trading analysts who look at the algorithms and see if they’re functioning well in the market and doing what we designed them to do.”

Proprietary traders haven’t submitted completely to their machines. There’s still an element of human interaction with the trading systems, said Mark Spanbroek, vice chairman of the FIA European Principal Traders Association.

“It’s like autopilot,” said Spanbroek, who formerly worked at automated trader Getco Europe Ltd. “The pilots are sitting there to navigate it through bad weather.”

Instead of old-school traders, XTX has analysts like the one who stepped in when the pound plunged last week. At about 12:07 a.m. in London, an employee saw multiple alerts showing the British currency had strayed way outside its normal range. The pound’s early morning ride — at one point a 6.1 percent drop — triggered XTX’s risk controls and halted trading.
Flash Crash

After consulting senior staffers, the alerts were overridden shortly after and XTX fired up its trading algorithms again. Platform operators including FastMatch Inc. say electronic specialists have lately provided more bids and offers — in other words, much-needed liquidity — than banks when trading goes haywire.

Still, banks are here to stay, even if some of their trading operations aren’t, says Greenwich Associates’ Kevin McPartland.

“The parts of the banks’ trading business that have become less profitable since the financial crisis is where the principal trading firms are stepping in,” said McPartland, head of research for market structure and technology at the firm. “They can do those lower margin, high volume businesses in a much more efficient way.”

Even before the pound’s plunge, XTX had argued that liquidity was evaporating because balance sheets — the market-making shock absorber known as inventory — had evaporated, too. Bank of America Corp.’s analysts said last week that foreign-exchange transactions have a 60 percent greater impact on prices than just two years ago.

XTX’s balance sheet is part of its pitch. XTX doesn’t always have to dart in and out of trades because, more like a traditional bank market maker, it takes risk using capital. Prices change in microseconds in some markets, but the firm touts holding periods that can last 10 minutes or more. It has 100 million pounds ($122 million) of regulatory capital.

XTX isn’t the only electronic trading company that takes trading risk, but doing so is a change from the past when most such firms didn’t commit capital at all, Greenwich Associates says. KCG Holdings Inc. has about $500 million of regulatory capital and shareholder equity of $1.45 billion.
Speed Bumps

XTX executives also favor speed bumps that neutralize the advantages of the fastest trading firms, arguing that some lightening-fast trading does little more than arbitrage prices between markets. Such strategies could end up costing an investor because subsequent trades will be more expensive, XTX says.

A challenge for XTX is finding and recruiting talent to create its intellectual fuel for trading. The competition to lure the world’s top mathematicians and technologists isn’t just against Wall Street and other computerized traders, as XTX is now also up against tech giants like Google.

Forget MBAs, XTX is looking for uncommon traits like “extreme quantitative skills and a good understanding of technology,” said Amrolia, 53, who has a Ph.D. in mathematics from the University of Oxford.

The competition between trading firms and Silicon Valley startups for top talent is a relatively new phenomenon, says Denis Ignatovich, former head of the central-risk trading desk at Deutsche Bank AG, where he started in 2007.
Startup Gold

“When I was getting into this industry, things like Facebook seemed so out there,” said Ignatovich, who went on to help found an artificial intelligence firm called Aesthetic Integration. “It seemed random for someone to go and strike gold with a startup.”

And if foosball tables, PlayStations and other tech firm perks aren’t enough to draw the brightest minds, XTX gives most employees equity in the company. Ultimately, however, talent will go there to prove themselves, learn from some of the best minds and, hopefully, make some money, Ignatovich said.

If it works, the new breed of trading firms perhaps someday will make even more bank operations go the way of MySpace or VHS.

“They will hone their market making skills and we will see a number of them become big established names,” said Niki Beattie, a Merrill Lynch alum who now heads adviser Market Structure Partners. “Over time, yes, these guys can replace what banks did.”

Helicopter Money Might Be Saved

October 13th, 2016 5:51 am

Via Bloomberg:

Catherine Bosley
cbSwiss

October 13, 2016 — 5:17 AM EDT

Helicopter money — the direct transfer of cash from central banks to consumers — has been touted as a radical form of stimulus to boost moribund inflation. A study by ING suggests it may not have much of an impact.

If people were to receive 200 euros ($220) in their bank account each month for a year with no strings attached, respondents in 12 European countries said they’d be more likely to save the cash than spend it. The results are based on a survey among some 12,000 consumers conducted by Ipsos from June 3-24 using internet-based polling.

Only 26 percent said they’d spend most of the money, while 52 percent said they’d save it, invest it or leave the bulk untouched. Fifteen percent said they’d pay back debt.
“If people behaved in the way they’ve responded to the survey, you’d have to question the effectiveness of this form of delivery,” said Ian Bright, a senior economist at ING. He said an alternative would thus be giving money to the state for infrastructure spending, tax cuts or for paying down national debt — an option irrelevant for the European Central Bank, which is forbidden to finance governments.

While the whole idea of helicopter money may seem bizarre, the concept — dreamed up by Nobel laureate Milton Friedman nearly fifty years ago — is being seriously debated by economists, after the trillions of dollars central banks around the world have pumped into financial markets in recent years have failed to revive growth and inflation. Policy makers haven’t signaled that they consider it a valid tool.

ECB President Mario Draghi called it a “very interesting concept” earlier this year, though he and his colleagues say they haven’t discussed it as an option.

Bank of Japan Governor Haruhiko Kuroda has repeatedly ruled out helicopter money, arguing it is not under consideration and is prohibited by current law, while Bank of England Governor Mark Carney called it a “flight of fancy.”

–With assistance from Enda Curran and Alice Baghdjian.

Credit Pipeline

October 13th, 2016 5:48 am

Via Bob Elson at Bloomberg:

IG CREDIT PIPELINE: SWED, EIBKOR to Price; Mandates Added
2016-10-13 09:33:42.422 GMT

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

* Kingdom of Sweden (SWED) Aaa/AAA, to price $benchmark
144a/Reg-S 3Y, via managers Barc/GS/HSBC/SEB; guidance MS +7
area
* Export-Import Bank of Korea (EIBKOR) Aa2/AA, to price
$benchmark 4-part deal, via
ANZ/BAML/CA/Miz/MS/Samsung/SG/UBS
* 3Y, guidance +80 area
* 3Y FRN, guidance equiv
* 5Y, guidance +90 area
* 10.5Y, guidance +100 area

LATEST UPDATES:

* Enersis Americas (ENRSIS) Baa3/BBB, mandates
BBVA/C/JPM/MS/SANTAN for roadshow Oct. 17-19; intermediate
maturity deal expected to follow
* International Finance Corp (IFC) Aaa/AAA, to market 5Y
inaugural Forest Bond, via BNP/BAML/JPM; at least $75m may
price week of Oct. 24
* Hyundai Capital Services (HYUCAP) Baa1/A-, to hold investor
meetings from Oct.17, via C/HSBC/Nom
* Kingdom of Saudi Arabia (SAUDI), to hold investor meetings
Oct. 12-18, via C/HSBC/JPM along with BoC/BNP/DB/GS/MS/MUFG;
144a/Reg-S 5Y/10Y/30Y deal expected to follow
* Sirius International Group (SIRINT) na/BBB/BBB-, has
mandated AMTD/BoC/C/JPM/WFS for 144a/Reg-S USD bond; last
issued in 2007
* Honeywell (HON) A2/A,announced a possible 4Q debt
refinancing in its guidance release Oct. 6
* May consider refinancing 2018, 2021 bonds, BI says
* Darden Restaurants (DRI) Baa3/BBB, filed debt shelf, last
seen in 2012
* Darden announced a new $500m share buyback program in
its 1Q earnings release
* Yes Bank (YESIN) Baa3/na, plans to raise $500m by year’s end
* Republic of Namibia (REPNAM) Baa3/BBB-, to hold non-deal
investor meetings Oct. 7-13, via Barc/JPM/StanBk
* Japan International Cooperation Agency (JICA) na/A+, files
to sell $125m bonds, via Barc/BAML/Daiwa
* ICBC NY Branch (ICBCAS) A1/A, hires BNP/BAML/C/WFS for
investor meetings Oct. 11-14; USD $benchmark issue expected
to follow
* Asciano (AIOAU) Baa3/BBB-, names ANZ/BNP/Miz for investor
meetings Oct. 10-28; it is a non-deal roadshow; last priced
a USD deal in 2011
* Western Union (WU) Baa2/BBB, filed debt shelf; last issued
Nov. 2013 following Oct. 2013 filing
* Global Bank Corp (GLBACO) Ba1/BBB-/BBB-, has mandated
C/DB/JPM/UBS for investor meetings Oct. 3-6; 144a/Reg-S
$benchmark deal is expected to follow
* Government of Bermuda (BERMUD) A2/A+, mandates HSBC for
roadshows Sept. 30- Oct. 10; 144a/Reg-S issue expected to
follow
* Partial tender also announced
* Bermuda last priced a USD deal in 2013
* Nafin (NAFIN) A3/BBB+; mandates BofAML, HSBC for investor
meetings Sept. 27-28; USD-denominated deal may follow
* Analog Devices (ADI) A3/BBB; ~$13.1b Linear Technology acq
* $5b loan received after $11.6b bridge (Sept. 26)

MANDATES/MEETINGS

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

M&A-RELATED

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

SHELF FILINGS

* Starbucks (SBUX) A2/A-; debt shelf; has $400m maturing Dec.
5 (Sept. 15)
* Brunswick (BC) Baa3/BBB-; automatic mixed shelf; last issued
in 2013 (Sept. 6)
* Enbridge (ENBCN) Baa2/BBB+; $7b mixed shelf (Aug. 22)
* IBM (IBM) Aa3/AA-; automatic mixed shelf (July 26)
* Nike (NKE) A1/AA-; automatic debt shelf (July 21)
* Potash Corp (POT) A3/BBB+; debt shelf; last issued March
2015 (June 29)
* Tesla Motors (TSLA); automatic debt, common stk shelf (May
18)
* Reynolds American (RAI) Baa3/BBB; automatic debt shelf; sold
$9b last June (May 13)
* Statoil (STLNO) Aa3/A+; debt shelf; last issued USD Nov.
2014 (May 9)
* Corporate Office (OFC) Baa3/BBB-; debt shelf (April 12)

OTHER

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

FX

October 13th, 2016 5:46 am

Via Kit Juckes at SocGen:

<http://www.sgmarkets.com/r/?id=h1183c17c,189a5d18,189a5d19&p1=136122&p2=c8389796cf291b9cbde7cf0299ef5c6a>

The FOMC Minutes reflected the fact that the decision to leave rates on hold in September was a ‘close call’ but, not for the first time, the decision to wait prevailed. A tightening labour market is the main argument for raising rates and although a recovery in the labour force has stopped the downtrend in unemployment, wage growth IS trending ever so slowly higher. The rates market still expects a hike in December but there was too, a small correction in the march higher in yields, helped by the correction in the rise in oil prices.

Softer oil prices and slightly lower Treasury yields, combined with weak Chinese data that posted the first y/y fall in exports in a while, have reversed the rise in USD/JPY while leaving global risk sentiment under a bit of a cloud. Not enough of a cloud, however, to de-rail the longer-term change in direction for Treasury yields which is the basic building block of the dollar’s rally. Today sees a dearth of data (US sees jobless claims and import/export prices), but there’s a 30-year bond auction to look forward to and that may demand a concession. We still favour longs in USD/JPY and short NZD/USD, in anticipation that the rising trend in US yields continue to dominate FX trend.

EUR/USD meanwhile, has fallen quickly to 1.10 after breaking support at 1.1130That may be more of a psychological than technical support, but a break could well open the way to a move to 1.08, which would look like a big move in the context of the recent range. Relative rates/yields in real or nominal terms, don’t really provide much support for meaningful Euro weakness, and while that won’t prevent a slip towards 1.08, something more fundamental would need to turn up to justify a break of that. There’s the DBRS review won Portugal’s credit rating (Oct 21) and the Italian referendum on Dec 3 but little on the economic calendar that springs out.

EUR/USD looks set for 1.08 if 1.10 breaks

[http://email.sgresearch.com/Content/PublicationPicture/234018/3]

A 75bp rise in UK 10year breakeven inflation rates since the EU referendum was the market’s verdict on inflation risks. Yesterday, the implications of the pound’s fall on prices and retailer margins hit home for the wider public as the country’s leading supermarket engaged in a war over prices with its highest-profile supplier of branded goods. Either UK consumers will eat store-branded yeast extract, or they’ll pay more for Marmite, or the impact of the pound’s fall will be shared between supplier and retailer. More prosaically, this may be the point where the correlation between rates and the currency starts to break down. If sterling falls further, that will not be because rates/yields are falling, it will mean that rates/yields are under pressure. And likewise, the link between a falling pound and a rallying equity market may get tested. Sterling has fallen as much as can be justified by the move in rate expectations so far and indeed, by as much as can be justified by the hit to the economy if a consensus view of very weak growth but no recession is correct. But the current situation is anything but stable and another slide would feed concern far more than it would help the UK’s competitive position. And so, it’s worth remaining short GBP vs both USD and EUR

GBP/USD and rates -a correlation under pressure

[http://email.sgresearch.com/Content/PublicationPicture/234018/4]

HSBC looks For Sharp Drop in US Stocks

October 12th, 2016 11:08 pm

Via Bloomberg:

Julie Verhage
julieverhage
Andrew Cinko
October 12, 2016 — 11:05 AM EDT

Yesterday’s big stocks drop may have just been the beginning.

 

Or so says HSBC Holdings Plc technical analyst Murray Gunn. In a new note, Gunn says he is now on alert for a big dip in U.S. equities. “With the U.S. stock market selling off aggressively on October 11, we now issue a RED ALERT,” he writes. “The possibility of a severe fall in the stock market is now very high,” he adds, noting that volatility has continued to rise since the end of the summer and the recent sell-off was seen across many areas of the market, and not just select groups.

Also causing some concern for Gunn is the intensity of the selling pressure, measured by what’s called the Traders Index, an indicator that combines both market breadth and the trading volume of advancing stocks versus declining stocks. The higher the index, the more bearish that day’s trading.

Earlier this week, Ben Laidler, global equity strategist at HSBC Holdings Plc told Bloomberg TV in an interview that the stock market is exposed to “a dangerous combination” of risk factors that investors aren’t looking at closely enough. Reasons for his caution included high earnings expectations, economic-policy uncertainty as well as the upcoming U.S. election and the Italian referendum. “We think markets are pretty vulnerable,” he concluded.

Other firms have issued similar warnings, with Citigroup Inc. Head FX Strategist Steven Englander telling clients that investors aren’t adequately hedging U.S. election risk and technical analysts at UBS AG calling for a top in the S&P 500 following the recent bond market sell-off that pushed yields on the benchmark 10-year U.S. Treasury above 1.7 percent.

The key levels that Gunn and his team are watching are 17,992 in the Dow Jones Industrial Average and 2,116 in the S&P 500. (As of 10:15 a.m. in New York, the Dow was trading at 18,147 and the S&P 500 at 2,140.) “As long as those levels remain intact, the bulls still have a slight hope,” they write. “But should those levels break and the markets close below (which now seems more likely), it would be a clear sign that the bears have taken over and are starting to feast,” they conclude.

Dim Future For Banking

October 12th, 2016 11:00 pm

Greg Ip at the WSJ writes an excellent piece on the dim prospects for banks:

By Greg Ip
Updated Oct. 12, 2016 6:21 p.m. ET

Seven years since the global financial crisis, banks don’t look like a source of trouble. They’re making money and have thickened their buffers against bad loans, while extensive new rules have excised much of the risk from their operations.

Yet the sudden resignation of Wells Fargo & Co.’s chief, John Stumpf , and the turmoil engulfing Deutsche Bank, tell a darker story. In different ways, they show how much harder it has become for banks to make money. The stock market suggests banks aren’t expected to earn much more than what investors charge them for capital in the foreseeable future. Blame rock-bottom or negative interest rates, tougher regulation and weak economic growth.

An industry that can’t earn more than its cost of capital is an industry destined to shrink. This matters to more than just the banks and their shareholders. When central banks ease the supply of credit, they rely on banks to transmit the benefits to the broader economy by making loans, handling trades and moving money between people, companies and countries. Shrinking, unprofitable banks hobble that transmission channel.

No politician wins votes by feeling sorry for banks. Quite the opposite: Democratic presidential nominee Hillary Clinton would make it easier to punish miscreant bankers while charging banks a new “risk” fee.

Some finance officials, however, are starting to worry.

“We don’t have a banking crisis, we have a profitability crisis,” Hans Jörg Schelling, Austria’s finance minister, said recently. Central banks in Europe and Japan are skittish about cutting interest rates even further for fear of undermining their banks.

The point is illustrated well by a recent study by Natasha Sarin and former Treasury Secretary Larry Summers, both of Harvard University, and presented at the Brookings Institution. They decided to assess the stability of banks not as regulators do, which usually means looking at capital (such as shareholders’ equity), but as markets do. They examined the behavior of common shares, preferred shares, options, credit default swaps and various valuation yardsticks.

They discovered that markets think banks are much more likely now to lose half their market value than before the crisis. They interpret this as a “decline in the franchise value of major financial institutions, caused at least in part by new regulations.” The counterintuitive implication: The bevy of rules designed to make banking safer may, by endangering their long-term viability, ultimately achieve the opposite.

One telling data point is the decline in the ratio of banks’ market value to the value their books say they are worth. For example, Bank of America Corp. and Citigroup Inc., which traded at about double their book value before the crisis, have since traded below, as have banks in France, Germany, Japan and Italy.

That means investors think that banks will be earning negative returns on their assets, after costs. And indeed, the Institute of International Finance, which represents global banks, finds that since 2010, European, Japanese and U.S. banks have on average been earning less than their cost of capital.

Regulation is part of the reason. To better buffer loan losses, banks must now hold more capital such as shareholders’ equity, which spreadsprofits across more shares. To deal with sudden outflows of funds, they must hold more highly liquid short-term assets, such as Treasury bills, which earn less than loans.

This has been compounded by the sluggish economy, which has held back loan growth, and by monetary policy. Banks profit from the spread between the interest they charge on loans and pay to depositors. But loan rates have been pulled down as central banks hold short-term rates at or below zero and buy bonds, and banks are reluctant to pass that on to depositors by charging to hold their money. Moreover, when central banks buy bonds, they pay with newly created cash that sits on banks’ balance sheets earning nothing, or less.

This can explain a lot of the problems in Europe’s banks, including Deutsche Bank, which is facing a potential multibillion-dollar U.S. penalty over crisis-era mortgage activity. The German powerhouse has €123 billion ($135 billion) tied up in cash and central-bank deposits. Meanwhile, its investment banking revenue has been sapped by regulations and docile markets. George Karamanos, an analyst at Keefe, Bruyette and Woods, says if current interest rates persist, by 2020 European banks’ profits will drop 20% and Deutsche Bank will be unprofitable.

Wells Fargo seemed to separate itself from its peers by boosting the number of products such as accounts and credit cards each customer bought. But in the process, many customers ended up with accounts and cards they didn’t want. Not only did that business earn nothing for Wells, it cost it a $185 million penalty, some $20 billion in market value and Mr. Stumpf’s job, and triggered a Justice Department investigation.

Indeed, investors must now discount the possibility that any bank could be one scandal away from indictment and a crippling, multibillion-dollar fine. Banks have responded by exiting or downsizing businesses that carry the most reputational risk, such as international money transfers and issuing mortgages to less creditworthy borrowers.

Those who blame many of the economy’s ills on a wasteful and overgrown financial sector will no doubt cheer this retreat. Everyone else should worry.

Write to Greg Ip at [email protected]

Five Year Repo

October 12th, 2016 6:30 pm

Via my former colleague Steve Liddy:

More FOMC Analysis

October 12th, 2016 3:20 pm

Via TDSecurities:

TD: FOMC Minutes: Plenty of discussion, but 2016 rate hike remains likely

·         September FOMC minute should not materially change the calculus for a 2016 rate hike.

·         The minutes reveal a lively discussion about the improving labor force participation rate and a low r-star world.

·         We continue to believe that ongoing strength in labor market and growth momentum should allow the Fed to take rates hikes in December.

The September FOMC minutes shed some light on the key discussions occurring at the Fed, but should not materially change the calculus for a rate hike later this year. It was noted at the meeting that the case for rate hike “had strengthened,” but with some slack remaining in the labor market, the majority at the FOMC decided to “await further evidence of progress” before taking rates higher. The minutes reveal considerable discussion around both the longer-term and near-term goals. Nevertheless, the debate was to have been expected given Yellen’s statement that there is “less disagreement in the committee than you might think…” This is consistent with several participants stating that “the decision at this meeting was a close call.”

In fact, the minutes noted that “a reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labor market and inflation.” This suggests that the Fed is as close to pulling the trigger on rate hikes this year as the more hawkish September statement suggested, particularly with 14 of 17 SEP dots pointing to at least one rate hike in 2016. There are a few points to the discussion worth highlighting:

Participation rate: The labor force participation rate saw considerable discussion given its recent improvement. Yellen mentioned the LFPR five times in her September press conference, but the discussion of the improvement was somewhat split. Some participants noted that the rise in the LFPR “suggested more room for labor supply to expand than previously expected.” Others nevertheless noted the rise in the LFPR as evidence of improvement in labor market fundamentals. There was some disagreement about the potential benefits of undershooting the longer-run normal rate of unemployment, with seemingly no consensus emerging at the meeting (warranting caution).

What more will it take: There was little discussion about what further criteria would need to be met for the Fed to be comfortable to hike rates later this year. We believe continued to expectations of steady growth momentum, a further decline in labor market slack, and improvement in the participation rate should be enough to keep the Fed on course for a rate hike in December. There was some concern among a few participants that the “further evidence” line in the September statement would be misconstrued as indicating the passage of time, suggesting that the Fed is keen to accumulate further evidence of improving growth momentum (rather than simply allowing the recovery to run further before hiking).

Lower r-star: A large part of the discussion at the FOMC had to do with a low r-star world. There appears to be considerable uncertainty at the Fed regarding how long such a low level of r-star would persist, with much discussion of productivity growth and recent evidence of the falling neutral rate. A number of participants similarly noted that they had revised their long-run r-star contributions (dots) lower at the meeting, consistent with a slip in the long-run median to 2.875% from 3% in June.

FOMC Minutes Analysis

October 12th, 2016 3:14 pm

Via Stephen Stanley at Amherst Pierpont Securities:

We have gotten about as much Fed transparency as we can take over the last six weeks or so, as hawks and doves have been making their respective cases in a very public way.  Most of these arguments were rehashed at the September 20-21 FOMC meeting, so there were few surprises in the minutes.

In terms of the economic outlook, I would say that there are two main areas of disagreement between those who would like to hike rates and those preferring to wait.  First, there are varying views on how much labor market slack remains.  Doves have taken the view that the surge in labor force participation (along with the leveling out of the unemployment rate) so far this year suggests that there is more slack than previously thought.  I find this argument a little puzzling, as I think the simplest logic would stipulate that the faster the economy takes up slack in the labor market, the less slack there is remaining, but far be it from me to try to understand the mind of a Fed dove!  In any case, hawks felt that the economy was close to full employment and that the longer the Fed waits to normalize policy, the higher the risk that the economy eventually overheats, necessitating sharper tightening and eventually, based on historical experience, a recession.

The other area of disagreement is the inflation prognosis.  Hawks point to the gradual progress of core inflation toward 2% and the waning of the special factors (most notably, the drop in energy prices in late 2015/early 2016) as reasons to believe that we are headed to 2% in a reasonable timeframe.  Doves, in contrast, are skeptical, having seen inflation remain below the Fed’s target for years.  Some of them are also concerned that long-term inflation expectations may have moved lower (a view expounded upon by Chicago Fed President Evans a few days ago).  In my view, it is the inflation piece of the puzzle that will be critical to the next steps for the Fed.  I believe that inflation, headline and core, will be heading higher on a year-over-year basis over the next few months, which will tip the scales in the hawks’ direction.

The policy debate was a close one.  Almost everyone agreed that the case for a rate hike had strengthened.  “Most” wanted to wait for more evidence of progress before moving, while “some other participants” felt that a rate increase was needed right away. This must have been a significant minority (3 voters and multiple non-voters).  Several of them felt that the Fed was risking its credibility by delaying, a very strong charge in central bank circles.  There were even significant differences among the majority.  “Several” of the group that wanted to wait stated that the decision in September was “a close call” (presumably, Vice Chair Fischer was one of those).  The “stand pat” crew was divided into two subgroups: “some” felt that it would be appropriate to raise rates soon as long as progress continued (i.e. more of the same would be sufficient to warrant a near-term move) while “some others preferred to wait for more convincing evidence that inflation was moving toward the Committee’s 2 percent objective.”

In my view, a coalition of the hawks and the “more of the same is enough” crowd from September will provide critical mass for a December rate hike, unless the economic data actually weaken substantially.  I expect that in the end the decision in December probably will not be that close, because, on top of the natural pull of raising rates before year-end, I expect the inflation data to rise by enough to get the attention of all but the most unyielding doves.