Paying Up for Ten Year Notes

June 8th, 2016 9:31 am

Via Bloomberg:

U.S. 10-Year Treasury Demand Highest in 50 Years Before Auction
2016-06-08 07:36:35.472 GMT

By Wes Goodman
(Bloomberg) — Treasury 10-year notes are in the highest
demand in half a century by one measure as investors prepared to
bid at a $20 billion sale of the securities Wednesday.
The so-called term premium dropped to negative 0.47
percentage point at the end of last week, the lowest level since
1962, according to the Federal Reserve Bank of New York. A
negative reading indicates investors are willing to accept
yields below what’s considered fair value.
A weaker-than-expected U.S. jobs report for May and concern
U.K. voters will decide to leave the European Union at a June 23
referendum are driving investor appetite for the relative safety
of government debt. Demand is spreading beyond the U.S., sending
global yields to an all-time low. They have fallen to records in
Japan and Germany.
“There’s demand” for debt, said Hideo Shimomura, the chief
fund investor at Mitsubishi UFJ Kokusai Asset Management in
Tokyo, which oversees about $112 billion. “People are quite
nervous for the future.”
Benchmark Treasury 10-year note yield was little changed
from Tuesday, with the yield at 1.71 percent as of 8:33 a.m. in
London, according to Bloomberg Bond Trader data. The price of
the 1.625 percent security maturing in May 2026 was 99 7/32.
For more on the falling Treasury market term premium, click
here.
The U.S. sold $24 billion of three-year notes Tuesday and
plans to auction $12 billion of 30-year bonds Thursday.
Japan’s 20-year yield slid to a record 0.205 percent
Wednesday after Germany’s 10-year bund yield declined to an
unprecedented 0.045 percent. The yield on the Bloomberg Global
Developed Sovereign Bond Index dropped to 0.619 percent Tuesday,
the lowest level in data going back to 2010.
The 10-year notes being sold Wednesday are attractive given
that they have a higher yield than debt in other countries and
because of the liquidity of the world’s biggest bond market,
said Kazuaki Oh’E, the head of fixed income at CIBC World
Markets Japan Inc. in Tokyo. “Demand will probably not be too
bad.”

Long End Flatteners the Way to Go

June 8th, 2016 9:28 am

This is an excerpt from a note written by Steve Liddy, a friend and former colleague. It is from a longer piece but the graphs he employs do not translate well on to my very low rent blog. That is my fault and not Steve’s.

Via Steve Liddy:

Not overly scientific here…but, with Yellen taking June off the table and putting July in doubt, I think we are basically waiting on the next month’s payroll data, no? Sure, I guess CPI and and PCE numbers could move things, if they were upside surprises, but last Friday’s number really poured cold water on what could have been an interesting month:
Monday’s Yellen speech
Next week’s FED decision/presser

Yellen’s 6/21 congressional testimony
Now..I’m not sure the latter 2 have much impact, what else can she say?

With that, I think with the ECB now buying Corporates, and German 10y yields about to go negative, the grab for yield is likely to continue and drag the market higher. Corporate supply is down so far this month-though May was a record, with a lot of 30y issuance. The June-July lag between 10y/30y issuance is 5 weeks, where it is normally 4 weeks. Futures OI is up this month, and when looking at how US/WN have performed, you’d have to assume that is buying. Weekly MoF data continues to show that part of the world is buying, and $/¥ basis swaps would indicate they are buying dollars and swapping back. The S&P is within 20pts of its all –time high, which could prompt some quarter end asset allocation moves from the ALM crowd too.

5s30s stopped steepening, and the RSIs (daily here) are neutral. After this week, we get no long end supply for 5 weeks. If you get the chance to sell against the 50d MA-134.2, I think you do that.

FX

June 8th, 2016 7:16 am

Via Marc Chandler at Brown Brothers Harriman:

Currencies Broadly Stable, but Greenback is Vulnerable

  • Japan’s Q1 GDP was revised to 1.9% (annualized) from 1.7%
  • China’s May trade surplus stood at $49.98 bln
  • UK reported stronger than expected IP
  • The South African economy contracted much more than expected in Q1; Fitch affirmed its BBB- rating on South Africa with a stable outlook.
  • Polish central bank kept rates steady; Brazil’s should too

The dollar is mostly softer against the majors.  The yen and the Swiss franc are outperforming while the Aussie and the Norwegian krone are underperforming.  EM currencies are mostly firmer.  ZAR, RUB, and KRW are outperforming while MYR, SGD, and CNY are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei rising nearly 1%.  MSCI EM is up 0.5%, with Chinese markets down modestly.  Euro Stoxx 600 is down 0.4% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 1 bp at 1.71%.  Commodity prices are mostly higher, with oil up 1% and copper up 0.5%.

The foreign exchange market is quiet.  The euro remains confined to the narrow range seen on Monday between $1.1325 and $1.1395.  We continue to look for higher levels near-term as the drop from May 3 (~$1.1615) to May 30 (just below $1.11) is corrected.  A move above $1.1420 would likely spur more buying.  

The dollar has surrendered yesterday’s gains against the yen that had lifted it to almost JPY108.00.  The pullback has been limited to the JPY106.75 area.  The intraday technicals are slightly positive for the dollar, but a return to yesterday’s highs may be too much to expect.  

Sterling is little changed.  It is consolidating at the upper end of yesterday’s range and is a bit softer against the euro.  The Australian dollar is also in a tight range near yesterday’s best levels.  The Aussie advanced about 2.5 cents over the last five sessions.  The $0.7500 is the next important barrier.  The Canadian dollar is extending its recovery for the fourth consecutive session, and the greenback is approaching CAD1.27.  A convincing break targets CAD1.25.  

Asian equities were mostly higher.  Gains in Japan, Korea, and Taiwan offset weakness in several other centers to lift the MSCI Asia Pacific Index about 0.5%, for the fourth consecutive advancing session.  MSCI Emerging Market Index is up about 0.3% and extends the rally into the fifth session.   European bourses have seen profit-taking.  The Dow Jones Stoxx 600 is off about 0.5% near midday in London.  The only sectors gaining today are energy and utilities.  

Bond yields are mostly softer, though Germany Bund yields are pinned near record lows and Gilts are steady.  The ECB has officially launched its corporate bond buying program.  It will provide overall holdings every Monday, while the details of its holdings will be published monthly starting July 18.  Newswires are reporting some of the issues bought today.  

The program is expected to begin off gradually and increase over time.  Given liquidity conditions, purchases are expected to be below five bln euros a month, at least at the beginning.  Purchasing less than three bln euros a month would be seen as disappointing, according to some market participants.  Some see the drop in the average German yield into negative territory, and the record low 10-year bund yield, as evidence of a shortage of German paper.  On the other hand, part of the demand for German bunds may also be tied to the angst surrounding the UK referendum.  German assets ostensibly may also serve as a call option amid fears that a Brexit vote could spark an EMU crisis.

There are four main macro developments today.  First, just like US and eurozone Q1 GDP was revised higher, so was Japan’s.  Japan’s Q1 GDP was revised to 1.9% (annualized) from 1.7% due to stronger consumption and less of a drag from private investment.  These fully offset the drop in inventories and public investment.  Some argued that these revisions reduce the pressure for more fiscal or monetary efforts.  We are less convinced and note the public investment slumped 0.7% in Q1 rather than advance 0.3% as the initial report estimated.  

The Abe government is already committed to a fiscal stimulus package, and the postponement of the sales tax increase was only a part of this.  Many look for more details of the package ahead of the upper house election on July 10.  The BOJ meets next week, but few expect a change in policy.  Some suggest it is too close to the election.  The focus appears to be more on the late-July BOJ meeting as a more likely window for additional measures.  

Second, China’s May trade surplus stood at $49.98 bln.  This is larger than April’s $45.56 bln surplus but less than the median expectation of $55.7 bln).  Exports fell 4.1% year-over-year, which was a touch more than expected and follows a 1.8% decline in April.  Imports were more surprising.  They were off only 0.4%.  The market had been looking for a 4% fall after dropping 10.9% in April.

There are at least two important takeaways from the Chinese trade figures.  Imports have been contracting since October 2014.  The 0.4% decline is the smallest in more than a year and a half.  The news seems too good to believe.  Consider that imports from Hong Kong reportedly increased by $2.48 bln.  This is the most since 1999 and represents more than a 240% increase from a year ago. The suspicion is that this reflects over-invoicing to disguise capital exports.  

The other important takeaway is that China’s steel exports rose 3.7% in May and in the first five months are running 6.4% above year ago levels.  The US and EU are already taking action to deter a further surge of Chinese steel imports.  China’s surplus capacity is likely to be a source of tensions for years to come.  

The third macro development today is the unexpectedly strong UK industrial output report.  The market had expected a flat report in April, in part due to the below 50 reading of the manufacturing PMI.  Instead, UK industrial output jumped 2.0%, the biggest increase in four years.  Manufacturing production itself rose 2.3%.  Pharmaceutical output surged 8.6%, and auto production (ostensibly for domestic demand) rose.  There was a 3.9% rise in gas and electricity production, though oil and gas extraction fell 1.3%.    

The UK referendum is overshadowing the economic data.  The local press is not leading with last night’s Cameron/Farage interviews.  The media focus is escalating.  It may take a few days for the polls to detect the impact.  We suspect that at this juncture, more of the same rhetoric is unlikely to change many minds.  

Fourth, Clinton did unexpectedly well in yesterday’s primaries.  She appears to have won handily in California where some polls had shown a tight race.  Typically, when a candidate secures their party’s nomination, they experience a bump in the polls.  This has not been a particularly good period for Trump.  His recent comments have been criticized by many Republican officials, including those who have recently endorsed him.  Both parties will hold their conventions next month.  The focus shifts toward the vice-president candidates, and on the Democratic side, how Clinton will reach out to Sanders’ support is important as well.  

The North American session features the JOLTS report on the labor market, which some Fed officials have cited in the past.  Note that the new Federal Reserve Labor Market Index fell sharply in May after the April series was revised sharply lower.  API estimated that oil inventories fell 3.56 mln barrels last week.  The median estimate is that the DOE will show a 3.1 mln barrel draw.  Oil prices are firm with Brent testing $52 and WTI near $51.

South Africa reported Q1 GDP at -1.2% q/q annualized vs. -0.1% expected.  It reports April manufacturing production Thursday, which is expected to rise 1.5% y/y vs. -2.0% in March.  With the economy so weak, the SARB is probably reluctant to hike rates much further.  It stood pat in May, and it may not hike at the next policy meeting July 21.  This is especially true if the rand remains firm, but obviously, a lot can happen between now and then.

Meanwhile, Fitch affirmed its BBB- rating on South Africa with a stable outlook.  It noted that the rating is at risk if GDP growth fails to recover or if fiscal policy loosens.  We believe the agencies remain much too generous with South Africa, especially in light of the Finance Minister fiasco.  S&P just affirmed its BBB- rating but maintained a negative outlook, while Moody’s has it at an inexplicable Baa2 (equivalent to BBB) but has a negative outlook.  The Q1 GDP data should get the attention of the agencies, and we see growing downgrade risks.    

National Bank of Poland kept rates steady at 1.5%, as expected.  CPI fell -1.0% y/y in May, and so deflation risks remain alive even though the real sector is fairly robust.  This was the last meeting for Belka, whose term ends this month.  Incoming central bank chief Glapinski and the rest of the new MPC appear reluctant to cut rates further.  However, persistent deflation risks and a slowing economy could change things.

Brazil reports May IPCA inflation, which is expected to rise 9.29% y/y vs. 9.28% in April.  Mid-May IPCA came in higher than expected at 9.62% y/y vs. 9.34% in mid-April, and so we see upside risks to this reading.  COPOM also meets today and is expected to keep rates steady at 14.25%.  With several inflation measures accelerating again, the start of the easing cycle may be delayed beyond July.

Early FX

June 8th, 2016 7:13 am

Via Kit Juckes at SocGen:

<http://www.sgmarkets.com/r/?id=h10ad4a5f,173ec089,173ec08a&p1=136122&p2=0da585090c7aff2ac357e6294dab1d42>

I fear there should be a disclaimer on this morning’s note: It’s a bit long, quite verbose and largely lacking in interesting ideas. But apart form that….
The S&P 500 made a dash towards its all-time highs yesterday before global risk sentiment hit a speed bump in the form of Chinese trade data that showed a 4.1% y/y fall in exports. If you strip out the volatility that comes about as a result of the timing of the Chinese New Year, this is about the same pace of decline as we saw for much of the last year, and is consistent with the idea that the pace of slowdown has slowed, but hasn’t been reversed. Chinese inflation, money supply, retail sales, industrial production and Capex data are all due in the coming days but our overall sense is that growth is too soggy to support non-oil commodity prices and will probably be perceived as being consistent with continued gradual CNY depreciation. Not bad enough (yet) for full-blown risk aversion, but a speed-bump in the way of markets nonetheless.

The winner this morning was the yen, albeit only to the extent of a ¼% or so. Q1 GDP was revised up to show a 1.9% annualised growth rate in Q1. The same series is flat on a y/y basis so I’m not getting over-excited. I received more feedback than usual on my observation yesterday that the yen is now so the second chart shows a little context. USD/JPY has fallen by 5% since the start of 2006, but in real terms, it has risen by 40% 9and has fallen by 11% from its peak a few months ago). So the yen certainly isn’t ‘expensive’ in any absolute sense, though our FEER estimates of fair value are around 1.5, so the extreme cheapness of the yen on the basis has been mostly reversed this year. My sense that it’s now expensive reflects a view that it’s moved too far relative to realm or nominal rates, and is inconsistent with capital flows out of Japan,. The market clearly disagrees with me and I’m not about to go on a protracted war with market trends, especially since it’s clear that one of the reasons for yen demand at the moment is as a form of ‘Brexit’ insurance. Perhaps the real driver of a higher EUR/JPY (the trade that stands out most on relative real yields) could be the UK remaining in the EU on the June 23 vote. That however is a rather depressing though since what I want most of all is to look at trades that have nothing whatsoever to do with ‘Brexit’!

Japan GDP – growing q/q, not so much annually

[http://email.sgresearch.com/Content/PublicationPicture/227089/2]

USD/JPY. Yen ‘less cheap’ rather than ‘expensive’

[http://email.sgresearch.com/Content/PublicationPicture/227089/3]

The Australian dollar is a touch softer this morning and we remain short. The divergence between oil and non-oil commodity prices continues, with oil edging higher but some metals looking sickly. NZD is going to focus on the RBNZ meeting tonight with the market pricing in a 30% chance of a cut, odds that have tumbled from a peak above 80% a month ago. We like longs in AUD/NZD at the bottom of the current range but today, the risk-reward that’s best is simply to sell NZD/USD.

The data calendar is pretty thin (again). French business sentiment slipped to 97 from 99, but that’s been ignored. UK manufacturing output probably fell by about 0.3% m/m, -1.9% y/y but politics trumps data at the moment. The US sees the JOLTS jobs data this afternoon. The chart below though is worth throwing out, as it has come across my screens several items since it was posted by Sky news yesterday. It shows monthly changes in financial firms’ net exposure to sterling relative to other currencies on a monthly basis (in GBP bn). The Sky headline suggested it was a sign of capital flight; the FT stressed that it shows banks’ customers taking out insurance against a fall by sterling. To re-phrase the second interpretation, it shows a big increase in net short GBP positions in March, which may be one reason why EUR/GBP peaked just above 0.81 in early April. Maybe the subsequent rally to EUR/GBP 0.76 at the end of May got positions to a more even keel and that leaves us able to track every single twist and turn in unreliable opinion polls for the next fortnight….

UK banks’ customers loaded up on GBP shorts in March….

[http://email.sgresearch.com/Content/PublicationPicture/227089/5]

Credit Pipeline

June 8th, 2016 7:11 am

Via Bloomberg:

IG CREDIT PIPELINE: 5 to Price as List Grows Longer
2016-06-08 10:00:22.858 GMT

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

* Asian Development Bank (ASIA) Aaa/AAA, to price at least
$500m 5Y FRN, via managers BAML/C; IPT 3ML +19 area
* FMS Wertmanagement (FMSWER) Aaa/AAA, to price $bench Global
5Y, via BNP/Barc/DB/GS; guidance MS +32 area
* Province of Ontario (ONT) Aa2/A+, to price $1b Global 3Y,
via BAML/Barc/C/RBC; spread set at MS +31
* Sultanate of Oman (OMAN) Baa1/BBB-, to price $bench 2-part
144a/Reg-S deal, via C/JPM/MUFG/NBAD/Natix
* 5Y, IPT MS +mid/high-200s
* 10Y, IPT MS +mid-300s
* Bank of Montreal (BMO) Aaa/AAA, to price $bench 144a/Reg-S
5Y covered bond, via Barc/BAML/BMO/HSBC/JPM; IPT very low
70s

LATEST UPDATES

* SMBC Aviation Capital (SMBCAC) has mandated
C/CA/JPM/RBC/SMBC to hold investor calls June 8-9; a
potential US$ 144a/Reg-S offering may follow
* Dubai’s Emaar Properties (EMAAR) Ba1/BBB-, plans potential
USD bond sale
* Zimmer Biomet (ZBH) Baa3/BBB, to acquire LDR for ~$1b; co.
said it plans to issue $750m of sr unsecured notes after
deal completion
* Kookmin Bank (CITNAT) A1/A, mandates BAML/CA/HSBC/Miz to
arrange investor meetings
* Emera (EMACN) Baa3/BBB, to held investor calls June 2-3 in
connection with sr debt and hybrid securities offerings;
company may issue up to $800m notes, filing shows
* Abu Dhabi National Energy (TAQAUH) A3/A, mandates
BNP/C/FGB/HSBC/NBAD/SG for investor meetings June 8-10;
144a/Reg-S USD bond may follow
* Air Liquide (AIFP) A3/A-, held calls regarding Airgas
refinancing; planned to refinance the $12b loan backing the
deal via a combination of USD, EUR long-term bonds
* Raymond James Baa2/BBB, has engaged BAML/JPM/RayJ to arrange
investor meetings June 13-15; last priced a new deal in 2012
* ITC Holdings (ITC) Baa2/BBB+, filed an automatic debt
securities shelf; last issued May 2014
* USAID Ukraine (AID) heard to be in the works with possible
full faith & credit deal
* Bayer (BAYNGR) A3/A-, said to secure $63b financing, via
BAML/CS/GS/HSBC/JPM, for Monsanto (MON) A3/BBB+ bid; co.
likely will issue $20-$30b bonds to refinance part of the
bridge loan
* Omega Healthcare Investors (OHI) Baa3/BBB-, to hold investor
meeting, via BAML/JPM, June 14
* Poinsettia Finance Baa2/BBB+, mandates MS to arrange
investor meetings June 6-9; USD 144a/Reg-S deal may follow
* Fibra Uno (FUNOMM) Baa2/na, mandates BBVA/DB/GS/SANTAN for
investor meetings June 6-7; USD 144a/Reg-S deal may follow
* Kingdom of Saudi Arabia (SAUDI), weighing sale of $10b-$15b
after end of Ramadan in July
* May replicate Qatar’s $9b sale by issuing 5y, 10y, 30y
bonds, sources say
* Great Plains Energy (GXP) Baa2/BBB+ to issue long-term
financing including equity, equity-linked securities and
debt prior to closing of Westar Energy (WR) A2/A deal; says
financing mix will allow it to maintain investment-grade
ratings
* Apple (AAPL) Aa1/AA+, may return to market
* It priced $12b in 9 parts Feb. 16
* Re-opened 3 of the above issues for $3.5b March 17
* Merck & Co (MRK) A1/AA; has not priced a new issue since
Feb. 2015, $1.5b matured May 18
* General Electric Company (GE) A3/AA-, has yet to issue YTD;
parent GE Co has $11.1b maturing this year, $2.3b matured in
May
* GE may be among high grade industrials to add leverage
in 2016, BI says in note (see point 3)

MANDATES/MEETINGS

M&A-RELATED

* 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)
* Shire (SHPLN) Baa3/BBB-; ~$32b Baxalta buy
* $18b loan to be refinanced via debt issuance (Jan 18)
* Molson Coors (TAP) Baa2/BBB-; ~$12b MillerCoors buy
* $9.3b bridge (Dec 17)
* Teva (TEVA) Baa1/BBB+; ~$40.5b Allergan generics buy
* $22b bridge; $5b TL commitment (Nov 18)
* Duke Energy (DUK) A3/A-; $4.9b Piedmont Natural buy
* $4.9b bridge (Nov 4)
* Anthem (ANTM) Baa2/A-; ~$50.4b Cigna buy
* $26.5b bridge (July 27)

SHELF FILINGS

* Tesla Motors (TSLA); automatic debt, common stk shelf (May
18)
* Debt may convert to common stk
* Reynolds American (RAI) Baa3/BBB filed automatic debt shelf;
sold $9b last June (May 13)
* Statoil (STLNO) Aa3/A+, files debt shelf; last issued USD
Nov. 2014 (May 9)
* Corporate Office (OFC) Baa3/BBB-; debt shelf (April 12)
* Rogers (RCICN) Baa1/BBB+; $4b debt shelf (March 4)

OTHER

* Discovery Communications (DISCA) Baa3/BBB-; may revisit bond
market this yr, BI says (May 18)
* Ford Motor Credit (F) Baa2/BBB; may have ~$7b issuance this
yr (May 10)
* Wal-Mart (WMT) Aa2/AA; 2 maturities in April (April 1)
* GE (GE) A1/AA+; $25b debt possible for M&A, buybacks (Jan
29)

Some Corporate Bond Stuff

June 8th, 2016 7:08 am

Via Bloomberg:

2016-06-08 10:27:18.253 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $16.9b vs $13.2b Monday, $16.8b the previous Tuesday.
10-DMA $15.3b; 10-Tuesday moving avg $17.6b.

* 144a trading added $4.6b of IG volume, the highest since
$5.3b March 26, 2015, vs $2.4b Monday, $2.6b last Tuesday

* The most active issues:
* BAC 1.70% 2017 was 1st with client trades accounting for
100% of volume
* AET 3.20% 2026 was next with client and affiliate flows
taking 73% of volume; client selling 3.5x buying
* WBA 3.45% 2026 was 3rd with client and affiliate trades
taking 85% of volume
* DHR 3.15% 2026 was most active 144a issue; client flows took
87% of volume

* Bloomberg US IG Corporate Bond Index OAS at 155.1 vs 156.0
* 2016 high/low: 220.8, a new wide since Jan. 2012/150.8
* 2015 high/low: 182.1/129.6
* 2014 high/low: 144.7/102.3

* BofAML IG Master Index at +154 vs +155
* 2016 high/low: +221, the widest level since June
2012/+152
* 2015 high/low: +180/+129
* 2014 high/low: +151/+106, tightest spread since July
2007

* Standard & Poor’s Global Fixed Income Research IG Index at
+202, unchanged
* +262, the new wide going back to 2013, was seen
2/11/2016
* The widest spread recorded was +578 in Dec. 2008

* S&P HY spread at +639 vs +645; +947 seen Feb. 11 was the
widest spread since Oct. 2011
* All time wide was +1,754 in Dec. 2008

* Markit CDX.IG.26 5Y Index at 73.9 vs 74.3
* 73.0, its lowest level since August, was seen April 20
* 124.7, a new wide since June 2012 was seen Feb. 11
* 2014 high/low was 76.1/55.0, the low for 2014 and the
lowest level since Oct 2007

* Current market levels
* 2Y 0.787%
* 10Y 1.711%
* Dow futures +16
* Oil $50.88
* ¥en 107.14

* IG issuance totaled $9.35b Tuesday vs $4.55b Monday; June
now stands at $34.15b
* May ended at a record $209.51b; stats and recap
* YTD IG issuance now $837b; YTD less SSAs $700b

What to Watch Today

June 8th, 2016 7:05 am

Via Bloomberg:

WHAT TO WATCH:

* (All times New York)
* Economic Data
* 7:00am: MBA Mortgage Applications, June 3 (prior -4.1%)
* 10:00am: JOLTS Job Openings, April, est. 5.675m (prior
5.757m)
* Central Banks
* 5:00pm: Reserve Bank of New Zealand cash rate target,
est. 2.25% (prior 2.25%)
* 9:10pm: Reserve Bank of New Zealand’s Wheeler testifies
to Parliament Select Committee
* Supply
* 1:00pm: U.S. to auction $20b 10Y notes in reopening

In Need of a Vulcan Mind Meld

June 7th, 2016 7:56 pm

Via L J Kawa at Bloomberg:

In Star Trek, top cadets at Starfleet Academy face a terrible training scenario: Do they abandon a civilian vessel to annihilation in the Neutral Zone or risk war with the Klingons—and their own demise—by embarking upon a rescue mission?

In her quest to save the U.S. economy from deflation, Federal Reserve Chair Janet Yellen faces a similar challenge to that faced by then-cadet James T. Kirk, according to RBC Dominion Securities Inc. Strategist Matthew Barasch.

Yellen can elect to head into the Neutral Zone—that is, deliver more rate hikes—supported by a variety of modified Taylor Rule models that suggest policy rates should be higher. Doing so would risk damaging emerging market economies, including China, and cementing deflationary forces around the globe.

Conversely, she can leave her Kobayashi Maru (the phantom ship in Star Trek lore) to its fate, foregoing hikes in light of sluggish economic activity. But that strategy risks having inflation rise above the central bank’s 2 percent target. If that were to happen, a series of rapid rate hikes to tamp it down could send the U.S. economy into recession.

“The Fed has been facing a no-win situation for the past couple of years, but especially in the past six to 12 months,” wrote Barasch. “On the one hand, the underlying economic data in the U.S. has been supportive of raising rates off of what would be categorized by most as emergency levels; on the other hand, global growth remains broken.”

Yellen’s speech in Philadelphia on Monday, which emphasized uncertainties on the evolution of economic data, the neutral level of interest rates, and the Fed’s course of action, can be viewed as a nod to this dilemma.

Several decades ago, former Fed Chair Paul Volcker faced his own version of the this situation (Extending his Star Trek analogy, Barasch compared him to Kirk’s mentor, Captain Christopher Pike). While Volcker’s severe tightening regime, aimed at bringing inflation to its knees, proved unpopular at the time, “today he is viewed by many as one of the saviors of the U.S. economy,” said Barasch.

If Yellen elects to hold off on rate increases, perhaps her actions will someday be seen as heroic, too, the strategist mused.

“The right answer here is hard to pin down, just as it was over 35 years ago when the high levels of inflation argued for very high rates, but the slow rate of growth in the economy argued for the opposite,” he wrote. “The easier course of action is maintain rates at very low levels, risk some inflation and worry about cleaning up the inflation problem down the road.”

Now, if this were Star Trek, Yellen could try to follow Captain Kirk’s lead by finding a way around the no-win scenario. But unlike the simulator at Starfleet Academy, there’s no reprogramming this conundrum.

World Bank Cuts Global Growth Forecast

June 7th, 2016 7:50 pm

Via WSJ:
By Ian Talley
June 7, 2016 4:01 p.m. ET

WASHINGTON—The global economy is increasingly vulnerable to a sharp slowdown as troubles in emerging markets mount and as advanced economies struggle to grow, the World Bank warned Tuesday.

The bank’s latest projection pegs global growth at 2.4%, down from the 2.9% forecast in January and slower than last year’s weak pace. The bank also cut its forecast for growth in 2017 to 2.8% from 3.1%.

“The global outlook faces pronounced risks of another stretch of muted growth,” said World Bank chief economist Kaushik Basu. “A wide range of risks threaten to derail the recovery.”

Commodity exporters such as Brazil, Russia, Nigeria and Angola suffered some of the largest downward revisions. Governments have been forced to cut spending due to the price collapse in metals, energy and other commodities. Weakening currencies also are forcing central banks to raise interest rates to curb rampant inflation. And higher borrowing costs are weighing on investment and putting many company balance sheets deep into the red.

The bank pared its projections for the world’s largest economy, the U.S. A wounded energy sector, strong dollar and anemic international demand contributed to a 0.8-percentage-point cut in growth expectations—to 1.9%—for the year.

Japan, the world’s third-largest economy, isn’t gaining traction despite the Bank of Japan ’s charge into negative-rate territory. The World Bank said Japan will grow by 0.5% this year, nearly a full percentage point lower than expected in January.

The bank fears emerging-market growth could decelerate further. The bank kept its forecast for a 6.7% expansion in China, the world’s No. 2 economy, as Beijing juices output with more stimulus. But the World Bank warned of building financial risks that could trigger a deep slide in growth.

Bank economists are also concerned the Federal Reserve could tighten faster than markets expect, causing a jump in borrowing costs that could spark financial turmoil around the world. Volatility in capital flows also could flare up again if jittery investors pull out of emerging-market equity, currency and bond markets, they said.

The economists cited political risks as a threat to future growth. A U.K. exit from the European Union could severely damp investment as uncertainty weighs on markets, they said.

In the U.S., many economists are also pointing to uncertainty in the presidential election as suppressing activity. Governments from Brazil to South Africa to Indonesia also are facing deepening political turbulence, on top of persistent risks from wars in the Middle East and geopolitical tensions in the South China Sea.

“If we have a major shock, it can translate into a very sharp slowdown for the global economy,” said Ayhan Kose, the chief author of the bank’s Global Economic Prospects report.

Policy makers’ room to maneuver is shrinking. Although debt levels have moderated in many advanced economies, central banks are starting to run out of monetary-policy options. And politicians are reluctant to use government balance sheets to fund major injections of stimulus.

Options are even fewer among emerging-market exporters. Debt levels are rising, budget deficits are deepening and central banks are having to raise rates instead of cutting them to temper rising prices as their currencies weaken. Those countries, such as Angola, Kazakhstan, Malaysia, South Africa and Venezuela, are running average budget deficits of 5% of gross domestic product.

One major indicator of global weakness—trade growth—remains muted at 3.1%, well below precrisis trends.

“Persistently low growth could intensify protectionist tendencies that would further weaken growth prospects,” the bank said.

That attitude can be seen in the antitrade rhetoric gathering strength in the U.S. presidential election, but it isn’t isolated to North America. Around the world, discriminatory practices that act as a barrier to international trade outpace liberalization efforts by more than two-to-one, the bank said.

One bright note in the outlook: Emerging-market importers aren’t suffering the same downturn as exporters. In countries such as India, Hungary, Thailand and Vietnam, government deficits are actually lower than the bank forecast two years ago and debt levels as a share of economic output are falling.

Write to Ian Talley at [email protected]

Three Year Note Auction

June 7th, 2016 9:51 am

Via Ian Lyngen at CRT Capital:

We are optimistic about this afternoon’s $24 bn 3-year auction and see the risk of a stop-through in light of the historically strong takedowns of new 3s (despite the Feb/Mar poor performance) and the NFP-inspired Fed rethink.  In addition, the WI suggests the 3-year yield will be the highest since March – an inventive that might bring in otherwise sidelined investors.  Moreover, the takedowns of this benchmark have gone well historically, stopping-through or on-the-screws at 18 of the last 20 auctions – a dynamic we don’t feel compelled to bet against this afternoon. Volumes have been light this morning with 3s at 62% of the auction-day norms and with a below-average marketshare at 14% vs. 15% norm.  Given the interest rate differentials and the push back in Fed timing we expected that foreign demand once again be a wildcard at this week’s auctions given the recent safe-haven inspired moves — for context overseas awards average 20% of the 3-year auction.

Highlights:
• 3-year auctions have recently seen solid receptions, stopping through at six of the last eight auctions for an average through of -0.7 bp vs. two tails averaging 0.6 bp.

• Investment Fund buying has increased recently, taking 41% or $9.8 bn during the last four auctions vs. 37% or $9.0 bn at the prior four.

• Foreign bidding has slipped recently, averaging 20% at the last four auctions vs. 21% at the prior four. Foreign investors initially bought just $6.1 bn (19%) of the maturing 3-year; middle of the range.

• Maturities for this week’s trio of auctions are $32.0 bn, leaving a net cash need of $24.0 bn – mid-range but nonetheless providing a meaningful amount of cash for potential reinvestment.

• Technicals are bullish, with momentum extending but not yet into overbought territory. Initial resistance comes in at the low yield-close of 91.3 bp before the range bottom at 89.1 bp.  Through there is the Bollinger-bottom of 84.7 bp.  For initial support we’re watching the 95.9 bp 40-day moving-average before the 96.9 bp 38.2% retracement level of the move since mid-May.