Across the Curve

Mobil Loses AAA Status

Via WSJ:

By ERIN AILWORTH and AUSTEN HUFFORD
Updated April 26, 2016 5:48 p.m. ET
Exxon Mobil Corp. was stripped Tuesday of the perfect triple-A credit rating it has held for more than six decades by Standard & Poor’s Ratings Services, a sign that the oil bust is hurting even the strongest players in the energy industry.

The world’s largest publicly traded oil company, Exxon, was just one of three American companies— Microsoft Corp. and Johnson & Johnson are the others—that had the triple-A rating. S&P said it first gave the company the triple-A mark in 1949. A representative for Exxon said it had been triple-A since 1930, counting its predecessor companies.
But the company’s willingness to go into debt to fund its capital spending and keep paying out dividends even as oil prices plunged from highs of over $100 a barrel to as low as $26 has taken a toll on its balance sheet. Its total debt, which stood at $38.7 billion at the end of last year, has more than tripled since 2012, according to S&P Global Market Intelligence.

“Nothing has changed in terms of the company’s financial philosophy or prudent management of its balance sheet,” Exxon spokesman Scott Silvestri said Tuesday.

In downgrading Exxon by one notch to double-A-plus, S&P cited the company’s rising debt level and said dividend payments and share repurchases “substantially exceeded” internally generated cash flow.

U.S. government debt itself is ranked at double-A-plus.

Earlier this year, Exxon sold $12 billion of new bonds in one of the biggest corporate-debt deals of the year. S&P said it expects Exxon to return cash to shareholders instead of reducing its debt.

“Other AAAs have no debt or almost no debt and a lot of cash,” said Ben Tsocanos, an analyst for the ratings agency, in a February interview. “Exxon is the only AAA company in a capital intensive industry. That should be kept in mind.”

The ratings downgrade isn’t expected to affect Exxon’s ability to borrow money. But the triple-A rating status—which Exxon managed to maintain in one form or another through the Great Depression, World War II, Arab oil embargo and several previous price crashes—had long been a point of pride for the Irving, Texas company.

Exxon Chief Executive Rex Tillerson said during an interview with CNBC in March that he’d be disappointed if it lost the triple-A rating. “You know, over 90 years of being AAA, this is not the first time we’ve been through a period of this pretty extreme stress on the financial-model of the company,” he said. “I hope we can maintain the rating ‘cause it’s important to us reputationally.”

Investors rely on ratings from S&P, Moody’s Investors Service and Fitch Ratings when deciding whether to buy bonds.

In February, S&P cut the ratings of 10 U.S. oil and gas exploration and production companies, citing the price decline. It also placed Exxon on watch for a possible downgrade, which was resolved with Tuesday’s release. S&P said Exxon’s outlook is stable.

Also in February, Moody’s Investors Service affirmed its triple-A rating for Exxon but placed the company on a negative outlook, saying it feared a diminished level of capital reinvestment could hurt Exxon’s ability to replace reserves and hurt production in future years. It stood by that rating and outlook in an April 1 credit opinion.

Peter Speer, an analyst with Moody’s, said Exxon’s problem is that it is completing complex, large-scale, expensive projects that don’t work in the current low-price environment.

“There will be higher prices in the future, but not returning anywhere to the prices we saw a few years ago,” Mr. Speer said.

Energy companies have suffered from a prolonged decline in oil and natural gas prices, with many severely cutting planned capital expenditures.

The financial ratings industry has been under criticism in recent years stemming from the high-marks given to mortgage-backed securities, whose failure later caused the financial crisis. In Feb. 2015, S&P agreed to pay $1.5 billion to resolve litigation alleging it knowingly issued rosy grades of risky mortgage bonds before the crisis.

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Consumer Confidence

Via Stephen Stanley at Amherst Pierpont Securities:

The Conference Board gauge of consumer confidence fell by about 2 points in April to 94.2, reversing the March gain.  Assessments of the present situation improved, including a 1-point gain in the assessment of labor market conditions to the best reading of the cycle.  However, expectations deteriorated, unwinding the 4-point rise registered in March.  Over the last five months, the headline index has meandered within a 4-point range, which is not telling me very much about the consumer spending picture.  With real labor income gains likely to stay solid, I remain upbeat about the prospects for consumer expenditures.

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Durable Goods Orders

Via Stephen Stanley at Amherst Pierpont Securities:

Once again, durable goods orders disappointed.  The headline figure rebounded by 0.8%, on the back of a jump in defense bookings, but the increase was less than expected, as aircraft orders failed to bounce despite a significant increase reported by Boeing.  Excluding the volatile defense and aircraft sectors, durable goods orders sank by 0.7% on top of February’s 0.6% fall.  That makes 5 negative months out of the last six.  The “ex-transportation” component declined by 0.2% in contrast to projections for a small gain.

Core capital goods orders were flat in March, also a disappointment after the 2.7% drop in February (revised from -2.5%).  This aggregate is down 2.4% vs year-ago, but that only scratches the surface of the malaise in business investment.  The March 2016 reading is down 6½% from 2 years ago, is roughly flat vs. 3 years ago, and is down about 5½% from March 2012.  After a calamitous drop during the recession, we saw a nice bounce in equipment investment in 2010 and 2011, but this sector lost momentum almost 5 years ago and has not produced any sustained strength since then.  There are, of course, many possible explanations for this period of weakness, but most of you know that I suspect a big part of the story is a growth-hostile set of tax and regulatory policies, a development that first rose to the forefront in 2011.  Given how little confidence the political environment currently inspires, I would expect that, if anything, investment demand will be even weaker than before between now and November (and possibly thereafter).

Core capital goods shipments managed a 0.3% rise in March, though this pales in comparison to the 1.8% and 1.4% drops in January and February respectively.  I am assuming a 4% drop in real business investment in equipment for Q1 (the GDP report will be released Thursday).  Today’s numbers, if anything, would nudge me lower by a few billion dollars but not by enough to make a difference to my GDP estimate.

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More on Stable Funding Rules

Yesterday I published this piece and just found this illuminating article at the WSJ:

WASHINGTON—Large U.S. banks would have to prove they have enough cash to withstand severe market turmoil lasting as long as a year under a new rule set to be proposed Tuesday.

The regulation would require about 30 of the country’s biggest banks to adjust their balance sheets, cutting the odds they would run into the kind of funding crunch that crippled Bear Stearns and Lehman Brothers in 2008. But critics say it could also crimp banks’ profits by forcing them to devote more resources to low-return investments or higher-cost sources of cash, and could disrupt markets by forcing banks to curb their trading in certain types of instruments or pull back from certain types of loans.

The rule is being crafted by three agencies: the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency. The FDIC will release details of the liquidity proposal at its board meeting Tuesday, along with voting on an unrelated postcrisis rule to rein in incentive-compensation on Wall Street. That bonus-pay proposal is being prepared by six regulators and was released last week by one of them, the National Credit Union Administration.

The core element of the new regulation is the “net stable funding ratio,” or NSFR. This new requirement would force banks to show they have sufficient “stable funding” to help them endure a year of extreme duress. The idea is to encourage banks to rely more on sources such as core deposits and longer-term funding from small businesses, and less on short-term wholesale funding—which includes instruments such as repurchase agreements—that help to provide another way for large banks to get cash.

The question banks are waiting to see answered is whether the U.S. version of the NSFR will be similar to one suggested by global regulators two years ago or whether U.S. officials will follow their pattern of “gold-plating” international rules by imposing stricter requirements. Banks also fear that regulators won’t just give them numerical benchmarks to meet, but issue detailed rules prescribing for them what kinds of transactions are needed to meet those benchmarks.

Critics of the coming rule say they worry that while it might make banks safer, it could undermine the smooth functioning of different parts of the financial system by forcing banks to pull back from sectors where they have traditionally played a major role—essentially shifting potential liquidity problems from banks to the broader financial system.

In addition to worries within the industry, “there is significant fear among even global regulators that maybe this is a problematic result in terms of undermining market liquidity,” said Karen Shaw Petrou, a managing partner of advisory firm Federal Financial Analytics Inc.

Some industry observers also warn about a “chilling effect” on long-term lending such as aircraft, shipping and project finance, according to a memo by the law firm Shearman & Sterling assessing the possible impact of the new rule. The regulation would effectively raise banks’ costs of keeping such longer-term assets on their books to offset more expensive longer-term liabilities, according to the memo.

The one-year stable-funding requirement was completed in 2014 by the Basel Committee, and is one of the remaining pieces for U.S. regulators to complete their version of that global framework. These regulations are designed to make banks less likely to face distress to avert a potential collapse. The Basel proposals aren’t binding, but come in the form of recommendations for regulators to carry out in their own economies.

Many of the rules are aimed at forcing banks to maintain more capital on their books to ensure they have a buffer to protect against losses from risks they take. Those have existed for years, though they have been strengthened since the crisis.

A new layer of postcrisis protections is aimed at ensuring banks have sufficient liquidity to protect against a sudden funding crunch, a modern version of a bank run, even if their underlying balance sheets are healthy. As the financial crisis began to unfold in 2007, “Many banks—despite meeting the existing capital requirements—experienced difficulties because they did not manage their liquidity,” according to a document from the Basel Committee on Banking Supervision, the group of global regulators proposing the NSFR rule, explaining the rationale behind it.

The first such regulation in place, completed by three main American bank regulators in September 2014, is called the “liquidity coverage ratio.” That requirement calls on large banks to hold highly liquid assets such as central bank reserves, and government and corporate debt, which can be converted into cash quickly to cover a firm’s obligations over a 30-day period.

The new regulation to be proposed Tuesday is aimed at addressing stresses that could emerge in a bank’s balance sheet if a financial crisis lasts longer than a month.

The NSFR regulation will apply to roughly 30 U.S. banks with $50 billion or more in total consolidated assets on their balance sheets, excluding client money. But, if past practice is any indication, U.S. policy makers will likely impose a more-stringent rule on the eight largest and most complex banks that hold $250 billion or more in assets, including J.P. Morgan Chase & Co. and Bank of America Corp., while applying a more relaxed standard to banks that have more than $50 billion in assets but aren’t internationally active.

A spokesman for J.P. Morgan couldn’t immediately be reached, while a spokesman for Bank of America declined to comment.

“This process should result in a regulation that reduces the probability of banks coming under short-term funding pressures,” Fed governor Daniel Tarullo said in 2014 speech previewing the liquidity rules. “Maintaining more stable funding, such as retail deposits and term funding with maturities of greater than six months, will help avoid the spiral of fire sales of illiquid assets that deplete capital and exacerbate market stress.”

Write to Donna Borak at [email protected]

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FX

Via Marc Chandler at Brown Brothers Harriman:

Greenback Mostly Softer, Sterling Shines

• The gains the US dollar registered in the second half are being pared; sterling’s strength stands out
• The US reports March durable goods orders and February Case-Shiller house price index
• News that 1MDB missed a coupled payment sparked cross default clauses
• Hungarian central bank meets and is expected to cut rates 15 bp to 1.05%

The dollar is broadly weaker against the majors.  Sterling and Kiwi are outperforming, while the Swiss franc and the euro are underperforming.  EM currencies are mixed.  TRY, RUB, and PLN are outperforming while MYR, KRW, and ZAR are underperforming.  MSCI Asia Pacific was down 0.2%, with the Nikkei falling 0.5%.  MSCI EM is up 0.1%, with Chinese markets up around 1%.  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 down 1 bp at 1.90%.  Commodity prices are mixed, with oil up nearly 1% and copper down 1%.  

The gains the US dollar registered in the second half are being pared, but it is sterling’s strength that stands out.  It is difficult to attribute it to Obama’s push against Brexit, but there does appear to have been a change in sentiment.  

Sterling is the best-performing currency not only today but for the past five sessions, rising 1.25% against the US dollar to its best level since mid-February.  The next target is $1.4600 and $1.4670, the high from early February.  Sterling is rising against the euro for the eighth consecutive session.  The next target for the euro is near GBP0.7685, which corresponds to the 38.2% retracement of the euro’s rally off the mid-November low near GBP0.7000.  

However, investors need to be careful extrapolating too much from the decline in the benchmark three-month volatility and call-put skew.  The issue here is the calendar.  Three-month optionality goes well beyond the referendum, which has now moved within the two-month window.  The pressures have been squeezed into two-month duration.  Two-month sterling volatility is at new six-year highs today, reaching more than 14.5% earlier, surpassing three-month volatility which has fallen below 13%.  

Similarly, the call-put skew (25 delta risk-reversal) is being reduced in the three-month options and rising sharply in the two-month period.  In the three-month period, the premium for sterling puts over calls finished last week at 4.45% and is now quoted near 3.68%.  The two-month skew favors sterling puts by 3.8% compared with 1.22% before the weekend.  

The news stream remains light ahead of tomorrow’s conclusion of the FOMC meeting and Thursday’s BOJ conclusion.  Many observers seem to be exaggerating how important the former is for the latter.  Recall that the Fed’s rate hike in December (and indications at the time that most at the Fed thought four hikes this year would be appropriate) did not deter the BOJ from adopting negative interest rates at the end of January.  Nor did the ECB easing in early December preclude the Fed from tightening a fortnight later.  

The US reports March durable goods orders and February Case-Shiller house price index.  Durable goods are the last piece of data for economists before the preliminary Q1 GDP report.   It is unlikely to alter the view that the US economy slowed in Q4 15 and slowed further in Q1 16.  However, the early April data is looking better.  Today Markit will provide an initial estimate for April services PMI and the composite, both of which are expected to tick higher.  Apple will report its earnings later today.  

Better than expected earnings are helping lift European shares after the MSCI Asia-Pacific Index edged lower for the third consecutive session.  That said, many national markets in Asia, including China, Hong Kong, Taiwan, Korea, and India advanced.  Japan slipped, and notably so did Malaysia.  Mitsubishi Motors remains under pressures amid a further admission today that it has been improperly testing fuel economy of its autos since 1991.  The shares have fallen by around 50% since the scandal first broke last week.  

News that 1MDB missed a coupled payment sparked cross default clauses.  The Malaysian ringgit is off 0.4% today, making it the worst performing emerging market currency.  Although South Korean shares advanced 0.25%, the 2.7% year-over-year growth in Q1 GDP was in line with expectations, but the weakest since Q2 15, and the won is the second weakest emerging market currency today, off 0.25%.

The issue with 1MDB is not one of solvency given its backing by the sovereign.  Rather, it is a technical default that nevertheless highlights ongoing issues with corporate governance.  At the heart of the dispute are bond guarantees issued by Abu Dhabi’s sovereign wealth fund IPIC back in 2015.  Malaysia claims IPIC is obligated to make the bond payments as co-guarantor, while Abu Dhabi claims Malaysia has violated the terms of their agreement and is now obliged to make the payment itself.  Either way, investor confidence in the nation has been damaged further by these developments.      

Europe’s Dow Jones Stoxx 600 is snapping a three-day decline and is up about 0.5% near midday in London.  Only health care and information technology shares are lower among the various industry groups.  Financials are the strongest with a 1.4% rise and energy up a close second.  Several European companies, including Bayer, BP, Orange, Standard Chartered and Swedbank all reported better than expected earnings/revenue data.  Italian and Spanish banks are also doing well.

The euro extended yesterday’s recovery.  A move above $1.1310 would see $1.1330-1.1340 today, but we suspect that the market will turn more cautious now ahead of the FOMC.  Support is pegged near $1.1260.  The dollar marginally poked through the JPY110.70 area we identified yesterday as an important chart area.  News that Japan’s largest pension fund (GPIF) is considering hedging some of its overseas assets back into yen (requires buying yen) seems large to confirm what many have already taken on board–that is much of the Japanese outbound portfolio flows have less direct impact on the yen’s exchange rate because they are hedged.   If JPY110.70 marks the dollar’s near-term downside, the upside extends to the JPY111.30-111.40 area.  

The dollar-bloc currencies are firm.  The Canadian dollar is consolidating within last Friday’s range.  The Australian dollar is trading above yesterday’s highs, but there is little momentum.  Resistance is seen in the $0.7750-$0.7760 area.  The New Zealand dollar fell 31% in the second half of last week but is moved higher yesterday and today.  Resistance is seen near $0.6900.  Most do not expect the RBNZ to cut rates this week, though many see a rate cut in the coming months.

Hungarian central bank meets and is expected to cut rates 15 bp to 1.05%.  The real economy remains fairly robust.  However, deflation has returned with CPI at -0.2% y/y in March and well below the 2-4% target range.  Further rate cuts are seen in the coming months, and other unconventional measures are possible too.  Forint sentiment is also being hurt by an unfolding corruption scandal at the central bank.

Mexico reports March trade and February GDP proxy.  The IGAE is expected to rise 3% y/y vs. 2.3% in January.  Q1 GDP will be reported Friday, which is expected to rise 2.3% y/y vs. 2.5% in Q4.  With inflation still below the 3% target, we do not think Banco de Mexico will hike rates again anytime soon.

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Pacific Ocean President

Interesting opinion piece by Gideon Rachman at the FT:

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Another Century Bond

Via the FT:

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Supply Leads to Higher Yields

Via Reuters and thanks to Steve Feiss  ( @stevefeiss)at Government Perspectives for this one:

* Euro rescue fund selling new 16-year bond

* Some analysts say yield rise more alarming

* Wednesday’s Fed meeting keeps markets wary

By John Geddie

LONDON, April 26 An unexpected bond sale from the euro zone rescue fund kept German yields near five-week highs on Tuesday, as worries grew that a recent rise in yields resembled the prologue to the brutal sell-off in 2015.

The European Stability Mechanism is set to price a new 16-year bond later on Tuesday. The announcement of the deal late Monday coincided with rise in benchmark Bund yields and appeared to catch investors off guard, coming on top of 10 billion euros of sovereign bonds due to be sold this week.

Ten-year German yields were flat at 0.26 percent on Tuesday, after climbing 3 basis points on Monday. That put them at levels not seen since mid-March and further away from a year’s low of 0.075 percent hit a fortnight ago.

With investors also anticipating hawkish signals from the U.S. Federal Reserve at its policy meeting on Wednesday, some analysts wondered whether the recent rise in yields was the start of a more sustained move.

Bund yields sprang from a record low of 0.05 percent to over 1 percent in a matter of weeks last spring, inflicting double-digit losses on many investors.

“We feel a little bit reminded of the spring 2015 episodes when – also without ready explanation – Bund yields started to sell off hard,” said Peter Schaffrik, RBC’s chief European macro strategist.

The rising yields were particularly worrisome with long-term inflation expectations still near record lows, Schaffrik said.

The five-year, five-year forward rate – which is often cited by the ECB and measures what 2026 inflation expectations will be in 2021 – is near 1.40 percent, well below the ECB’s target rate of near 2 percent.

Other strategists, like Mizuho’s Peter Chatwell, said the ESM sale caused the rise in yields.

Yields tend to rise before debt sales as investors make room in their portfolios for the new supply. The deal comes on top of scheduled German and Italian bond sales this week.

In addition, Wednesday’s Fed meeting may could deliver hints of another increase in U.S. interest rates.

While rates are expected to remain unchanged on Wednesday, officials have repeatedly said an increase is possible in June. Markets now price in about one chance in five of a move at the June 14-15 meeting.

“Depending on whether it is an aggressive, neutral or cautious signal that the Fed intends to send out with respect to the June interest-rate meeting, the FOMC get-together might well point the markets in a new direction,” DZ Bank analyst Birgit Figge said. (Editing by Larry King)

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Speculative Frenzy in China

Via Bloomberg:

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Early FX

Via Kit Juckes at SocGen:

<http://www.sgmarkets.com/r/?id=h1058f9e2,16b98adb,16b98adc&p1=136122&p2=49bc7d804aae2b3667ff345185241a2b>

The market watches the Fed and the Fed watches the markets. And the Fed sees rising breakeven inflation rates………….
Central bank policy decisions kick off with Hungary today (exp -15bp), before we get to the FOMC and RBNZ tomorrow evening, then the Central Bank of Brazil and the BOJ on Thursday. The BOJ will probably cut loan rates to banks, and while the RBNZ is unlikely to ease again yet, their bias is to do so at some point, highlighting the contrast between RBA and RBNZ, which keeps us long AUD/NZD for now. The Fed’s the focus of course, despite no rate change being on the cards. The recent drift higher in 10year Treasury yields (to 1.9%) and in breakeven rates (to 1.66%) just might prompt a marginally less dovish message than in March; a possibility which will probably give markets a slightly risk-off sense today.

The story of the last few weeks in FX, has been one of position-reduction across the board. Speculative long dollar positions have been cleared in the CFTC data; yen longs were squeezed on Friday, sterling shorts were hit yesterday. The driver, is the dollar’s correction since January. The first chart shows US portfolio outflows (bond, equity and direct investment) and the dollar’s trade weighted index. The pace of US outflows fell sharply in the second half of last year which help propel the dollar high. We don’t have Q1 data, or more particularly Feb-March data, but these are likely to show flows in particular to EM, resuming with a vengeance. I think this highlights the relative importance on the FX market of sentiment in emerging markets over what’s going on G3. The reaction of emerging market investors to every nudge and nuance of Fed comments matters more than what it means for the US economy directly (not much).

In Q4, the dollar jumped as US investors brought cash home

[http://email.sgresearch.com/Content/PublicationPicture/224550/2]

The second chart shows bond-buying by g3 investors, in US dollars FX moves mess the data up a bit, but at least this way they’re comparable. The story of the last couple of years is of a steady rise in European and Japanese buying of foreign bonds, while US investors have stepped back. I see no change in the trend in capital being pushed out of Europe and Japan by central bank policies. The ERCB and BOJ have done nothing to support their currencies, winning only by default. Again, the key to 2016 moves so far is the return of capital flows to oil and commodity sensitive currencies and to higher-yielding assets overall. And the threat to those come from China’s debt level, and from over-sensitivity to every nuance of Fed communication

Buying of foreign bonds, USD bn, annual sums

[http://email.sgresearch.com/Content/PublicationPicture/224550/3]

All of April’s fall in GBP/NOK has now been reversed in a few days, and if this trade sup through 12, we’ll give up. There is no UK data due today and the market’s likely to remain choppy but even if the thinking behind this trade is intact, the danger of a deeper position-reduction is a concern. The extent of position-reduction everywhere is a concern. USD/CAD and EUR/RUB shorts are sufficient to reflect our cautiously upbeat view of oil prices. AUD/NZD longs remain as do CHF/SEK shorts.

Dollar longs decimated….

[http://email.sgresearch.com/Content/PublicationPicture/224550/4]

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