Biggest holder of American govt debt held $1.16 Tln in Sept.
Japanese holdings fell for second straight month to $1.14 Tln
China’s holdings of U.S. Treasuries declined to the lowest level in four years, as the world’s second-largest economy runs down its reserves to support the yuan.
The biggest foreign holder of U.S. government debt had $1.16 trillion in bonds, notes and bills in September, down $28.1 billion from the prior month, according to U.S. Treasury Department data released Wednesday in Washington and previous figures compiled by Bloomberg. That’s the lowest level since September 2012.
The portfolio of Japan, the largest holder after China, fell for a second straight month, down $7.6 billion to $1.14 trillion. The Treasury holdings of oil-producing Saudi Arabia declined for an eighth straight month, to $89.4 billion.
China’s foreign reserves, the world’s largest stockpile, are down to $3.12 trillion from a record $4 trillion in June 2014 amid support for the currency.
The report, which also contains data on international capital flows, showed net foreign selling of long-term securities totaling $26.2 billion in September. It showed a total cross-border outflow, including short-term securities such as Treasury bills and stock swaps, of $152.9 billion.
Net foreign selling of U.S. Treasuries was $76.6 billion in September and $3.21 billion in equities, while foreigners purchased a net $1.08 billion of corporate debt and $32.1 billion in agency debt, according to the report.
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President-elect Donald Trump has the opportunity to remake the Federal Reserve.
Or does he? And if he does, what would it look like?
Trump has opinions on monetary policy – and they resemble many of his other opinions in that they are flexible. Early in his campaign he praised a low interest rate environment. Later, he accused Federal Reserve Chair Janet Yellen of holding interest rates low to help support President Barack Obama and in the process create a “false” economy. Despite this mix of praise and criticism, Trump Economic Advisor Judy Shelton, claims that his administration will respect the Fed’s independence.
Given Trump’s mixed messages, speculation on the future Fed is just that, speculation. Still, begin with what we know. Trump can nominate two governors to fill open positions on the Fed Board immediately. Yellen’s position as chair expires Feb. 3, 2018. Trump previously stated he would replace her with a Republican. That would be a third spot.
Or would it? Technically, Yellen’s spot on the Board does not expire until 2024. While it would be expected that she vacated the board when she vacates the chair, it is not required (and indeed former Fed Chair Marriner Eccles remained on the board after his chairmanship expired). Yellen could stay on as a thorn in the administration’s side.
In the financial community, questions are being asked about how long Vice Chair Stanley Fischer nor Governor Daniel Tarullo will stay on. The election of Trump could affect their calculus, prompting them to remain until their terms end, in 2020 and 2022, respectively. Governors Lael Brainard and Jerome Powell can hold their seats until 2026 and 2028, respectively. Brainard, obviously, will not be headed to the U.S. Treasury as some had speculated she might under a win by Democratic Nominee Hillary Clinton.
In other words, fears that Trump would be able to remake the board immediately are premature. Indeed, the Fed is structured to prevent just such an occurrence. We forget this because turnover has been high in recent years. But it could slow dramatically, especially if current board members remain to protect the institution’s independence. Trump’s two nominees, one of which may become chair in 2018, would not by themselves form a significant voting bloc even if so inclined to pursue a dramatically different policy than the current Fed.
Under this path, the Fed retains much of it current identity with the possible change of dissents shifting from regional presidents to board members. One could even imagine the chair as one of the dissenters (Eccles was also the last chair to cast a dissenting vote). But overall the Fed’s reaction function, and hence the expected policy path, would remain familiar to market participants.
There are two possible branches from this path. One is that the Fed continues to follow policies consistent with “best practices” in central banking and the administration respects its independence. This is the best of all outcomes.
But a darker branch could emanate from this path. Consider the possibility that the administration becomes enraged that they cannot remake the Fed. This may be the case, for instance, if the Fed deems it necessary to offset impending fiscal stimulus and the inflation it might bring with higher interest rates. Some Fed officials already see room for higher rates in a Republican-controlled government.
The administration, aided by a friendly U.S. Congress, might in this case pursue legislative options to bring the Fed more in control of the executive branch, thereby curtailing the Fed’s independence. The central bank was made by congress, and can be unmade by congress. Indeed, the Fed will almost certainly face additional efforts to rein in its independence via a revival of “Audit the Fed” bills in any event. In the worst case scenario, the Fed as we know it could become a completely different organization that does not adhere to central banking best practices.
But what policies would such a Fed pursue? Consider the path that Trump does get to remake the Fed by either taking advantage of upcoming resignations of Board members or in the medium term by legislative action. Typically, we would think such an outcome would be inflationary. If the administration fears a monetary offset, it would pick pliable board members who are willing to hold rates low, thereby allowing the Fed to overshoot its current mandates. The future might then look like the 1970s.
Source: Bloomberg
Yet another direction is possible. The “Audit the Fed” movement generally believes monetary policy remains too loose. For example, the suggestion of forced application of a Taylor Rule, or even just requiring the Fed to explain deviations from the Taylor Rule, are a reaction to the persistently low interest rate policies pursued in the post-Great Recession world. If the administration continues to pursue this logic, it may be that a Trump Fed would be a so-called “hard money” Fed.
There are two potential challenges with a “hard money” Fed. The first is that it would remove financial accommodation too quickly. This does not seem likely in the near term; it would take until 2018 at the earliest until the Fed could be remade either through attrition or legislation.
The second challenge, however, is more disconcerting. Trump’s characterization of the current economy as “false” suggests a sympathy for the Austrian school of economics, in which short-term monetary benefits are believed to come with longer-run costs. The “false” economy fosters asset price bubbles that pop and end in an even deeper recession than would otherwise be the case.
A Fed packed with Austrian economists would likely react slowly to a recession and resist extraordinary policies such as quantitative easing. They would also likely attempt to tighten policy soon after the recession ended. They would, in other words, tend toward a liquidationist approach that risks turning the Great Recession into another Great Depression.
Finally, note that regulatory policy — not monetary policy — faces more immediate impacts from the new administration. One of Trump’s nominees would most likely serve in the currently vacant position of vice chair for supervision. This would give Trump the ability to exert influence on the regulatory environment facing the financial industry. That the nominee will likely possess a business-friendly attitude.
Bottom Line: There are three possible directions for monetary policy. The best outcome would be continuity, or a Fed that remains independent and follows current best practices supported by personnel chosen for their expertise. Alternatively, the Fed— either through personnel attrition or legislation — becomes politicized. That path leads to either a loose money Fed or a hard money Fed. The former sets the stage for inflation, the latter, deep, long, and painful liquidationist recessions. My expectation would be the former. In any case, Trump’s first marks will be felt on regulatory rather than monetary policy.
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Via Stephen Stanley at Amherst Pierpont Securities:
The PPI was much weaker than expected in October, as the headline figure was flat and the core component posted a 0.2% decline. However, when I delved into the nitty-gritty details, it was hard to put a finger on any meaningful trends in the data that tell us much about the broader inflation picture. The core reading was pushed down by declines in a hodge-podge of categories, but nothing that will impact tomorrow’s CPI. Meanwhile, the food and energy components of the PPI did about what they were expected to do, food was down while energy was up.
I am not tweaking my CPI forecast in any meaningful way. I expect a 0.4% rise in the headline figure, in line with the consensus (though I think there is a very real risk of “only” a 0.3% advance). The October CPI rise was most likely driven in large part by energy, which may register an increase of somewhere around 2½% on a seasonally adjusted basis. By the way, my forecast for October would likely take the year-over-year advance in the headline CPI up to 1.7%, the highest we have seen in 2 years. 2%, here we come. Meanwhile, the core CPI probably increased by 0.2% last month, bouncing back after September’s 0.1% rise.
For what it’s worth, as weak as the PPI was, the components of the PPI that feed through into the core PCE deflator were not especially soft. For example, the medical care piece of the PPI was down, but the particular indices that feed into the PCE deflator were not. In any case, broadly, the downside surprise in the PPI do not change my view that consumer price inflation is firming and will continue to do so over the next few months.
Via Stephen Stanley at Amherst Pierpont Securities::
Industrial production was flat in October, weaker than expected. Manufacturing output advanced by 0.2%, not far from expectations, but a 2.6% drop in utilities, presumably due to warmer-than-usual weather, dragged the aggregate down. There were big offsetting revisions (up in August and down in September). In assessing the underlying state of the manufacturing economy, I would point to the manufacturing ex motor vehicles piece. It was up 0.1% in October and is essentially flat over the past 6 months. This feels about right. The worst of the effects of the late 2014/early 2015 dollar appreciation are behind us, but the sector is still just treading water or maybe slightly better.
We will see how much of a game changer the new Administration can be, but for the moment, this economy will continue to be driven mainly by consumers. As we move into 2017, I wouldn’t be surprised to see business investment finally roused out of its long slumber, but that will depend on what policies are enacted (as well as getting rid of the uncertainty associated with the various policy question marks).
Broad loan-to-deposit ratio at 80% for top 50 China banks: S&P
China’s credit reliance could worsen NPL problem, Fitch says
Add another credit indicator to the financial warning signs flashing in China.
The adjusted loan-to-deposit ratio, which includes a range of off-balance sheet items and is an indicator of the banking system’s ability to weather stress, climbed to 80 percent as of June 30, according to S&P Global Ratings. For some smaller lenders, the ratio has already topped 100 percent, S&P estimates.
S&P’s adjusted measure is rising much faster than the official loan-to-deposit ratio as banks pile into off-balance sheet lending, sidestepping government efforts to rein in credit. At the current pace, overall credit could surpass deposits on an adjusted basis within a few years — a level that would give China little leeway to stave off financial turmoil, S&P says.
“The next two to three years is a crucial window for China to rein in the ratio, or we will be in serious trouble,” said S&P’s Beijing-based director Liao Qiang. “Reaching 100 percent doesn’t mean a crisis will ensue immediately, but it shows China’s entire deposit base is used up and any loss of confidence from savers will severely destabilize the banking system.”
Even after S&P’s adjustments, the ratio in China remains lower than in many other countries. Yet the country’s rapid loan growth, diminishing return on credit and rising bad debts combine to make deposits a particularly important buffer against future financial distress, according to Liao.
Cap Abolished
Deposit-taking has formed a cornerstone of China’s banking system as it expanded in tandem with the economy, providing lenders with a stable, low-cost funding base to fuel credit growth. Chinese households and companies hold $22 trillion of bank deposits, more than anywhere else in the world. That cushion has made lenders less dependent on short-term wholesale funding than banks elsewhere.
For two decades, China imposed a cap that limited loans to a maximum 75 percent of deposits as part of measures to contain risks. That ceiling was abolished in October 2015, in part because it was seen as a blunt tool that encouraged illicit deposit-hoarding and moving loans off balance sheets. The official loan-to-deposit ratio among Chinese lenders stood at 67 percent at the end of September, up only slightly from 66 percent when the cap was lifted.
But that measure has become less relevant as Chinese banks — especially small and mid-sized ones — have stepped up shadow lending and sales of savings-like offerings called wealth management products, which don’t get carried on their balance sheets. The shift is captured in S&P’s adjusted ratio, based on the country’s 50 largest banks, which stood at 70 percent in 2013 and rose by 10 percentage points over the following two years.
Adjusting Ratio
S&P came up with its adjusted ratio by treating all loan-like assets and corporate bond investments on banks’ balance sheets, as well as corporate credit made off-balance sheet, as loans. On the other side of the equation, it added wealth management products to deposits.
Jonathan Cornish, Hong Kong-based head of bank ratings for North Asia at Fitch Ratings, said adjusting the loan-to-deposit ratio to capture items like interbank borrowing, wealth management products and other assets can contribute to “a more comprehensive assessment of liquidity across the system and for individual banks.” Fitch doesn’t calculate its own adjusted ratio, he said.
A nine-year credit expansion meant to protect economic growth has prompted numerous warnings of impending financial trouble. China’s debt-to-gross domestic ratio reached 247 percent after expanding at the fastest pace among Group of 20 nations, according to economists Tom Orlik and Fielding Chen at Bloomberg Intelligence; such sharp increases have been known to trigger crises in other countries, they say.
“Targeting economic growth and continued heavy reliance on credit to support growth means that economic leverage is unlikely to abate soon,” said Cornish. “This will increase the risks for the financial sector.”
Wholesale Funding
When loans exceed deposits, banks are forced to rely on wholesale funding that can quickly vanish during market dislocations, Cornish said. In such an event, the central bank — which sets benchmark rates for deposits as well as loans — would be forced to raise interest rates to draw in deposits, according to Liao. That, in turn, would make it harder for companies coping with slower economic growth to repay loans, putting further stress on banks, he said.
The fragile nature of interbank funding was revealed in June 2013, when a credit crunch drove the one-day repurchase rate to a record and the central bank was forced to inject cash amid rumors of lenders missing payments. The episode exposed “deficiencies” in commercial banks’ liquidity management, the chairman of the banking regulator said at the time.
Some banks are already pushing into danger territory. Bank of Jinzhou Co.’s adjusted loan-to-deposit ratio stood at 153 percent at the end of 2015 and the lender got 43 percent of its funding from interbank borrowings last year, S&P estimates. At mid-sized Industrial Bank Co., the broadly adjusted ratio was 115 percent while 39 percent of its funding came from the interbank market, according to S&P.
Industrial Bank declined to comment. A press officer at Bank of Jinzhou didn’t respond to phone calls.
Wang Tao, head of China economics at UBS Group AG, in April compiled her own adjusted loan-to-deposit ratio for China and came up with an estimate closer to 90 percent. “Once the LDR visibly exceeds 100 percent, banks may become more vulnerable to credit market sentiment,” she wrote in a report at the time.
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Defaults are rising in a key corner of the commercial real-estate debt market just as borrowing costs are set to jump, raising the likelihood of a slowdown of the $11 trillion U.S. commercial property sector in 2017.
A financial crisis-era regulation is about to take effect that is expected to make some commercial real-estate borrowing more expensive and complicated, analysts said.
At the same time, interest rates have increased since the election of Donald Trump as the nation’s 45th president last week and seem poised for a sustained rise from recent historic lows, which would further squeeze an industry built on borrowed money.
“I can paint a picture that it could be disastrous, with runaway inflation and high interest rates,” said Charlie Bendit, co-chief executive of Taconic Investment Partners LLC, at a New York industry luncheon last week.
The worries raise fresh concerns for the commercial property market as it enters its eighth year of expansion.
Already, landlords are battling a slowdown in sales and rising vacancy rates of multifamily housing units across the U.S. and of office space in Houston, Washington, D.C., and other big markets. Commercial property sales volume was down 8.6% in the first nine months of 2016 to $345.4 billion, according to Real Capital Analytics.
Now defaults are on the rise as well. More than 5.6% of some $390 billion worth of commercial property mortgages that have been packaged into securities was more than 60 days late in payment in September, according to Moody’s Investors Service. That was up from a 4.6% delinquency rate earlier this year.
The culprit: loose lending before the financial crisis. Ten-year loans issued in 2006 and 2007 are now coming due, and many borrowers aren’t able to pay them off despite rising property values.
In all, Morningstar Credit Ratings LLC predicts borrowers won’t be able to pay off roughly 40% of the commercial mortgage-backed securities loans coming due next year. Suburban office properties and shopping centers are being hit particularly hard, said Edward Dittmer, a Morningstar vice president.
“We’re seeing a lot of stress,” Mr. Dittmer said.
Consider the Skyline office complex in Fairfax, Va. Vornado Realty Trust financed the property in 2007 with a $678 million mortgage that was converted into bonds.
Vornado was forced to restructure the loan in 2012 after the portfolio ran into trouble. Earlier this year, Vornado for a second time notified the loan servicer that “cash flow will be insufficient to service the debt,” according to a regulatory filing. A Vornado spokesman declined to comment.
Similarly, a venture including New York investor Jacob Chetrit that owns a 1.2-million-square-foot office property on Seventh Avenue in Manhattan is negotiating an extension of a $136.9 million loan made in 2006. The space is about 15% vacant.
Victor Gerstein, a lawyer working for the venture, stressed that it is current in its monthly debt service and that there hasn’t been a default. The owners are moving to increase the building’s occupancy and “will be very well positioned to get a very attractive loan in the near future,” Mr. Gerstein said.
Adding to the market’s worries are new rules that go into effect on Christmas Eve under the Dodd-Frank regulatory overhaul requiring issuers of commercial mortgage-backed securities to keep at least 5% of the securities they create.
The so-called risk-retention rules likely will make borrowing more costly and complicated, raising the chances that some property owners won’t be able to refinance loans from the boom years.
“You couldn’t have planned worse timing,” said Tad Philipp, director of commercial real-estate research at Moody’s.
Mr. Trump promised during his campaign to repeal Dodd-Frank, but analysts said that could take a long time and that certain provisions might remain on the books, including risk retention.
To be sure, banks, insurance companies and other finance firms have picked up some of the slack from the shrinking commercial mortgage securities business. More than half of the bonds issued in 2005 and 2006 for New York properties were refinanced by such lenders, according to a report earlier this year by CrediFi, a real-estate data and analysis firm.
But there are other problems flaring up as well. Regulators earlier this year warned that vacancy has been growing in the rental apartment market, and that higher interest rates in the next two years could damp price growth there.
“They’re flashing a yellow light over the market,” said Ely Razin, CEO of CrediFi.
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The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2016 is 3.3 percent on November 15, up from 3.1 percent on November 9. The forecast of fourth-quarter real personal consumption expenditures growth increased from 2.6 percent to 2.9 percent after this morning’s retail sales report from the U.S. Census Bureau.
US: Robust Retail Sales Give the Fed Additional Confidence to Move in December
·Retail sales increased by 0.8% m/m in October, surpassing the market consensus for a more moderate 0.6% m/m gain. The details were equally strong, with gains in 11 of the 13 major subcomponents while core retail sales mirrored the 0.8% m/m advance in the headline series against market expectations for 0.4% m/m.
· In addition to the strong numbers reported for October, September retail sales saw upward revisions that added 0.4 percentage points to headline retail sales while the control group saw sales revised from 0.1% m/m to 0.3% m/m.
· Despite the strong upbeat tone of the report, this will have limited implications for the Fed given that markets had already priced in a 90% probability of a move in December prior to the release.
Headline retail sales rose by 0.8% m/m in October, beating the market consensus for a 0.6% m/m gain and providing a very strong start to the fourth quarter. Sales increased in 11 of the 13 major components, with gasoline stations (+2.2%), motor vehicles (+1.1%) and building materials (+1.1%) leading the advance. Higher gasoline prices were partially responsible for the increase in sales at the pump, while the pickup in retail auto sales was foreshadowed by a sizeable gain in motor vehicle sales during the month. Upward revisions to September retail sales added to the upbeat tone of the report, with an initially reported 0.6% m/m gain revised higher to 1.0% m/m while sales in the control group were revised from 0.1% m/m to 0.3% m/m, which raises the likelihood of upward revisions to Q3 consumption.
Core retail activity was equally upbeat, with sales in the control group (ex. autos, gas, food, building materials) up 0.8% m/m (market: 0.4% m/m) while sales were up by 0.6% m/m when excluding only autos and gas (market: 0.3% m/m). Core retail sales were driven by gains in the miscellaneous category (+2.4%), health/personal care stores (+0.8%), clothing sales (+0.6%) and the non-store category (+1.5%), which captures online retail sales. Furniture sales fell by 0.9% m/m, providing a partial offset.
Overall, this report exceeded expectations on all fronts and will present the data-dependent Fed with additional evidence to go forward with a hike in December. However, with markets already attaching a >90% probability of a December rate hike, this report will do little to strengthen expectations further. Looking forward, we believe details on potential fiscal stimulus and their implications for the pace of tightening will have a greater impact on markets.
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The Long Bond continue to outperform its yield curve cousins. At the close of business last Thursday I had marked 5s 30s at 140.3. In late trading yesterday I marked it at 134.7 and this morning it rests at 131.0. Similarly, 10s 30s closed last week at 81.1 and opened yesterday at 76.2, That spread trades at 73.6 this morning.
I watch 10 year US vs several overseas instruments and that spread has cheapened significantly recently. Prior to the election 10 year US vs Bunds was trading in the high 160s. That spread is 191 this morning. Ten year Gilts are also at the wide end of their range vs US.They trade 93 rich to US this morning which places them back near the wide end of a range which prevailed post Brexit. Ten year Italy and ten year Spain had significant pops overnight as each outperformed their Treasury counterpart by 11 and 13 basis points respectively.
In overnight trading dealers report chunky buying of 10s and 30s by end users in Asia. The same clients were better sellers of the 7 year sector.
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Mark Carney said arguments by politicians that loose monetary policies in the U.K. and elsewhere have widened inequality miss the mark.
“The focus on monetary policy is a massive deflection exercise,” the BOE governor told lawmakers at a Parliamentary hearing in London on Tuesday. “It’s very important to distinguish the stance of monetary policy and the reasons why global interest rates are low,” he said, adding that “inequality is caused by much more fundamental factors.”
Central banks around the world have been criticized for keeping interest rates at record lows since the global financial crisis, undermining savers, weakening banks and widening pension deficits. U.K. Prime Minister Theresa May told delegates at the Conservative Party conference last month that loose monetary policy had had some “bad side effects” as people with assets got richer while those without have suffered. She said “a change has got to come.”
Her comments came after the BOE loosened policy further in August following the shock Brexit vote as they prioritized supporting growth. Recent data has tilted the balance toward containing cost increases as the bank and economists see inflation breaching the 2 percent target next year. Earlier this month BOE officials shifted their guidance to say policy could head in either direction next after the weaker pound starting fanning inflation.
“Rates could go up, could go down,” Carney reiterated to lawmakers on Tuesday.
Bloomberg’s most recent survey, conducted from Nov. 4-11, found the median forecast of economists is for the BOE’s main rate to stay at 0.25 percent until at least the first quarter of 2019, just months before Carney is due to stand down as governor.
In October, a majority of policy makers expected another loosening this year following August’s stimulus measures. Officials dropped that language last week when they announced no change in their stance and said they now have a “neutral bias” going forward.
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