Across the Curve

Goldman Sachs on Appreciating Dollar and the FOMC

October 31st, 2016 6:29 am

Via Bloomberg:

The trade-weighted broad dollar index, which tracks the U.S. currency versus 26 of the country’s biggest trading partners, has rallied 3.1 percent since its lows Aug. 18. At the same time, the S&P 500 Index has slipped just 2.8 percent in the same period, while crude has risen 0.5 percent. That pales in comparison to market moves from mid-October 2015 to early January, when the trade-adjusted dollar gauge gained more than 5 percent. The Fed last raised rates in December.

FBI Impact

The Mexican peso rose 0.2 percent to 18.9394 per dollar as a CBS/YouGovsurvey showed support for Democratic candidate Hillary Clinton holding firm after the Federal Bureau of Investigation said that it is re-opening an inquiry into her use of private e-mail while secretary of state, less than two weeks before the U.S. presidential election.

The peso has tended to weaken on evidence Republican nominee Donald Trump’s electoral prospects are improving. It fell 0.8 percent Friday after FBI Director James Comey’s announcement.

“Clinton is still closer than Trump in securing the 270 electoral college votes needed to win the presidency,” Philip Wee, a senior currency economist at DBS Group Holdings Ltd. in Singapore, wrote in a note to clients. “Even so, the market is wary of a Brexit-like outcome at the presidential election,” he said referring to the shock decision of British voters in June to leave the European Union.

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FX

October 31st, 2016 6:18 am

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

• In the US, there are three drivers: politics, FOMC meeting, and the employment report
• The eurozone reports the three most important macroeconomic data points:  GDP, inflation, and unemployment
• Of the four central banks that meet, the Bank of England is the most likely to change policy
• The BOJ recently adopted a new policy framework but this week’s meeting is too soon to expect changes
• EM likely to remain volatile ahead of the FOMC meeting and US elections; individual country risk remains important

The dollar is mostly firmer against the majors.  The Aussie and the Loonie are outperforming, while the euro and the yen are underperforming.  EM currencies are mixed.  ZAR and MXN are outperforming while the CEE currencies are underperforming.  The rand recovered on reports that fraud charges against Finance Minister Gordhan will be dropped.  MSCI Asia Pacific was up 0.3%, even with the Nikkei falling 0.1%.  MSCI EM is down 0.1%, with Chinese markets falling 0.1%.  Euro Stoxx 600 is down 0.5% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 1 bp at 1.84%.  Commodity prices are mostly lower, with Brent oil down 0.3%, copper down 0.1%, and gold down 0.1%.

The week ahead features four central bank meetings, the PMIs that begin the monthly cycle of high frequency data, and the US employment report.  Here we sketch out the main impulses from the US, EMU, UK, Japan, Canada, and Australia.  

In the US, there are three drivers: politics, FOMC meeting, and the employment report.  First, as we saw before the weekend (despite most polls and predictive markets showing Clinton with a large lead), investors realize that as unlikely as a Trump victory may be, the impact could potentially be huge.  In addition, even though most polls showed the UK referendum was a close call, many insist that polls underestimate the strength of insurgency movements.  Barring a specific “smoking gun,” we do not expect the re-opening of Clinton’s email investigation to significantly alter voter preferences.

The probability of a Trump victory had already begun stabilizing and recovering a little.  A few swing states seemed fluid and may have swung toward Trump, but weekend polls suggest not by enough to change the likely electoral college outcome.  The odds also favor the Democrats taking the Senate by a slim majority.  The Democrats had little chance to garner a majority in the House of Representatives, and this does not appear to have changed either.  

The reaction to the news in thin pre-weekend activity gave investors a sense of what to expect if our assessment is wrong.  Speculators will likely sell the Mexican peso, and the Canadian dollar will underperform.  The euro and yen may be among the biggest beneficiaries.  Stocks will sell-off and bonds will rally.  

Second, there is practically no chance that the Federal Reserve changes policy at this week’s FOMC meeting.  A move this close to the election would be unprecedented.  The Fed’s forecasts (dot plot) will not be updated, and there is no press conference scheduled.  While these obstacles are not impossible to overcome, they are formidable.  Moreover, the hawks on the Fed recognize this and do not appear to be pushing for a hike now.  But that does not mean that there won’t be any dissents.  To the contrary, we expect 2-3 dissents.  

The FOMC statement is unlikely to change substantively.  There will be some minor tweaks to recognize the recent data and the improved growth.  Last October, the FOMC statement pre-committed itself to a hike in December.  We don’t think the Fed has to go to this extreme now.  The market is pricing in a 70%-75% of a hike before the end of the year.  A year ago the odds were around half as much.  The Fed can indicate that the bar to a hike is low, needing only continued improvement in the data and no major negative shocks.  

Third, the US employment data is one of the most important high frequency economic reports.  It often sets the tone for the economic data for the entire month, and the Federal Reserve has shown that it is sensitive to the monthly prints.  We expect job growth slowed a little, but it will not challenge the December hike scenario, especially if we are right about the FOMC guidance and the economic threshold for the second hike in two years.  We expect that the proximity of full employment and the emerging skills shortage will see wage pressures continuing to increase.  

As seen with the initial estimate of Q3 GDP (at 2.9%, it was stronger than most forecasts but there was a little reaction), we expect little sustained reaction to the employment data.  Barring a significant surprise, it will not impact policy expectations, and there the Fed will see another job report before the December meeting.

The eurozone reports the three most important macroeconomic data points:  GDP, inflation, and unemployment.  Eurozone growth in Q3 came in as expected at 0.3% q/q, with the year-over-year pace steady at 1.6%.  This is close to what economists regard as a trend.  The preliminary estimate of October CPI is showed a continued gradual move higher (0.5% vs. 0.4% in September).  The core rate was steady at 0.8%.  Data is probably not strong enough to counter notions that the ECB extends its asset purchases when it meets in December.  The unemployment rate (due out Thursday) may slip to 10.0% from 10.1%.  

The main weight on the euro has been renewed focus on the divergence of monetary policy. This is not simply a function of high frequency data.  Both sides of the policy divergence are in play.  There is a very strong likelihood that the ECB extends its asset purchases beyond next March.  Barring a significant downside economic surprise or a new global shock, the Fed is likely to hike rates in December.  The euro has found support near $1.0850.  There is scope toward around $1.1050 within a near-term consolidative/corrective phase.  

Of the four central banks that meet, the Bank of England is the most likely to change policy. There are a few economists that expected the MPC to deliver a 10-15 bp rate cut.  We expect no change in policy.  Carney has been clear about his distaste for negative rates.  This means that there is scope for one more and a small one at that.  The does not have to be a hurry to deliver it, and it probably wouldn’t have much economic impact in any event.  Although the economy continues to show little impact from the late-June decision to leave the EU, the growth risks are on the downside and inflation risks are on the upside.  Carney was also clear.  Sterling is not a target of policy, though that does not mean the BOE is indifferent to it.  Since the flash crash, it has begun stabilizing at lower levels against the dollar and the euro.

The November inflation report will be issued at the conclusion of the BOE meeting.  It has taken on new importance amid speculation that Carney may use that forum to announce his plans.  There is much speculation in the UK press that Carney may resign.  The ostensible reason is the broad criticism from government and several MPs.  We suspect that what is really at stake is whether Carney signs on for another full term (2021) or keep to the initial agreement to leave in 2018.  Nevertheless, if we are wrong and Carney does step down early, investors will see this as a result of the encroachment on the central bank’s independence, and will likely take sterling lower.  

Ahead of the BOE meeting, the UK’s three PMIs (manufacturing, construction, services) will be released.  Sterling is not being driven by the high frequency data, but by the prospects of the UK losing access to the single market.  The economy is presently growing near-trend, and the expected softening of the PMIs will likely be minor.  

The Bank of Japan recently adopted a new policy framework.  This week’s meeting is too soon to expect changes.  Two of the 43 surveyed by Bloomberg expect the BOJ to take the negative deposit rate, which applies to a relatively small fraction (compared with other central banks) of reserves, to minus 20 bp.  There is some speculation that the BOJ could push out again when it will achieve its inflation target.  We argue the BOJ may be better served to adopt the practice of other major central banks and have a medium-term inflation target, rather than a date-specific target.   September IP and retail sale data reported today were disappointing.

Canada’s Fall Economic Statement on November 1 may not appear on many economic calendars, but it is an important input to monetary policy.  The central bank’s recent cut in its GDP forecasts (to 1.2% this year from 1.4% and 1.8% next year from 2.2%) may induce the government to provide more fiscal stimulus, in addition to details for its infrastructure spending.  Governor Poloz acknowledged that easing was actively discussed at the last Bank of Canada meeting.  If the government does not provide more fiscal support, such discussions will likely continue.  

Canada is one of the only high income countries that reports monthly GDP figures.  Shortly before the Fall Economic Statement, the August GDP estimate will be reported.  A small gain (~0.1%-0.2%) is expected, owing primarily to manufacturing and wholesale trade.  Mining (including oil and gas) recovered from the spring wildfires earlier and growth has flattened.  Still, the Bank of Canada’s monetary policy review earlier this month offered a modest 3.2% Q3 GDP forecast.  If the economy does expand by 0.2% in August, the forecast would seem to anticipate a weaker September.

At the end of the week, Canada, like the US reports October jobs.  The outsized 67.2k headline gain in September was misleading.  It was three-quarters part-time jobs.  Job losses in the service sector are expected to produce an overall 10k job loss in October.  The unemployment rate is expected to hold steady at 7.0%.  At the same time, Canada reports its September trade balance.  The trade performance is gradually improving, and the trend is likely to remain intact.   We do not see an immediate impact from the free-trade agreement with the EU.  

The Reserve Bank of Australia meets on November 1.  Some economists expect a rate cut, but we do not.  Former Governor Stevens and his successor Lowe indicated that the RBA would not respond mechanically to the undershoot of inflation. They have indicated that provided growth and the labor market do not deteriorate, the RBA is not in anxious about cutting rates further from the record low levels.  The housing-related data remain firm.  The Australian dollar remains resilient even though $0.7700 ceiling is proving formidable.  Australia’s relatively high-interest rates and AAA rating are important attractors.  The rally in industrial metals and better terms of trade are frosting on the fundamental cake.

EM ended last week on a soft note but is trying to gain some traction as this week starts.  FBBI news Friday hit MXN particularly hard, but it has recovered since.  Markets are likely to remain volatile ahead of the FOMC meeting this week as well as November 8 elections in the US.  China PMI readings will provide the first snapshot of the mainland economy in Q4, though markets remain fairly comfortable with yuan weakness.

Individual EM country risk remains important.  The rand is gaining today on reports that fraud charges against Finance Minister Gordhan will be dropped but we do not think this saga is over.  He may still be charged on matters related to the alleged “secret unit” at the SARS.  Brazil budget data is likely to provide a reminder of how bad fundamentals remain.  Turkey is expected to report a higher inflation print, which comes even as the lira trades at record lows.  Lastly, Mexico is expected to report a weak Q3 GDP reading, and sentiment is likely to remain vulnerable.   

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Betting on Higher Vol

October 31st, 2016 6:05 am

Via WSJ:

Wall Street’s bet against fear, a big winner this year, is starting to wane.

The relative calm in the U.S. stock market has made wagering on a decline in the CBOE Volatility Index, or VIX, a popular trade for much of this year. The two biggest exchange-traded funds that short volatility, as betting on a decline in the VIX is known among traders, are up 46% this year. Hedge-fund bets that the VIX will decline reached a record in September, according to data from the Commodity Futures Trading Commission.

“These strategies have had a pretty significant up year,” said Rocky Fishman, equity-derivatives strategist for Deutsche Bank. “Those positions make money most of the time, but they lose money very quickly when volatility rises.”

Lately, investors seem increasingly worried about that outcome.

The VIX, a measure of traders’ expectations for market swings, climbed 5.4% Friday after the Federal Bureau of Investigation announced that it was reviewing new evidence in the investigation of Democratic presidential candidate Hillary Clinton’s email server, a probe that the FBI had closed this summer. The news sparked worries about a surprise election outcome after polls had shifted toward Mrs. Clinton in recent weeks and traders had been positioned for a muted response to the outcome of the Nov. 8 vote.

Even before then, hedge funds had been paring their short bets. Since early September, short bets on volatility futures are down by 21%, CFTC data show. And flows into and out of exchange-traded funds indicate expectations for greater volatility. In the month ended Oct. 25, $822 million flowed into ETFs that profit when volatility rises, while $326 million has been pulled out of the shorts, according to FactSet.

The adjustment could reflect concerns about two upcoming potentially market-moving events—the U.S. presidential election and a possible interest-rate increase. The Federal Reserve isn’t expected to raise rates at its November meeting this week, but may send a signal about its plans for December.

The interest in trading volatility also shows the rise of the VIX as an asset class. Since the VIX tends to soar when stocks tumble, betting on volatility to rise—called going long—has emerged as a popular way to protect portfolios.

The advent of volatility ETFs in 2009 increased the appeal. The funds can be bought and sold like any other stock, allowing investors to bet on the VIX without trading futures and options directly.

Using volatility as portfolio protection comes at a cost. Because uncertainty increases with time, the further away an anticipated downturn is, the more expensive it is to insure against. That means VIX futures for this month are typically cheaper than next month’s contracts, which are cheaper than the month after that, and so on.

That forces most buyers to pay a premium to maintain their insurance. It is especially draining for the long exchange-traded funds that seek to profit from rising volatility. Some of the funds maintain their exposure through a combination of this month’s VIX futures and next month’s. Every day, they sell contracts that are nearing expiration and buy contracts for the following month. Put simply, the ETFs that are long volatility sell low and buy high, almost every day. The largest such ETF, the iPath S&P500 VIX Short-Term Futures ETN, has declined 58% this year.

This creates an opportunity for the hedge funds and short ETFs that sell the insurance and take the opposite side of the trade. They will profit when the VIX declines. But even if volatility is relatively flat—and sometimes even if it rises—sellers still take their cut, buying low and selling high. That premium is why the trade has been so reliably profitable.

Shorting volatility has drawn interest in recent years because unconventional central-bank policies have calmed markets, enticing investors to try to boost returns through the trade.

But shorting the VIX can amplify losses in a stock-market downturn. For every percentage-point gain in volatility futures, hedge funds stand to lose $163 million on short bets, CFTC data show. The day after the U.K.’s surprise vote to exit from the European Union, the S&P 500 fell 3.6% and the VIX spiked 8.5 points. The two biggest short-volatility ETFs lost a quarter of their value, although the losses later reversed.

Systematic volatility sellers aim to collect the premium, and take measures to protect themselves against such brutal reversals. The San Bernardino County Employees’ Retirement Association uses options to buffer downside exposures, said Don Pierce, the chief investment officer.

“I worry every day about my positions and I worry about my hedges, but I believe in a systematic approach so you don’t have to make decisions in the middle of a market panic,” said David Pedack, a portfolio manager at Russell Investments.

The severity of the post-Brexit losses came as a shock to Bryan Sullivan, chief executive officer and managing partner of WealthSource Partners LLC. WealthSource, an investment advisory firm in San Luis Obispo, Calif. that manages more than $600 million, bought 76,000 shares of the ProShares Short VIX Short-Term Futures ETF shortly before the vote. It was a new strategy for WealthSource, which saw its investment plummet 26% in hours, Mr. Sullivan said.

“Brexit was a good example where we got hammered for a few weeks,” Mr. Sullivan said. “It was a big question: Are we sure we want to be doing this? We had some deep conversations about it, but we decided let’s wait this out.”

The ProShares ETF recovered its post-Brexit losses within a month, and is now 25% higher than it was the day of the vote. Mr. Sullivan said, though, that he has since bailed out because of worries about rising volatility amid election-year uncertainty.

“A lot of things could drive volatility higher through the end of the year,” Mr. Sullivan said. “So being short is not necessarily the right place to be.”

Write to Asjylyn Loder at [email protected]

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No Production Accord at OPEC

October 31st, 2016 6:00 am

Via Bloomberg:

Money managers increased bets on lower West Texas Intermediate oil for the first time in five weeks as Iraq joined Iran, Nigeria and Libya in seeking to be excluded from OPEC’s first agreement to reduce output in eight years. The deal was reached in Algiers on Sept. 28 and sent futures climbing. But internal disagreements over how to implement the cuts prevented an accord to secure the cooperation of other major suppliers this weekend in Vienna.

The Organization of Petroleum Exporting Countries agreed in the Algerian capital last month to trim production to a range of 32.5 million to 33 million barrels a day, and is due to finalize the deal at a Nov. 30 summit in Vienna. The accord helped push oil prices to a 15-month high above $50 a barrel earlier this month, although they have subsequently fallen amid doubts the group will follow through on its pledge. More than 18 hours of talks over two days in the Austrian capital this weekend yielded little more than a promise that the world’s largest producers would keep on talking.

“It might be impossible for OPEC to come to an agreement on making cuts,” said Mark Watkins, the Park City, Utah-based regional investment manager for The Private Client Group of U.S. Bank, which oversees $136 billion in assets. “The best that can realistically be expected is a freeze. Iran, Libya and Nigeria will probably be allowed to raise production to pre-disruption levels.”

OPEC signaled last month that Iran, Nigeria and Libya would be spared from any cuts, due to sanctions and security issues that have curtailed their output. Iraq, citing its war with Islamic State militants, wants similar treatment.

“There’s plenty of time for the market to shift, and perhaps shift again before the meeting on Nov. 30,” said Tim Evans, an energy analyst at Citi Futures Perspective in New York. “Even the official OPEC meeting might not answer all the questions we have. We’ll need additional time to evaluate compliance with the agreement and see if it has any actual impact on the market.”

Shifting Market

In addition to increasing short positions in WTI in the week ended Oct. 25, hedge funds reduced their long positions, or wagers that prices will rise, Commodity Futures Trading Commission data show. The resulting net-long position decreased 8 percent.

WTI dropped 0.7 percent to $49.96 a barrel in the report week. Prices slipped a second day on Monday, dropping 0.4 percent to to $48.52 a barrel as of 12:09 p.m. Singapore time.

“Right now it’s not looking good but these things always go right down to the wire,” said Mike Wittner, head of oil-market research at Societe Generale SA in New York. “There’s an awful lot at stake here. If they don’t reach an agreement oil will fall like a rock and be testing $40 in no time.”

OPEC’s 14 members pumped a record 33.75 million barrels a day in September, according to Bloomberg estimates. Iraqi production climbed to a record 4.54 million barrels a day last month while Iranian output rose to 3.63 million, the highest since June 2011.

“OPEC total production might still be rising,” Evans said. “It looks like there’s some added output in both Nigeria and Libya, so we might find out that OPEC production reached another record high in October. That would underscore the challenge OPEC faces and ratchet up the pressure.”

Money managers’ short position in WTI climbed 0.4 percent to 56,563 futures and options, the CFTC said. Longs fell 6.6 percent, the most since August.

In fuel markets, net-bullish bets on gasoline rose 1.6 percent to 40,730 contracts, the highest since March 2015, as futures slipped 0.4 percent in the report week. Wagers on higher ultra low sulfur diesel prices climbed 46 percent to 12,356, the highest in two months. Futures declined 0.4 percent.

OPEC is seeking the backing of non-members for production cuts to support oil prices. Russian President Vladimir Putin suggested in Istanbul on Oct. 10 that his country was prepared to reduce supply, only to add two days later that it would refrain from further increases at most.

“I still think there’s going to be an agreement because there’s too much at stake,” Wittner said. “If there’s no progress in the short term I think you will see Saudi Arabia, Russia, Iran and Iraq get together and thrash out a deal. The four countries have incentives to come to an agreement before Nov. 30.”

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Some Early Corporate Bond Stuff

October 31st, 2016 5:55 am

Via Bloomberg:

IG CREDIT: Volume Drops 30% as Spreads Leak Wider
2016-10-31 09:43:09.330 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $14.3b Friday vs $20.3b Thursday, the highest volume
since July, $12b the previous Friday. 10-DMA $16.5b; 10-Friday
moving avg $12.1b.

* 144a trading added $1.7b of IG volume Friday vs $3.3b on
Thursday, $1.6b last Friday

* Trace most active issues longer than 2 years:
* C 3.20% 2026 was 1st with dealer-to-dealer trades
accounting for 55% of volume; client buying 1.7x
sessling, affiliate buying near twice selling
* VZ 2.625% 2026 was next with client and affiliate flows
sharing volume with trades between dealers near 50/50;
client selling 1.8x buying
* WFC 3.00% 2026 was 3rd with client flows at 84% of
volume; client buying 1.8x seeling
* T 4.50% 2048 was the most active 144a issue with client
flows accounting for 90% of volume; client selling 2.2x
buying

* Bloomberg Barclays US IG Corporate Bond Index OAS at 132 vs
131
* 2016 wide/tight: 215 (a new wide since Jan. 2012)/129
* 2015 wide/tight: 171/122
* 2014 wide/tight: 137/97
* All time wide/tight back to 1989: 555 (Dec. 2008)/54
(March 1997)

* BofAML IG Master Index unchanged at +137 vs +136; +135, its
tightest spread of 2016 was seen Oct. 19-25; 2015 tight was
+129

* Current markets vs early Friday levels:
* 2Y 0.849% vs 0.880%
* 10Y 1.840% vs 1.850%
* Dow futures +16 vs flat
* Oil $48.58 vs $49.57
* ¥en 104.93 vs 105.29

* U.S. IG BONDWRAP: IG Volume Tops $30b for the 3rd Straight
Week
* October total now $144.5b; YTD $1.48t

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Early FX

October 31st, 2016 5:53 am

Via Kit Juckes at SocGen:

<http://www.sgmarkets.com/r/?id=h11a64bfd,18d1d930,18d1d931&p1=136122&p2=c7c826f52e5e15483e6c287f65680e0a>

With a little over a week to go until the US Presidential Election, it’s no surprise that politics is set to play an even bigger role in markets in the coming days. This morning, rather than creating the sort of Halloween ‘fright night’ that would suit the tabloids, it’s creating the same sort of fog over markets that made getting to work in London scarier than usual. This is what London was always like in black and while pre-EEC films, isn’t it?                                                                                              The announcement at the end of last week that the FBI is taking a new look at Hillary Clinton’s emails appears to have boosted Donald Trump in weekend opinion polls and has left markets in an uncertain mood this morning. That the Mexican Peso and Brazilian real sit at the top of the October FX performance table tells us the market has been getting comfortable with the idea of a Clinton presidency and suggests some wobbles head for risk sentiment.

Last week’s CFTC data show overall dollar longs being cut back a bit, yet the dollar’s trade-weighted value continues to rise (slowly). Over October as a whole, the dollar has out-performed the rest of the G10 currencies, as well as the Yuan, but by last week the picture was just a lot more blurred, with the Euro topping the G10 table, the Swedish Krona, Yen and Canadian dollar at the bottom and the dollar in the middle. Still, if dollar longs aren’t excessive yet and as long as the upward crawl in Treasury yields remains intact, we’ll stick with dollar bullish trades and views. 10year Treasuries are up 8bp on the last week, 25bp over the last month. Only half of that rise is due to real yields moving up (the other half’s down to higher breakeven inflation), but that’s enough to keep the dollar on track, though it could do with some more ‘real’ help.

CFTC USD longs have stopped growing

[http://email.sgresearch.com/Content/PublicationPicture/235254/2]

We still prefer dollar, longs against the yen to longs vs. the Euro. EUR/USD looks like drifting down to 1.08 or so, but we’re still worried about how much Euro softness depends on the ECB crowding private sector investors out of European bonds and the Euro. We’ve written about how tapering of bond purchases could trigger a Euro bounce, but more broadly, a weaker currency was one of the major channels by which ECB policy has worked but if the Euro is now just range-trading and the ECB has virtually run out of ammunition, then we struggle to see a catalyst for another significantly lower.

The dollar could do with more real yield help…

[http://email.sgresearch.com/Content/PublicationPicture/235254/3]

By contrast, there are still lots of yen longs lout there to squeeze as US rate expectations rise and B OJ policy is well-designed to help yield differentials widen in the favour of the dollar as long as the upward crawl in treasury yields goes on. The only concern is risk sentiment more broadly – I couldn’t make a credible case for Yen softness on a trump win…

The FT reports that BOE Governor Mark Carney has told friends he is planning to stay on for his full term. That’s stopped the rot for sterling, for now. From here, the test comes from the data, and whether it goes on holding up as well as it has been. If (as seems likely) we see a series of somewhat soggier data releases form here onwards starting with this week’s PMIS, sterling will struggle to rally very far, but will probably see volatility leach out of the market. We retain a bearish bias, but maybe with fewer thrills.

There’s a lot of data and news due this week in general. The first highlight comes from tomorrow’s RBA announcement, where of 27 forecasters, 21 see no changed and 6 (including SG) see a 25bp cut. The FOMC meets on Wednesday and presumably does nothing other than tee up a December hike, and the BOE meets and releases the Inflation Report is due Thursday. The US also releases ISM data tomorrow and non-farm payrolls on Friday. Another 200k increase in jobs would surely lock in the much-anticipated December hike, but any pick-up in wage growth would also keep the Treasury yield uptrend intact. And that’s what keeps a bullish dollar bias intact amid all the political noise.

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Credit Pipeline

October 31st, 2016 5:50 am

Via Bloomberg:

IG CREDIT PIPELINE: Dealers Expect at Least $20b of IG Deals
2016-10-31 09:15:33.43 GMT

By Robert Elson
(Bloomberg) — 80% of dealers, in a Bloomberg survey, look
for at least $20b of new IG issuance this week. 39% think it
will be over $25b; 18% over $30b.

LATEST UPDATES:

* Dow Chemical (DOW) Baa2/BBB, filed debt shelf; last issued
in Sept. 2014
* Qualcomm (QCOM) A1/A+; ~$47b NXP Semiconductor (NXPI)
Ba2/BBB-, acq
* Sees funding deal with cash, $11b new debt (Oct. 27)
* Rockwell Collins (COL) A3/A-, to buy B/E Aerospace (BEAV)
Ba2/BB+, for $8.3b in cash, stock, assumption of debt
* COL sees financing cash portion of deal with debt
financing; plans to pay down $1.5b of new debt by end of
its FY19
* Moody’s and S&P said COL’s rating may be cut to the mid-
BBB range following completion of the BEAV acquisition
* AT&T (T) Baa1/BBB+ to buy Time Warner (TWX) Baa2/BBB for
$85b in cash, stock deal; cash portion will be financed with
new debt, cash on hand
* $40b bridge loan in place
* T may be cut by Moody’s; any potential downgrade would
be limited to one notch
* European Stability Mechanism (ESM) Aa1/na/AAA, mandates
Barc/C/DB/JPM to advise on its USD issuance program
* First ESM USD transaction scheduled for 2H 2017, subject
to market conditions
* ConAgra (CAG) Baa2/BBB-, could borrow up to $2.5b for
acquisitions
* Province of Nova Scotia (NS Gov) Aa2/A+ , filed Friday a
$1.25b debt shelf; last issued in USD in 2010, has $500m
maturing January
* Korea Hydro & Nuclear Power (KOHNPW) Aa2/AA, mandates BNP/C
for investor meetings Oct. 18-20
* 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
* 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
* 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
* 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
* 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, approx. EU5b convertible bond
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)
* 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)

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)

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Stops Are For Buses

October 30th, 2016 11:36 pm

Via WSJ:

Some currency investors, worried that events such as the pound’s recent collapse could become more common, are abandoning an automated trading mechanism that was supposed to protect them from losses after big market swings.

The trading mechanism, known as a stop-loss order, is meant to sell an investor’s position as soon as a currency hits a preset level against another currency. Banks and electronic trading platforms often struggle to execute the orders at exactly the level an investor requested, resulting in trades below the indicated price even when markets are relatively calm.

The rise in “flash crashes”—sudden drops that often quickly reverse—has made the orders even more risky and ineffective, investors say. Stop-losses can lock in a low price during a burst of volatility, turning what was a sharp but temporary price decline into a permanent loss. These trading orders were once used across financial markets but after share-price flash crashes they fell out of favor among stock investors and exchanges; currency-market gyrations are now making foreign-exchange traders wary as well.

A report from the currency trading platform FXCM Inc. showed that between January 2015 and March 2016, 40% of stop-loss orders and similar trading mechanisms executed on its platform were filled below the price level that investors had requested.

This so-called “negative slippage” has become the norm for larger currency trades: About 95% of orders over $10 million were executed below investors’ chosen price in the first quarter of this year, according to the FXCM report. FXCM didn’t say by how much the trades were made below the stop-loss pricing level.

“I can’t tell you how many times I was completely burned by it,” said Paresh Upadhyaya, director of currency strategy at Pioneer Investments. “What’s the point of a stop-loss if I don’t get it done around the level I left in the market?”

He said stop-loss orders have been filled as much as half a percent off the requested price, which for multimillion-dollar trades could mean tens of thousands of dollars worth of additional losses. “It was just painful,” Mr. Upadhyaya said.

Analysts say the challenge for stop-losses is they are trying to hit a moving target. Investors select the level at which they want their position sold, but a trader or  algorithm can’t always execute at that price before the market moves lower.

Some investors say stop-loss orders have contributed to recent flash crashes. Although analysts believe the initial catalyst for the pound’s crash on Oct. 7 was an algorithm or a mistaken trade, many say a chain reaction of selling—which likely included automated stop-loss orders—helped push the pound from $1.26 to $1.18 in just a few minutes.

U.S. regulators also cited stop-losses as a factor in the Dow Jones Industrial Average’s more than 1,000 point plunge in August 2015. The New York Stock Exchange this year stopped accepting stop-loss orders, citing the risks during volatile trading, although brokerages may still offer them.

Stop-loss orders remain popular among traders in oil, gold and other commodities. Many of those markets have seen volatility pick up in recent years, but have largely avoided the dramatic plunges that have hit the currency, stock and bond markets.

FXCM still offers stop-loss orders on currency trades but often recommends that traders use limit orders, which guarantee investors the price they want. If FXCM can’t fill the order at that price, it won’t execute the trade. “It’s important for FX platforms to offer a range of functionality as different traders like to trade in different ways,” a spokesman said.

Investors worry that volatile currency moves are growing more common as postcrisis financial regulation has forced banks to pare back trading and algorithms become an increasingly dominant force in the market.

A Bank of America Merrill Lynch report this month argued that liquidity in the foreign-exchange market has “materially worsened” even as official data indicates volumes remain stable.  The bank’s analysis showed that foreign-exchange trades now create 60% more volatility than they did in 2014.

Collin Crownover, who heads currency management at State Street Global Advisors, said he grew wary of stop-loss orders in January 2015, when the euro plunged by about 30% against the Swiss franc after the Swiss National Bank unexpectedly lifted its cap on the currency pair.

Mr. Crownover was one of many currency investors who lost money that day on his Swiss franc positions. “It wasn’t a fun day,” he said. “That got us thinking, could these issues crop up somewhere else?”

After the pound’s crash this month, he decided, “we need to consider other alternatives” to stop-loss orders.

He is weighing another trading mechanism known as a call level order, in which the firm would receive a phone call from his bank once the trigger level is hit to confirm he wants to sell the position and take the loss.

Paul Lambert, head of currency at money manager Insight Investment, says he has moved away from automated sell orders and prefers to use options contracts, or to close positions entirely if he is worried about overnight volatility.

Not everyone is ready to ditch stop-loss orders. Brad Bechtel, a managing director in foreign-exchange at Jefferies Group, says he hasn’t seen much change in his clients’ use of them.

“There’s still a need for people to use them to protect themselves,” he said, adding that investors accept “there’s an element of risk.”

Alternatives to stop-loss orders have their drawbacks, too. Buying options or closing positions frequently would be more expensive, and some money managers are prevented by agreements with clients from using those orders.

Chris Stanton, chief investment officer of hedge fund Sunrise Capital Partners, said his firm’s trading decisions are driven by mathematical models, but he is wary of relying fully on automation.

The firm’s algorithms are designed to wait for human input before selling in illiquid periods such as the pre-Asian trading session, where price spikes can be extreme.

“This is what you live in: micro volatility that drives things to where it shouldn’t be,” Mr. Stanton said.

Write to Chelsey Dulaney at [email protected]

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Just a Slight Whiff of Inflation Wafting Through the Macroeconomic Breeze

October 30th, 2016 8:57 pm

Via Greg Ip at WSJ:

After being given up for dead, inflation is gradually coming back to life.

It’s not roaring back. Indeed, it’s still below the 2% level the Federal Reserve targets, one reason the Fed is almost certain to leave interest rates unchanged when it meets this week.

But economic circumstances and attitudes of policy makers have shifted in the past year in ways that suggest the likeliest path of inflation is up, not down. Data released Friday showed that core inflation, which excludes food and energy, reached a two-year high of 1.7% in the third quarter, according to the Fed’s preferred measure. Other data found stirrings of wage acceleration.

The intellectual case for low inflation is also showing cracks. Central banks now openly entertain, and even welcome, inflation bubbling over 2%.

This isn’t bad news. To the contrary, markets and central bankers alike will be relieved that the world is no longer skirting a deflationary abyss. Normal inflation is a necessary (though not sufficient) condition for savers to once again enjoy normal interest rates.

Nonetheless, it could portend a significant repricing in financial markets, which had come to assume inflation would be too low forever. Since early July the U.S. 10-year Treasury yield (which moves in the opposite direction to price) has climbed half a percentage point to 1.85%. Yields in other countries have risen somewhat less.

Most of this increase reflects a reappraisal of the inflation outlook. The behavior of inflation-protected bonds suggests that in early July, investors expected U.S. inflation to average 1.4% over the coming decade. As of Friday, that had risen to 1.7%.

That is still below the Fed’s 2% target, evidence that investors remain unconvinced the Fed has licked the low-inflation problem. Yet many of the assumptions that underpin their skepticism are no longer warranted: that excess capacity and low oil prices will last indefinitely, that elected governments are fixated on austerity, and that central banks will clamp down if they see inflation about to top 2%.

The best gauge of spare economic capacity is the unemployment rate. In the U.S., it has fallen to 5% from 10% seven years ago. Across the seven largest advanced economies, it has fallen from 8.4% in 2009 to 5.4% in July, back to where it stood in 2007, just before the global financial crisis, according to economists at Goldman Sachs.

Typically, high unemployment nudges inflation down and low unemployment nudges it up. That inflation stayed low as unemployment declined led some economists to worry the relationship had broken down.

Goldman economists say the relationship was muddied by commodity prices. First, oil climbed above $100 a barrel in 2011, then crashed below $50 in 2015. This year, for the first time since the crisis, labor markets and commodity prices are pushing prices in the same direction.

Job growth remains robust across the developed world, and prices of oil and other commodities are up solidly since February. This is making itself felt in inflation, which overall is positive and rising in most countries. Core inflation across the Group of Seven developed economies is roughly back to where it was before the crisis, according to Goldman.

The main exception is the eurozone. Jan Hatzius, Goldman’s chief economist, said that isn’t surprising because Europe is the one part of the developed world still struggling with high unemployment.

The country where inflation is furthest along the road to normality is the U.S. Core inflation, according to the Consumer Price Index, is already above 2%. Using the Fed’s preferred index, it is 1.7%, but that may be artificially depressed by technical factors related to the measurement of medical costs.

Wage growth is still weak, but less weak than it was. The employment cost index released by the Labor Department Friday showed that excluding jobs paid via incentives, such as sales commissions, wages were up 2.4% in the third quarter from a year earlier, the fastest since 2009. Though well below the 3% to 3.5% that prevailed before the crisis, current wage growth is roughly in line with the sluggish pace of productivity growth.

Another potential worry is inflation expectations. On Friday, the University of Michigan said consumers’ long-term expectations had slipped to 2.4%, the lowest on record. However, this measure has been sliding for a while and this is because a minority of people who had expected runaway inflation have thrown in the towel. A growing share now expect inflation of exactly 2%. That leads Goldman to believe the public’s views on inflation really haven’t changed much in the past decade, a view top Fed officials share.

It’s not just the inflation data that have shifted; so have the attitudes of policy makers. Investors long suspected central banks treated 2% as a ceiling and would tighten as soon as inflation approached that level. This year, central bankers have gone out of their way to dispel that suspicion.

In Britain, inflation is likely to top 2% soon because of the pound’s drop after the vote to leave the European Union. Bank of England Governor Mark Carney recently said an overshoot was better than “another 400,000 or 500,000 people unemployed.”

That same week, Fed Chairwoman Janet Yellen spoke approvingly of allowing unemployment to fall to levels typically associated with accelerating inflation. to undo some of the damage that years of joblessness have done. And in September, the Bank of Japan committed to not just meeting but exceeding its 2% target.

Of course, aiming for higher inflation is one thing; achieving it another. The Bank of Japan and the European Central Bank both pushed short-term interest rates below zero and bought large quantities of bonds in an effort to spur lending, growth and prices, but the costs of those policies are rising.

Zero to negative rates are crushing banks’ lending margins, which could undermine their ability to lend. One reason bond yields now are rising is a belief that the ECB and BOJ want to protect their banks from further pressure.

Even as central banks lose their appetite for stimulus, elected governments are rediscovering theirs. Governments in Britain and Japan have relaxed their budgets, and many think the U.S. is likely to as well, regardless of who wins the presidential election. Morgan Stanley predicts fiscal policy will add to growth in the developed economies next year, for the first time since 2010.

While higher inflation and more fiscal stimulus portend more upward pressure on interest rates, there still seems little chance they will get to the 4% or above that investors once took for granted.

The U.S. grew just 1.5% in the year through the third quarter, the Commerce Department reported Friday, which may be the new trend given the drag from an aging population and lackluster productivity. Sluggish growth saps investment and borrowing and limits how high interest rates can go.

The expansion is also getting old, suggesting odds of a recession are also rising. The Fed may be on the verge of getting inflation back to normal, but getting growth back to normal remains as elusive as ever.

Write to Greg Ip at [email protected]

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Some Corporate Bond Stuff

October 27th, 2016 6:30 am

Via Bloomberg:

IG CREDIT: Client Buying of Long Bonds Lead High Volume Session
2016-10-27 10:12:19.770 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $18.9b vs $19.5b Tuesday, $18.1b last Wednesday.

* Highest of any Wednesday since $19.6b on July 20
* 15th highest of any Wednesday since Nov. 2005, more than 98%
of the Wednesdays since Nov. 2005
* 10-DMA $16b; 10-Wednesday moving avg $17.4b
* 144a trading added $2.9b of IG volume vs $2.7b Tuesday,
$2.3b last Wednesday

* Trace most active issues:
* F 4.75% 2043 was 1st with client buying twice selling
* GILD 4.15% 2047 was next with client buying 1.7x selling
* ABIBB 4.90% 2046 was 3rd with client buying 1.8x selling
* DAIGR 1.125% 2017 was the most active 144a issue with client
flows accounting for 100% of volume

* Bloomberg Barclays US IG Corporate Bond Index OAS at 131 vs
130
* 2016 wide/tight: 215 (a new wide since Jan. 2012)/129
* 2015 wide/tight: 171/122
* 2014 wide/tight: 137/97
* All time wide/tight back to 1989: 555 (Dec. 2008)/54
(March 1997)

* BofAML IG Master Index at +136 vs +135, its tightest spread
of 2016; 2015 tight was +129

* Current markets vs early Wednesday, Tuesday, Monday levels:
* 2Y 0.876% vs 0.863% vs 0.844% vs 0.828%
* 10Y 1.818% vs 1.760% vs 1.768% vs 1.724%
* Dow futures -9 vs -77 vs +22 vs +77
* Oil $49.38 vs $49.31 vs $50.86 vs $50.86
* ¥en 104.72 vs 104.14 vs 104.46 vs 103.91

* U.S. IG BONDWRAP: 2nd Double-Digit Session Brings Week Over
$25b
* October total now $132.155b; YTD $1.47t

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