Across the Curve

Money Market Reform

This excellent article by Liz McCormack at Bloomberg describes the changes to money market funds which will be implemented later this week. The reforms require greater transparency for riskier funds with the hope that a crisis such as that which occurred in 2009 following the Lehman bankruptcy can be averted. The unintended consequence of the changes is much lower rates at the short end of the yield curve for the US government.

Via Liz McCormack at Bloomberg:
A $1 Trillion Paradigm Shift Boosts Demand for U.S. Bills
Liz McCormick
mccormickliz
October 10, 2016 — 7:00 PM EDT
Updated on October 11, 2016 — 5:08 AM EDT

BlackRock, Fidelity say money-fund reform is boon for Treasury
Floating NAV comes at expense of banks, corporate borrowers

It’s the most sweeping change for U.S. money market funds in over three decades and the biggest operators say it’ll have a permanent effect on the way investors allocate their capital.

After years of wrangling with regulators, the $2.7 trillion industry will give up its rock-solid, dollar-for-dollar guarantee for institutional funds that invest mainly in riskier, non-government debt.

The impending change has been a boon for the U.S. government and comes at the expense of banks and other corporate borrowers. Already, investors have shifted more than $1 trillion away from so-called prime funds that buy certificates of deposit and company IOUs and flooded into government-only funds, which invest in T-bills and other short-term U.S. debt and are exempt from the change. Assets in those funds, which never exceeded 40 percent before December, now account for 77 percent of all money-market assets, according to Investment Company Institute data going back to 2007.

The $1-per-share fixed price, which gave investors the perception these higher-yielding money-market funds were as safe as bank accounts, will give way to floating values on Oct. 14. The intent has been to make the money-market industry safer and more transparent in the wake of the financial crisis, when the collapse of the $62.5 billion Reserve Primary Fund — which invested in debt issued by Lehman Brothers Holdings Inc. — sparked a run on other prime funds and led to hundreds of millions in investor losses.

Yet to BlackRock Inc., Fidelity Investments and Vanguard Group Inc., the influx also represents a long-term shift that may help contain America’s funding costs just as bigger deficits loom and the Federal Reserve considers raising interest rates again. The ramifications are significant as well for banks and other corporate borrowers, which have seen financing costs jump as demand for the prime money-market funds that buy their debt has dried up.

“These are permanent changes,” said Nancy Prior, the president of fixed income at Fidelity, the largest U.S. provider of money-market funds with $470 billion of such assets. “As the features of money funds changed, investors’ preferences led to these shifts in billions of dollars across the market. Assets in government funds will continue to surpass those in prime funds.”

The fixed net asset value has historically meant that money-market investors were always able to get every dollar of their principal back, regardless of the market’s fluctuations. And prime funds, which buy CDs and commercial paper, were an attractive alternative to bank accounts because they delivered slightly higher returns and were perceived to be just as safe.

But this week, the U.S. Securities and Exchange Commission will start requiring institutional prime and tax-exempt money-market funds to float their NAVs. That means that unlike government-only funds, investors can lose money if the market value of such funds fall below $1 per share. In addition, both institutional and retail classes of those funds will be allowed to impose liquidity fees and limit investor withdrawals in times of crisis.

The changes were designed to prevent a repeat of 2008, when the Reserve Primary Fund fell below its $1-a-share mandated value and subsequently collapsed under the weight of its Lehman-related write-offs. It spurred a panic among money-market investors and deepened the financial crisis.
Prime Exodus

The reforms have triggered an exodus from prime funds. Assets in that category have plunged by $974 billion in the past year to $473 billion. Almost all of it has flowed into government-only funds, which have doubled to $2.05 trillion over the same span.

“There is a lot of uncertainty around prime funds,” said Tom Callahan, the co-head of global cash management at BlackRock, the second biggest money-market fund company with about $250 billion of such assets. “For some, it’s the floating NAVs. For some, it’s the gates and for some, it’s the fees. For some it’s all of the above.”

The shift in demand will be key as government spending on Social Security, Medicare and Medicaid widens the budget shortfall. The public debt burden may swell by almost $10 trillion in the coming decade, according to Congressional Budget Office forecasts, and the U.S. government has already taken advantage of the increase in bill demand to boost issuance.

“The Treasury is probably real happy with the results,” said David Glocke, the head of taxable money markets and Treasury bond trading at Vanguard, which manages about $195 billion in money-fund assets. “They can increase the issuance at the short-end of the curve and take advantage of it.”

That’s already playing out in the relative cost of borrowing. While all market rates have risen since the Fed raised rates in December, banks and corporate borrowers have borne the brunt of the money-market reforms. The gap between the three-month T-bill rate and the comparable London interbank offered rate — a proxy for unsecured bank funding costs — jumped to 0.69 percentage point in the past month, the most since 2009.
Corporate IOUs

Corporate IOUs have also been hit. The amount of commercial paper outstanding has declined for six consecutive months to a level not seen since the late 1990s. The market for IOUs issued by foreign financial firms, which are particularly dependent on money-market demand, is in the midst of the worst downturn since the credit crisis.

“This was a structural change,” said Gregory Fayvilevich, an analyst in the fund and asset management group at Fitch Ratings. “Prime money funds traditionally made up a very big portion of holders of CP. That is why you are seeing a very big impact.”

Deborah Cunningham, the chief investment officer for global money markets at Federated Investors, says that investors will slowly reallocate money back to prime funds as the yield advantage grows. Though she says, the gap needs to reach somewhere “north of 40 basis points” (or 0.4 percentage point) to offset the perceived risks.

The seven-day yield for institutional prime funds stood at 0.29 percent as of Oct. 6, versus 0.17 percent for government funds, according to Crane Data LLC.

The Treasury plans to sell $138 billion of bills on Tuesday.

“What we saw flow out was pretty quickly exiting, whereas what will come back will be spread over time, in drips and drabs,” Cunningham said.

Even if the appetite for prime funds eventually recovers, the additional risks like the floating NAV and the potential lock-ups suggest that government-only funds will continue to garner the lion’s share of any new inflows.

Demand for prime funds isn’t “ever going to make it back to what it was pre-reform,” said John Donohue, the chief investment officer for global liquidity at JPMorgan Asset Management, the third-largest money fund provider with $240 billion in assets. “In the new world, the govvie funds will be the large flagship in the money funds space.”

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PIMCO Sees Multiple Rate Hikes in 2017

Via Bloomberg:

Wes Goodman
richwesgoodman
October 10, 2016 — 9:44 PM EDT
Updated on October 11, 2016 — 2:05 AM EDT

Treasuries are world’s worst-performing government securities
U.S. bonds falls as Russia, Saudi Arabia agree to oil limits

Pacific Investment Management Co. says the Federal Reserve may raise interest rates two or three times by the end of 2017. Treasuries tumbled after oil prices rose.

Higher economic growth and inflation would drive the central bank to act, Pimco said in a Twitter post Monday. The company, which manages the world’s biggest actively run bond fund and is based in Newport Beach, California, made the posting as rising oil prices added to speculation U.S. inflation will accelerate.

Investors preparing for a central bank move have made Treasuries the world’s worst-performing government bonds. U.S. securities due in 10 years and longer have fallen 5.8 percent in the three months through Monday, the biggest loss of 144 government bond indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies.

“U.S. Treasury yields are likely to go up,” said Hideaki Kuriki, a debt investor in Tokyo at Sumitomo Mitsui Trust Asset Management, which oversees $78.9 billion. “The Fed will raise rates by 25 basis points in December. Oil prices are going up.” Yields may retreat in 2017 as the economy softens, he said.

Pimco’s Total Return Fund has returned 4.2 percent this year, lagging behind almost three-quarters of its peers, based on data compiled by Bloomberg. Its five-year performance beat almost 80 percent of its competitors. Total Return’s $84.4 billion in assets makes it the biggest actively run bond mutual fund, though it is smaller than two index funds run by Vanguard Group Inc.
Trading Resumes

The benchmark U.S. 10-year note yield jumped five basis points to 1.76 percent as of 7:02 a.m in London, according to Bloomberg Bond Trader data. The price of the 1.5 percent security due in August 2026 slid 13/32, or $4.06 per $1,000 face amount, to 97 5/8. Treasuries opened in Asia after being closed Monday for a U.S. holiday.

Australia’s 10-year yield climbed six basis points to 2.25 percent, and Japan’s increased 1 1/2 basis points to minus 0.05 percent.

The U.S., Australia and Japan will all hold long-term bond sales this week. Australia and Japan both plan to sell 30-year debt Wednesday. It will be Australia’s first offering of the maturity. The U.S. is scheduled to auction three- and 10-year debt Wednesday and 30-year bonds Thursday.
Oil Deal

The selloff in Treasuries is being driven by the decision of Saudi Arabia and Russia to cooperate to limit oil output, said John Gorman, head of non-yen rates trading for Asia and the Pacific at Nomura Holdings Inc. West Texas Intermediate oil for November delivery jumped 3.1 percent Monday to $51.35 a barrel, the highest close since July 2015.

The decline was also being driven by Donald Trump’s performance in the presidential debate Monday, which may reduce the odds of the Republican nominee ousting the Democrats from the White House, Gorman said. The result is “a little more status quo,” Gorman said.

Treasuries are often used as a haven in times of uncertainty, while periods of stability reduce demand for the safest assets.

The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of expectations for consumer prices, expanded to as much as 1.69 percentage points, the most since May 3. The Fed targets inflation of 2 percent.

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More on FX Liquidity or Lack Thereof

I guess Bloomberg and WSJ are colluding on topics as this WSJ article visits the same territory as the previous post on currency market illiquidity via Bloomberg.

This WSJ article places the onus for the market’s illiquidity on the post crisis regulatory storm.

Via the WSJ:
By Chelsey Dulaney and
Ira Iosebashvili
Updated Oct. 10, 2016 12:24 a.m. ET

Wall Street’s retreat from currency trading may be reducing risk at the banks, but it is contributing to bouts of extreme volatility in the foreign-exchange market.

Currency analysts say that was evident on Friday, when the British pound plummeted from $1.26 to $1.18 in a matter of minutes during early-morning trading in Asia, with some electronic platforms recording trades below $1.15.

One reason the pound fell so sharply, these analysts say, is because Wall Street foreign-exchange desks have slimmed down in response to postcrisis financial regulations meant to limit risk-taking. Those rules forced banks to rein in a service known as market-making, by which they facilitate trading by agreeing to buy and sell currencies.

Major banks’ foreign-exchange desks have shrunk by 23%, to 1,477 traders in the first half of this year from 1,916 in 2010, according to Coalition, a London consulting firm. The top five banks also accounted for just 44.7% of the market’s volume, down from 61% in 2014, according to a Euromoney survey.

Proprietary trading firms and high-frequency traders, mostly driven by quantitative strategies instead of human decision-making, have stepped in to fill that gap.

But at times of high duress, like during the U.K. vote to leave the European Union and last week’s collapse of the pound, the lack of bodies can make a big difference, some observers say. A market staffed by bank traders might have executed orders more judiciously during the thinly traded session, recognizing that low volumes tend to exaggerate currency moves, industry veterans said. Banks also often took money-losing positions that helped to slow a currency’s move in a bid to appease their clients.

The retreat of big banks from the foreign-exchange market mirrors Wall Street’s pullback from other markets at the prodding of Congress and regulators, from real-estate investments to private equity and commodities.

The sharp turns in currency and other markets have led some observers to wonder if greater volatility may be an unintended consequence of an effort to reduce banks’ balance-sheet risk.

Robert Savage, chief executive of the currency hedge fund CCtrack Solutions LLC and a former Goldman Sachs Group Inc. executive, said when volatility increases to a point that high-frequency trading programs lose money by making markets, “they just shut down.”

Bank trading desks staffed by employees would have kept the selloff from escalating to the degree it did, he said. “You would find out who was selling, if there was any news,” Mr. Savage said. “In the old days, if there was no fundamental reason to sell, you wouldn’t sell.”

This isn’t the first time analysts blamed poor liquidity and few traders in foreign-exchange markets for big currency moves: This pound fell more than 10% in the hours after the results of Britain’s June 23 referendum on leaving the EU were announced. The euro plunged by as much as 30% against the Swiss franc in January 2015. The effect of reduced liquidity was considered a factor in both cases.

Not everyone thinks the currency market is necessarily worse off with fewer traders. Isaac Lieberman, the chief executive of quantitative hedge fund Aston Capital Management, said while electronic trading can lead to swift price moves, it also enables markets to recover more quickly. Within an hour of the initial selloff in the pound last week, the currency had rebounded by over 5%.

Kevin McPartland, who heads research on market structure at financial consultancy Greenwich Associates, thinks as more electronic traders enter the market, liquidity will eventually be improved during high-stress periods.

“The automated nature of the market causes market participants to react more quickly,” he said. “But it allows the market to come back more quickly as well.”

The shift toward electronic currency trading has been under way for the past decade. Deutsche Bank AG , once a leader in foreign-exchange trading, now claims just a 7.9% share of the market, down from about 15% in 2015 and over 20% in 2009, according to a Euromoney survey.

Citigroup Inc., which now has the biggest share of currency trading among big banks, also has retreated. Its market share fell this year to 13% from 16% in 2015. Chief financial officer John Gerspach said during a July earnings call that the bank has “adjusted our capacity” in its foreign exchange and other trading businesses. Mr. Gerspach said the business has “been under tremendous transformation” over the past five years and “and will likely continue to be so for some period of time.”

Meanwhile, foreign-exchange volume executed by nonbank traders rose to 20% in 2015 from 16% the prior year, according to a recent study by Greenwich Associates.

Computerized trader XTX Markets was the ninth-biggest global currency trader in 2016, according to Euromoney, the first time an electronic trader overtook a bank in the rankings. XTX’s 3.9% share of the market’s total volume is particularly notable because the London-based firm is just over a year old, having been spun out of hedge fund GSA Capital in 2015.

Kenneth Griffin’s Citadel Securities is also becoming a big player.

Some observers say one reason the currency market’s overall liquidity is suffering is because algorithmic trading hasn’t made up for the pullback among banks. The Bank for International Settlements triennial survey released in September showed global currency trading fell for the first time since 2001, with roughly $5.1 trillion a day of global currencies being traded in April, down from $5.4 trillion in April 2013.

“Something fundamentally had changed with liquidity provision,” said Collin Crownover, head of currency management at State Street Global Advisors. “You can hit these liquidity air pockets more readily in an algorithm-dominated trading environment.”

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Illiquidity in FX Markets

Via Bloomberg:

The inexplicable volatility that roiled the British pound last week came as no surprise to Bank of America Corp., which just days earlier warned that liquidity in the $5.1 trillion-per-day global currency market was far worse than anyone imagined.

Sterling sank 6.1 percent in a span of minutes in early Asian trading Oct. 7, following at least three other bouts of puzzling foreign-exchange turbulence in the past two years. The latest episode involved the fourth-most-traded currency, serving up a stark reminder of the pitfalls that investors face in the world’s biggest financial market as banks — the traditional middlemen — step back amid post-crisis regulations.

The currency market is growing more fragile because “phantom liquidity” is undermining investors’ ability to buy and sell when they need to, Bank of America analysts wrote in an Oct. 5 note. Their research found that with trading volumes in decline, transactions have a 60 percent greater impact on prices than just two years ago.

The size of last week’s move “in the deepest and biggest market in the world scares the hell out of everyone,” said Bob Savage, chief executive officer of hedge fund CCTrack Solutions LLC in New York. “The larger story is whether there’s anything to do about it.”

Stepping Back

The lifeblood of the global economy, the currency market has been blighted by staff reductions and a rate-fixing scandal that’s ensnared some of the world’s biggest banks. Stricter regulation enacted since the financial crisis has prompted dealers to step back, opening the door for automated market makers to expand, though the new entrants haven’t stemmed a drop in volumes. Daily trading in global currencies has shrunk almost 6 percent since 2013, Bank for International Settlements data show.

The pound’s so-called flash crash follows a similar event for South Africa’s rand, which in January tumbled 9 percent in 15 minutes, before rebounding. New Zealand’s dollar had its own flash crash in August last year.

“If investors have an urgency to transact, the liquidity that they see might disappear and they might not be able to do so,” said Vadim Iaralov, a foreign-exchange strategist in New York at Bank of America, the world’s fifth-largest currency trader according to Euromoney magazine. “There may be nobody on the other side of the trade.”

Shock events may trigger unexpected volatility and cause bid-ask spreads to widen significantly as market makers withdraw during turbulent periods to avoid losses, Iaralov and co-author Christopher Xiao wrote in last week’s note.

Liquidity’s Cost

For strategists at JPMorgan Chase & Co., the second-biggest currency trader, the pound’s plunge breathes new life into the debate about the market’s changing structure and its impact on liquidity.

In a sign of the growing competition from non-banks, computerized trading firm XTX Markets Ltd. placed ninth in Euromoney’s ranking of foreign-exchange traders, released in May. High-speed market makers have more than tripled currency volumes in the last three years, according to Aite Group, a consultant in Boston.

“The advent of non-bank liquidity providers such as HFTs has reduced bid ask spread and increased market efficiency in FX markets, but at the cost of lower market depth and withdrawal of liquidity provision in periods of stress,” JPMorgan strategists including Nikolaos Panigirtzoglou wrote in an Oct. 7 note.

2016 Laggard

The pound has already fueled plenty of handwringing.

At about $1.24 as of 9 a.m. in New York Monday, it’s down almost 16 percent against the dollar this year, making sterling the worst performer among 31 major currencies tracked by Bloomberg. It plunged to the lowest in more than three decades last week on speculation the U.K. economy will weaken in the aftermath of Britons’ June vote to exit the European Union. Sterling is the world’s fourth-most actively traded currency, after the dollar, euro and yen, according to the BIS.

The Bank of England is looking into the reasons behind sterling’s plunge, and Governor Mark Carney has asked the BIS to review the incident. The pound’s dive underscores the challenge of overseeing a market that’s mostly over-the-counter, spans the globe and doesn’t fit neatly under the authority of any single regulator.

In U.S. Treasuries trading, an episode of unusual volatility two years ago prompted the government’s first review of the market since 1998. On Oct. 15, 2014, yields on the 10-year note plunged 0.16 percentage point and then rebounded in just 12 minutes.

The growing role of automated and algorithmic trading makes this sort of turbulence more likely, said Thomas Suter, chief executive officer at QCAM Currency Asset Management AG, a Switzerland-based hedge fund that runs a $600 million foreign-exchange options program wagering on volatility.

“If such incidents take place regularly, this is very negative for trust in the financial markets,” he said.

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Saudis Rattle Metaphoric Tin Cup

Via Bloomberg:

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FX

Via Marc Chandler at Brown Brothers Harriman:

• With major central banks on hold and mostly secondary economic reports due out, the main drivers will the backing up of interest rates, the performance of Germany’s largest bank, US political developments and the OPEC meeting.  US earnings seasons formally kicks off and the completion of US money market reforms.  
• China markets re-opened from the week long national holiday.  Stocks rose, but the dollar advanced and closed above the CNY6.70 level, which previously was seen as a cap
• Sterling is trading broadly sideways after the pre-weekend flash crash
• The Mexican peso and Canadian dollar appear to be biggest beneficiaries of the US political dynamics

The US dollar is mostly higher to start the new week.  Turnover is lighter than normal as Japan, Canada and (some) US markets are closed.  The Mexican peso is nearly 2% stronger against the US dollar.  After having approached MXN20.0 in late-September, the changing fortunes of the US presidential contest say the dollar gap lower today and dipping below MXN19.00.  After the pre-weekend meltdown, sterling is stabilizing around $1.2400.  The euro and yen are a little softer.  Chinese markets re-opened after last week’s holiday.  The Shanghai Composite advanced nearly 1 5%, while the other regional markets were net-net flat.  The dollar was fixed higher, above CNY6.70, which previously was seen as a cap.  European equities narrowly mixed.  Deutsche Bank shares traded higher last week amid speculation of a compromise with the US Justice Department, However, the failure for such an agreement to materialize is weighing on share prices today (~-3.5%), despite reports that the Qatar royal family may be interested in boosting its stake to as much as 25% from around 10% presently.  The financial sector in Europe is more under pressure more broadly.  Bond yields are edging higher, though Portugal is an exception following comments by the finance ministry playing down the likelihood that DBRS takes away its investment grade status later this month.  

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No Reason to Hike Rates

Via Chris Low at FTN Financial:

Despite some headlines to the contrary, September’s jobs report does not support raising rates in December. If anything, it makes a good case against a hike. Of course, if the Fed is determined, they can always do it anyway, but there’s not much here to support tightening.

Nonfarm payrolls rose 156k in September, 16k less than the consensus estimate. August payrolls were revised 16k higher and July payrolls were revised 23k lower, for a net revision of -7k. The three-month average payroll rise was 191k.  Private payrolls rose 167k, only slightly below the 170k estimate, indicating the headline miss was mostly due to a pullback in government jobs. There’s no reason to worry about that, however, as government hiring was unusually strong over the summer.

Goods producing industries added 10k jobs. Manufacturing was down 13k, construction rose an impressive 23k and mining payrolls were flat.

Private service producers added 157k. Trade and transport was up 24k, of which 22k were retail workers; business services added 67k with the help of 23k temps; education and health added 29k, a bit less than typical; and leisure and hospitality added 15k.

Government payrolls fell by 11k due to a reduction in state and local payrolls; the federal government added 4k.

Average hourly earnings rose 0.2% in September, slightly below the 0.3% estimate. Year-on-year growth in average hourly earnings rose from 2.4% to 2.6%, though, which was better than expected.

In the household survey, employment rose 354k, which sounds like a lot, but the three-month average in this more-volatile series is 187k, essentially identical to the three-month average payroll rise. The labor force rose 444k, and averaged 342k in the past three months. when the labor force grows faster than employment, it means there were more people looking than found jobs. As a result, the unemployment rate rose to 5.0%, the same as last October. In other words, the unemployment rate has been stable for a full year. Labor force participation rose to 62.9%, the highest since February.

Bottom line: Job growth was strong enough to justify a rate hike, but the logic of rate hikes is to slow the economy enough to prevent job growth from exceeding labor force growth. Since that clearly is not happening, there is no reason to hike. As the above chart clearly shows, the unemployment rate is not falling.

A considerable contingent within the FOMC is conditioned to react to wage increases the way someone with a bee allergy responds to wasps at a picnic. They may bang the rate hike drum in response to the acceleration in year-on-year average earnings growth. But average hourly earnings growth in the vicinity of 2.5% nominal, or 1% real, is no threat. In fact, it’s a good thing, and even faster wage growth would be better still. After all, inflation has stalled at 1.5% and the income gap, which just recently was the widest since the 1930s, is only just beginning to close.

Chris Low & Jay Morelock

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Labor Report

Via TDSecurities:

US: September Jobs Report Meets the Fed’s Standard

·         Nonfarm payroll growth slowed to a 156k increase in September, missing consensus expectations for a stronger 172k print though at the heels of upward revisions to August. The unemployment rate unexpectedly rose a touch to 5.0% but reflected higher labor force participation. Meanwhile, alternative measures of labor slack fell further in September.

·         Average hourly earnings surprised somewhat to the downside in September, posting a 0.2% m/m gain while calendar effects pointed to a stronger 0.3% print. Nevertheless, the pace of earnings growth accelerated in line with expectations to 2.6% y/y, back toward its previous highs reached in June/July. Hours worked also recovered to 34.4 hours, which is a relief after the slip to a 2-year low of 34.3 in August.

·         Overall, the job growth numbers meet the standard set by the Fed in achieving a pace well above what is needed for further declines in labor market slack. Sustained job growth together with firming wage pressures and falling slack reinforces the Fed’s expectations for continued improvement in labor market conditions, keeping the Fed on board with their call for a rate hike by year-end. Attention now shifts more fully to the US election cycle which may keep market rate expectations capped in the coming weeks due to uncertainty over a Trump victory and the implications to Fed policy.

Nonfarm payroll growth slowed to a 156k increase in September, missing consensus expectations for a stronger 172k print. The September rise came at the heels of an upward revision to August growth (167k vs 151k previously reported). Payrolls on the weak side had been expected due to downward calendar bias in the month of September, suggesting the upward revisions in the months to come are likely to materialize. By industry, the September gains reflected a moderation in private service-providing jobs (157k vs 169k) and another hefty decline in manufacturing jobs (-13k vs 16k), the latter in line with recent survey readings. Meanwhile, mining/oil/gas payrolls ended its past two years of declines with a flat print in September, an indication of a recovering oil and gas sector hard hit by the oil shock. Construction employment also posted a healthy comeback, rising by 23k after registering relatively weak readings since April.

The unemployment rate unexpectedly rose to 5.0%, though unrounded figures show a very small uptick from 4.92% to 4.96%. The upward move also reflected higher labor force participation, which firmed to 62.9% from 62.8%. We expect the unemployment rate to fall back in the months ahead consistent with other labor indicators such as jobless claims and survey measures that indicate hot labor demand. Other measures of labor market slack showed further improvement, with part-time employment for economic reasons (PTER) falling 2.6%  and long-term unemployment dropping for the second month. On balance, indicators of slack conditions reinforce the view of improving labor conditions.

Average hourly earnings surprised somewhat to the downside in September, posting a 0.2% m/m gain while calendar effects pointed to a strong 0.3% print. Nevertheless, the pace of earnings growth accelerated in line with expectations to 2.6% y/y, back toward its previous highs reached in June/July. Hours worked also recovered to 34.4 hours, which is a relief after the slip to a 2-year low of 34.3 in August.

Overall, the job growth numbers meet the standard set by the Fed in achieving a pace well above what is needed for further declines in labor market slack. Sustained job growth together with firming wage pressures reinforces the Fed’s expectations for continued improvement in labor market conditions, in effect keeping the Fed on board with their call for a rate hike by year-end. Attention now shifts more fully to the US election cycle which may keep market rate expectations capped in the coming weeks due to uncertainty over a Trump victory and the implications to Fed policy.

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Morning Musings

This one is from Chris Low at FTN Financial. He argues that corporate bond issuance supports buybacks and has created an equity market bubble. He would not raiserates but would employ macroprudential policy to limit issuance (maybe via a tax on bond issuance). He also makes point that the raft of regulatory reform since the crisis has raised borrowing costs for individual borrowers and higher rates would hit that group hard.

This is worthwhile read.

Via Chris Low at FTN Financial:

Friday, October 7, 2016

Martin Feldstein wants the Fed to raise rates in December. Writing in today’s WSJ, he argues that a bubble is forming in the stock market and the Fed needs to act before it gets worse. He’s almost certainly right about stocks, but he’s wrong about hiking rates.

The stock-market bubble is the result of companies borrowing at all-time-low rates to buy back their own shares. Corporations are by far the biggest buyers of stocks. To meaningfully slow the rate of buybacks, rates need to rise at least a hundred and maybe a hundred fifty basis points.

Households cannot stand a rate hike that big. Indeed, household borrowing choked on the 25bp hike last December. US households account for two-thirds of US GDP, and in the past year, they account for more than 90% of GDP growth. A rate hike big enough to stop the corporate buyback machine will throw the US economy into recession.

Regulatory reform since the financial crisis was aimed at three things (primarily). 1.) Fix a corrupt mortgage industry. Among other things, this meant eliminating the cheapest-to-service teaser loans. 2.) Make banks safer. Among other things, this has made all bank transactions more expensive, because they have to pay for those armies of compliance and risk-management officers somehow. And 3.) Protect consumers from themselves. Among other things, the CFPB works hard to ensure people no longer use their homes a collateral to buy cars, gas and groceries.

As a result, the spread between the fed funds rate and the marginal rate at which households can borrow is wider than it was pre-crisis. Probably several hundred basis points wider. Given households’ prominence in the economy, we think this is the single most important reason natural rates, including long-term natural rates (r*) are so low. A much, much lower fed funds rate is required to achieve the same marginal rate for households. But not for corporations. As long as a company can access the bond market, regulation has not affected its borrowing costs.

Feldstein is right that the Fed should do something to prevent a stock market bubble from further inflating. Rate hikes are not the answer, however, because the economy cannot stand higher rates. Instead, the FSOC should use macro-prudential regulation to increase corporate borrowing costs. They could encourage Congress to tax bond issues, they could use “moral suasion” with the credit rating agencies to encourage them to rate over-leveraged industrials with the same scrutiny they currently apply to financials, or any number of other things. But raising the fed funds rate enough to choke off the corporate underwriting machine will crush household borrowing and result in recession.

Wage inflation is the only way the poor and middle class can close the income gap with the rich. Wage inflation only comes when he economy is at or near full employment, late in the business cycle. We are finally there. The recovery phase of this expansion was unusually long because the Great Recession was unusually destructive, but wages are finally rising faster than other forms of income. The gap closed a bit last year, but most Americans are making less than they did in 1999.

Even if you don’t care about the poor, closing the income gap is a good idea, because people are fed up with being left behind. If they cannot get relief economically, they will get it politically, through taxes and redistribution. They are already lashing out at the establishment who put them in this predicament. The anti-globalization sentiment on the front page of today’s WSJ, the Sanders and Trump phenomena, anti-Fed protests. These are all warning signs of what will be a lot worse if the Fed throws the economy into recession prematurely. So, yes, address the stock market bubble, but not by throwing the economy into recession with rate increases households cannot tolerate.

Today in the US, the September jobs report. It is being billed, by Bloomberg News anyway, as the deciding factor for the Fed in December, but since there are two more jobs reports before December 14, it is probably better to consider it one of several things that will decide what the Fed does in its last meeting this year.

·        Nonfarm payrolls are expected to have increased 172k

·        The unemployment rate is expected to be stable at 4.9%

·        Average hourly earnings are expected to have risen 0.3% m/m, 2.6% y/y

·        Also today, wholesale inventories and consumer credit.

Chris Low

Posted in Uncategorized | Comments Off on Morning Musings

Credit Pipeline

Via Bloomberg:

IG CREDIT PIPELINE: Friday Issuance Has Been Seen Often YTD
2016-10-07 09:30:26.669 GMT

By Robert Elson
(Bloomberg) — Friday sessions YTD have seen serious
issuance.

* Self-led Financials as C, JPM, MS, WFC, DB, RY have all done
Friday deals this year
* Non-financials have also done some Friday deals, including:
AT&T ($6b), PEP ($2.5b), NWL ($8b), F ($2.25b)

LATEST UPDATES:

* Yes Bank (YESIN) Baa3/na, plans to raise $500m by year’s end
* Republic of Namibia (REPNAM) Baa3/BBB-, to hold non-deal
investor meetings Oct. 7-13, via Barc/JPM/StanBk
* Japan International Cooperation Agency (JICA) na/A+, files
to sell $125m bonds, via Barc/BAML/Daiwa
* ICBC NY Branch (ICBCAS) A1/A, hires BNP/BAML/C/WFS for
investor meetings Oct. 11-14; USD $benchmark issue expected
to follow
* Asciano (AIOAU) Baa3/BBB-, names ANZ/BNP/Miz for investor
meetings Oct. 10-28; it is a non-deal roadshow; last priced
a USD deal in 2011
* Western Union (WU) Baa2/BBB, filed debt shelf; last issued
Nov. 2013 following Oct. 2013 filing
* Export-Import Bank of Korea (EIBKOR) Aa2/AA, hires
ANZ/BAML/CA/Miz/Samsung/SG/UBS for investor meetings from
Oct. 3; USD short to intermediate maturity deal may follow
* Comision Federal De Electricidad (CFELEC) Baa1/BBB+,
mandates BBVA/BAML/C for investor meetings from Oct. 4
* Global Bank Corp (GLBACO) Ba1/BBB-/BBB-, has mandated
C/DB/JPM/UBS for investor meetings Oct. 3-6; 144a/Reg-S
$benchmark deal is expected to follow
* Government of Bermuda (BERMUD) A2/A+, mandates HSBC for
roadshows Sept. 30- Oct. 10; 144a/Reg-S issue expected to
follow
* Partial tender also announced
* Bermuda last priced a USD deal in 2013
* Nafin (NAFIN) A3/BBB+; mandates BofAML, HSBC for investor
meetings Sept. 27-28; USD-denominated deal may follow
* Analog Devices (ADI) A3/BBB; ~$13.1b Linear Technology acq
* $5b loan received after $11.6b bridge (Sept. 26)
* Sumitomo Mitsui Trust Bank (SUMIBK) A1/A; mandates
C/Daiwa/GS/JPM to arrange investor calls beginning Sept. 26;
144a/Reg-S 3Y fixed and/or floating issue expected to price
in the near future
* Kingdom of Saudi Arabia (SAUDI), may raise over $10b
following roadshows in late Sept.
* KEB Hana (KEB) A1/A; mandates C/CA/JPM/SCB/UBS for investor
mtgs from Sept. 26; 144A/Reg S transaction may follow

MANDATES/MEETINGS

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

M&A-RELATED

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

SHELF FILINGS

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

OTHER

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

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