Across the Curve

Dueling PMs

Via Bloomberg:
Gundlach, Fidelity Differ on Treasuries as Citi Says Buy on Dips
Narayanan Somasundaram
sonarayanan
September 21, 2016 — 10:26 PM EDT
Updated on September 22, 2016 — 2:14 AM EDT

U.S. 10-year note yield will rise above 2% this year: Gundlach
Fidelity sees yields staying at historically low levels

Jeffrey Gundlach and Fidelity Investments differed in their outlook for Treasuries as Citigroup Inc. advised buying the securities on dips as the U.S. economy and inflation are unlikely to strengthen later this year.

Gundlach, chief investment officer at DoubleLine Capital LP, said on CNBC the U.S. 10-year note yield will rise above 2 percent in 2016 and a Federal Reserve interest-rate increase in December isn’t a given. Bill Irving, co-manager of Fidelity Government Income Fund, said yields will remain low and there’s a 60 percent chance of a Fed increase by year-end.

“Yields will remain at historically low levels for some time,” Irving said, according to the transcript of an interview on Fidelity’s website. “In that environment, I’d be cautious about reaching for yield.”

The two money managers agreed the world’s largest economy faces challenges. While signs of labor-market strength have led bond traders to price in a growing likelihood of a rate increase by year-end, other data such as August retail sales and industrial production have shown declines.

The U.S. 10-year note yield was little changed at 1.65 percent as of 7:10 a.m. in London on Thursday, according to Bloomberg Bond Trader data. The price of the 1.5 percent security due in August 2026 was 98 21/32. The yield will climb to 1.72 percent by year-end, according to analyst forecasts compiled by Bloomberg.
Positive Return

Treasuries have returned 4.6 percent in 2016 as economic circumstances in the U.S. and abroad caused the Fed to delay tightening policy multiple times after a liftoff from near zero in December. The central bank left its key rate unchanged for the sixth straight time Wednesday.

“The strategy going forward is to buy duration on dips for investors who agree with us that economic activity and inflation data are unlikely to strengthen into year-end,” Jabaz Mathai, a rates strategist at Citigroup in New York, wrote in a research note. The bank likes the seven-year part of the yield curve and also expects the longer end to do well, he said.

Duration is a measure of a bond’s sensitivity to changes in yield, and a larger figure indicates a more bullish position.

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FOMC Analysis

Via TDSecurities:

TD SECURITIES DATAFLASH

US:  Second Hike is Just Around the Corner

·         Federal Reserve leaves its fed funds rate unchanged but delivers a statement that virtually cements a 2016 hike. The accompanying dot plot helped to offset a lot of this dovishness by paring back the pace of 2017 hikes.

·         The Summary of Economic Projections (SEP) included minor tweaks, with the most notable being a flatter path in core PCE inflation and a downward revision to longer run GDP growth. The projections on balance indicate that while economic growth remains on track, a patient, gradual pace of rate normalization is still warranted.

·         Despite a dovish move lower in the dot plot, the statement and Yellen’s press conference suggests a Fed very close to hiking before year-end. We think this argues for higher front end US rates and a flatter 5s-30s curve. We initiate a 5s-30s flattener at current level.

·         The USD is likely to benefit over the medium term but carry trades still have value. Look for the CAD, EUR and GBP to weaken while the JPY remains focused on domestic factors.

Summary: The Federal Reserve matched the market expectation in holding its fed funds rate unchanged today but delivered a statement that expressed a firm willingness to hike before the end of the year. In an effort to counterbalance this hawkishness, the dot plot contained in the SEP showed a slower pace of hikes over 2017 (only two versus three). Going through the statement, every change was an upgrade, and the most notable hawkish element was the assessment that the near-term risks to the outlook ‘appear roughly balanced’. The statement also echoed Chair Yellen’s remarks from Jackson Hole that the case for an increase had ‘strengthened’ but that that the majority of members wanted to see a bit more evidence to ensure the growth narrative is on track. To that end, there were three dissents at this meeting with Mester and Rosengren joining George in voting for a hike at this meeting.

SEP: Medium-term GDP growth projections were nearly unchanged, with growth in 2017/2018 still expected at 2.0% while 2016 growth saw a downward revision (1.8% vs 2.0%) as anticipated on account of the Q2 slowdown. The new median estimate for 2019 growth shows a deceleration to 1.8%.  More notably, the median longer run GDP projection was lowered to 1.8% vs 2.0%.

PCE inflation projections were also little revised, with both headline and core inflation still expected to achieve the 2% target rate by 2018. The projections do indicate a slightly flatter trajectory in the near-term, with core inflation expected to firm to 1.7% by year-end and inch higher to 1.8% in year-end 2017 before reaching the target rate in 2018.

A slightly higher unemployment rate is expected in the near-term, with the median projection revised up to 4.8% vs 4.7% in June. The trajectory in subsequent years was lowered marginally, with the rate expected to fall to 4.6% in 2017 (unchanged from the June SEP) and to 4.5% in 2018 (vs 4.6% in June), before inching higher to 4.6% in 2019. The longer run unemployment rate estimate was left unchanged at 4.8%.

Dot Plot: The median 2016 mid-point fed funds target rate was 0.625%, indicating one 25bp hike by yearend. Near-term policy views saw more dispersion than expected: ten participants see one hike this year, while four participants look for 2+ hikes and three participants look for policy to be left unchanged. On balance, the distribution is tilted to the hawkish side. Looking further out, the updated dot plot implies a pace of 2 hikes in 2017, 3 hikes in 2018, and 3 hikes in 2019, indicating a flatter trajectory than implied in June (when the dot plot indicated 3 hikes each in 2017 and in 2018). The median for the longer run rate was lowered at touch to 2.9% vs 3.0%. On balance this suggests a slightly more patient Fed, consistently with flatter path in core PCE inflation.

Press Conference: Chair Yellen’s press conference echoed many of the themes outlined in the statement, emphasizing the likelihood of one hike this year absent the arrival of new risks. Her focus on an improvement in the labour force participation rate was particularly telling, as it suggests the Fed would like to see a bit more progress on that front before hiking. In discussing the dissents, Yellen noted that there was a range of views expressed but that there was less disagreement than the headline would indicate. As expected, Yellen ducked the question on the upcoming election.

Bottom-line: The Fed combined a hawkish statement with a dovish dot plot for 2017 and beyond. While some focus was on the three dissents for a hike today, the narrative actually suggests one of a broader consensus from more on the Fed for the path forward with larger clusters in the median expectations. It would take a significant deterioration in the data flow to push the Fed away from hiking by the end of the year. The sharpness of the language suggests the November meeting is possible though for the time being we expect the hike to come in December, given the timing of the election. Over a longer horizon, the dovish shift lower in the 2017 dot and in the longer-term dot helps to reinforce the theme of gradualism that still gives the Fed scope to hike at an even slower pace if the economy were to struggle.

Rates Implications: The market was pricing in only a 65% chance of a hike in 2016, so the combination of the FOMC statement today and dot plot argues for a higher probability of a hike this year. This should pressure front end rates higher. However, the Fed also highlighted an even slower pace of policy normalization (compared with June) with the move lower in the dot-plot including the long run dot. This should keep the long end of the curve well anchored. In addition, the BOJ earlier today also undertook yield curve targeting and aim to keep the 10y JGB at current levels. This removes one source of pressure for long end US rates to head higher. Thus, we like 5s-30s curve flatteners. The curve did flatten by 3bp on the day but we believe that there is more room to go. We initiate 25k DV01 of 5s-30s Treasury flatteners at 121bp with a target of 105bp and stop of 131bp. 

FX Implications: While the USD has seen some modest weakness in the immediate aftermath of the September FOMC, we think the outcome actually adds to our selectively bullish case for the USD as we approach Q4. Dips from here are likely to be shallow for the USD against most G10 counterparts. While the December meeting is still some time away – implying some risks that a hike could still be derailed – FX markets will come to think that the hurdle for this is relatively high. That the FOMC has moved toward a tightening posture despite disappointing recent performance in some high-profile economic indicators suggests that policymakers remain confident in the broader trajectory of the US economy. Despite the FOMC’s broadcast that a rate hike may be imminent, however, we think the FX market could exhibit some divergent performance across the G10 spectrum for the very near term. While the statement has taken on an incrementally hawkish tone, this is not (yet) enough to derail the carry trade in our view. This strategy, which has largely dominated currency markets in recent months, is not dead yet. Only a sharp drop in risky asset prices – equities in particular – may be enough of a catalyst to shake investors out of these positions in the immediate future. The initial knee-jerk reaction in equities is encouraging on this front. Looking forward, we think the European complex will come under increasing pressure in coming weeks. In particular, we expect the GBP and EUR to underperform. We are cautious toward USDJPY, however, as the market will need some time to digest last night’s BoJ, while the Fed’s decision should support our view that USDCAD will trend toward our end-2016 forecast of 1.35.

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BOJ

Via WSJ:
By TAKASHI NAKAMICHI and MEGUMI FUJIKAWA
Updated Sept. 21, 2016 3:33 a.m. ET
18 COMMENTS
TOKYO—Japan’s central bank took an unexpected step Wednesday, introducing a zero interest-rate target for 10-year government bonds to step up its fight against deflation, after an internal review of previous measures that fell short of expectations.

The adoption of a long-term target, the first such attempt in the BOJ’s history, came as global central banks struggle to find ways to get prices rising.

Financial markets gyrated following the Bank of Japan’s announcement of what it called a “new framework” to overcome deflation. Some thought it illustrated the limits of the BOJ’s powers, since the decision didn’t include any direct new stimulus measures, while others were encouraged by the BOJ’s tone.

The dollar was around 102.60 yen in afternoon Tokyo trading, compared with around ¥101.90 before the decision.

The 10-year Japanese government bond yield had already been near zero in recent weeks. It was minus 0.06% just before the decision and was minus 0.03% in Tokyo afternoon trading hours after the decision.

The new framework puts 10-year interest rates at the center of policy, a contrast to the BOJ’s approach for the last 3½ years under Gov. Haruhiko Kuroda, when asset purchases and expanding the monetary base were the key policy tool.

In practice, the difference may not be as great, since the BOJ will likely keep up the large-scale asset purchases it has made to date, aiming to guide the 10-year interest rate to the zero target.

Speaking to reporters, Mr. Kuroda said the new rate target makes it easier to respond flexibly to achieve his 2% inflation target. He said controlling bond yields was now the central pillar of his easing framework.
In an additional rhetorical easing step, the BOJ promised to keep the monetary base growing until after inflation “exceeds” 2% and stabilizes there. Previously the central bank had set a 2% inflation target without talking about exceeding it.

The monetary base is the sum of banks’ cash reserves and currencies in circulation. The revised “forward guidance” is tantamount to vowing to continue ultra-easy policy for longer than economists generally thought. Consumer prices, including energy, fell in July for a fifth straight month.
The BOJ has pumped hundred trillions of yen of fresh money into the banking system since 2013, and early this year it introduced negative rates on certain deposits held by commercial banks at the central bank.

It has sought to liberate the economy from a negative cycle of price falls dating to the 1990s. But the attempts have proved less powerful than advertised. Officials have recently acknowledged that more time may be needed to change what they call a “deflationary mind-set,” or entrenched doubts over inflation prospects that depress actual prices. Gov. Haruhiko Kuroda has missed a promise made in 2013 to generate 2% inflation in two years, and is now well into his fourth year in office.

The 10-year rate target followed intense debate among board members over how they could redesign the BOJ’s easing program to strengthen sustainability without suggesting it was in retreat.

The central bank left its annual target to buy Japanese government bonds unchanged at ¥80 trillion a year, and maintained its key rate at minus 0.1%. However, people close to the BOJ said central-bank officials no longer view the ¥80 trillion target as rigid and might adjust it if necessary to meet interest-rate targets.

Tohru Sasaki, head of Japan markets research at J.P. Morgan in Tokyo, said he didn’t expect the yen’s weakness to last because the BOJ’s “monetary policy is facing the limit on the currency front.” Previously, the yen has strengthened whenever markets take the view that the BOJ has run out of cards to play.

The BOJ left the door open to further easing, including driving lower the 10-year rate or the negative rate on commercial-bank deposits. The BOJ didn’t specify what conditions could spur it into action.

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Credit Pipeline

Via Bloomberg:

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FX

Via Marc Chandler at Brown Brothers Harriman:

BOJ Eases Self-Imposed Restrictions, but Can’t Weaken the Yen

• Much of what the Bank of Japan announced today had been largely leaked
• Attention turns to the Federal Reserve
• In lieu of a rate hike, the dot plots and Yellen’s press conference will be the focus
• A big (7.5 mln barrel) drop in API crude inventories is underpinning oil prices ahead of the DOE estimate
• USD/MXN made another all-time high above 19.90 yesterday before recovering; South Africa August CPI eased to 5.9% y/y ahead of SARB meeting tomorrow

The dollar is mostly softer against the majors ahead of the FOMC decision.  The Aussie and the Norwegian krone are outperforming while the euro and the Swedish krona are underperforming.  EM currencies are mostly higher.  ZAR and RUB are outperforming while TWD and PHP are underperforming.  MSCI Asia Pacific was up 1.6%, while the Nikkei was 225 up 1.9%.  MSCI EM is up 0.5%, as Chinese markets rose 0.3%.  Euro Stoxx 600 is up 0.9% near midday, while S&P futures are pointing to a flat open.  The 10-year UST yield is flat at 1.69%.  Commodity prices are mostly higher, with oil up 2%, copper up 0.3%, and gold up 0.4%.

Much of what the Bank of Japan announced today had been largely leaked.  While there was a sizeable response in the asset markets, the dollar’s knee-jerk gains against the yen were quickly unwound.  

The BOJ lifted its self-imposed restrictions on its asset purchases and shifted the focus of policy from the monetary base to the yield curve.  It is not clear that this shift increases the chances of the BOJ reaching its inflation target.  

Going forward it will implement its JPY80 trillion increase in the monetary base more flexibly, and will no longer have an average maturity target.  This produced a dramatic sell-off in JGBs.  Japanese bonds maturing in 1 to 15 years saw their yields jump 20-40 bp.  Longer-dated bonds rose less.  The 20-year yield rose 13 bp, and the 30-year yield increased by a dozen bp.  The 40-year bond yield was practically unchanged.  

The BOJ also indicated it would stick with its JPY6 trillion a year purchases of equity ETFs, but changed the distribution.  It will buy more of the broader Topix.  Many participants had anticipated this, and there had been some outperformance of the Topix and the Nikkei 400 in recent days.  This continued today with the Topix and Nikkei 400 up 2.8% and the Nikkei 250 up almost 2%.  

The dollar initially fell to almost JPY101 before rallying to JPY102.80.  However, the enthusiasm was not sustained and the greenback eased back to JPY101.60.  It has been confined to about a 30 tick range in the European morning.  

Most Asian equity markets were higher, led by Japan.  The MSCI Asia-Pacific Index rose 1.4%, the biggest gain in two months.  European markets are also higher, with the Dow Jones Stoxx 600 up 0.6% in late-morning turnover.  Financials and telecoms are outperforming.

Attention turns to the Federal Reserve.  Most participants are convinced the Fed will not lift rates today, but will signal its intention to hike in December.  There is a meeting in November, but there is no precedent for changing policy so close to a national election.  

We try to be careful to separate what we think the Fed will likely do from what we think it ought to do.  We think the Fed ought to raise interest rates today.  In one stroke it would recoup some of the credibility that critics say it has lost.  It would shift debate from over-promising and underdelivering to delivering a surprise.  We argue that the US economy is resilient enough to withstand a 25 bp rate hike.  In addition, contrary to some arguments that think the international climate is not supportive, we suspect that a Fed hike now would be welcomed by other central banks, whom many have exhausted the political willingness to ease monetary policy further.  

In lieu of a rate hike, the dot plots and Yellen’s press conference will be the focus. The FOMC finished last year saying that four hikes would likely be appropriate this year.  The dot plot, however, is not a commitment or promise.  Nevertheless, it shows how far the Fed was from the mark.  In June it shifted to two hikes.  Now, if it is going to maintain that every meeting is live, it must signal a single hike.  The news stream could be a bit more supportive.  Following last week’s CPI and yesterday’s housing starts, the Atlanta Fed shaved its Q3 GDP tracker to 2.9%.  It will still be the first quarter in four that growth surpassed its trend of around 2%.  

A big (7.5 mln barrel) drop in US crude inventories is underpinning oil prices today ahead of the government’s estimate.  It appears to be lending support to the Canadian dollar, Mexican peso, and the Norwegian krona.  Sterling remains out of favor.  It is the poorest performer over the past week, losing almost 2% and spending more time below $1.30.  The low from last month was set near $1.2865 and in July just below $1.28.  The euro sold off after poking through $1.1210 yesterday.  It closed on its lows near $1.1150 and saw follow through selling to just below $1.1125 to match the late August low.  Initial resistance is seen near $1.1160 ahead of the FOMC announcement.

USD/MXN made yet another all-time high just above 19.90 yesterday before recovering today.  MXN had weakened for 6 straight days and for 9 of the past 10 days, losing nearly 10% over that span.  If sustained, today’s gains could break that streak.  We’ve been warning of potential Banxico intervention, and we think it’s getting more likely.  The market is short pesos, though not as extreme as back in January/February.  On the other hand, MXN is underperforming and vol is spiking.  We don’t think they’d intervene to protect a particular level, however.  In terms of timing, one could make the argument that Banxico should wait until after the BOJ/FOMC meetings.  Then, if risk and EM rally afterwards, that would be the perfect time to come in and intervene, going with the market instead of against it.  We saw a similar dynamic back in February.

South Africa August CPI rose 5.9% y/y, as expected.  That puts it back in the 3-6% target range for the first time since December.  The South African Reserve Bank meets tomorrow and is widely expected to keep rates steady at 7.0%.  With the economic outlook so poor, we think the central bank would prefer not to tighten any more.  The rand is the wild card, but recent gains should allow SARB to stand pat tomorrow.  Indeed, the tightening cycle is likely over, but easing is unlikely until 2017.  

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Retail Sales Analysis

I wont be a regular blogger the next several days but here is a retail sales recap via TDSecurities:

US: Retail Sales Falls Short of Expectations  

·         August retail sales slipped by 0.3% m/m, which was worse than the consensus had expected. Much of the weakness was concentrated in autos and in sales at gasoline stations, but core spending was still lower in the month at -0.1%. The simultaneous release of regional manufacturing indices for September were also disappointing.

·         The theme of disappointment in the data helps to drive home the view that the Federal Reserve will remain on the sidelines next week. The outlook is nevertheless expected to brighten over the balance of the year and it will provide the Fed with the requisite confidence to hike at its December meeting.

Retail sales fell 0.3% m/m in August following a modestly upwardly revised 0.1% increase in July (previously reported 0.0%). Spending on motor vehicles and parts contributed to the decline as expected, as light-weight vehicle sales retreated to a 16.9m unit annual rate in August. Lower gasoline prices also dented gasoline station sales receipts, which fell 0.8%. Excluding the auto and gas components, retail sales fell 0.1% in August, matching the print in the control group. Sizeable declines were seen in sporting goods category (-1.4%), building materials (-1.4%) and furniture/home furnishings (-0.7%), all of which contracted for a second month. Sales at department stores remained weak, falling for the fourth consecutive month. The non-store retail category which included electronic shopping slipped 0.3%, posting its first decline since January 2015. Offsetting increases were recorded for food services and drinking places (0.9%) and clothing/accessories stores (0.7%), with more modest increases in food/beverage and electronics/appliance stores.

Underlying retail sales effectively stalled in August, as the core figures failed to register a bounce back from their July decline. Today’s release tempers our consumer spending projections for a 3+% annual pace in Q3.  It is important to note, however, that retail sales projections are heavily revised while a September bounce back remains in the cards given overall healthy consumer fundamentals.

A quick skim of the second-tier data released today also warrants a cautious tone. The September Empire Manufacturing index improved just slightly to -1.99 from -4.21 (the market had expected a -1.00 print) while the Philly Fed jumped to 12.8 from 2.0. On a ISM-weighted basis, the Philly Fed index ended up declining to 43.7 from 45.4 while the Empire index slipped to 45.4 from 50.1. Collectively, this does not paint a great picture of manufacturing activating given the drop in the ISM index in August.

Continued momentum in household spending in an important component in the Federal Reserve’s growth narrative and the softening in Q3 is consistent with the theme of patience. As outlined by Governor Brainard prior to the media blackout ahead of next week’s FOMC meeting, this is not the cycle to be preemptive when looking to normalize policy. In our view, and supported by the data released today, a September hike is simply too soon. This then makes a December move more likely conditional on the data to unfold as per our expectations. The releases today, however, are not a step in the right direction. In terms of the market reaction, the disappointment on retail sales initially extended the rally in government bonds and undercut the USD, but the move post data has since been unwound.

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Thirty Year Bond Auction Preview

Via Ian Lyngen:

We are cautiously optimistic about this afternoon’s long-bond Reopening auction and are anticipating a fair takedown (on-the-screws) or a modest stop-through – assuming that the recent concession is enough of an incentive to attract dip-buyers.  We’re also cognizant that the sector has recently performed well at auction and while the Fed’s off the table for next week, the notion holds that a hike by year-end should ultimately prove supportive for the long-end of the curve.  That said, rates are still low in absolute terms (despite a WI that points to the highest yielding 30-year auction since June) and the risk that no one wants to step in front to the recent trend is meaningful.  Between the general flattening bias and continued interest rate differentials vs. comparable sovereigns the overall non-dealer demand should be strong regardless of the through/tail dynamic. In addition, unlike yesterday’s 10-year, the long-bond doesn’t face a double-auction or proximity to a key Fed-speaker – clearing the way for a less muddied view on demand.

• 30-year auctions have recently been well-received with only one tail during the last six auctions – an impressive achievement for the duration-heavy sector that’s historically required a more significant concession to be underwritten.  Moreover, first Reopenings have a strong tendency to go well, stopping-through at four of the last five for an average of 0.8 bp.

• Overseas accounts have been improving in recent 30-year Reopening auctions taking 13% during the last four vs. 9% at the prior four.

• Investment fund buying has slipped to 59% or $7.1 bn during the last four Reopening auctions vs. 60% or $7.7 bn in the prior four.

• The technicals are once again bearish – a meaningful theme as we approach the auction.  Stochastics clearly point toward a further selloff – although we’re edging into oversold territory.  We’ve now seen the Brexit-day closing gap filled and what remains for support is Monday’s yield peak of 2.413%.  Beyond there is very little in terms of support until the Brexit-day opening gap at 2.521% to 2.555%.  For resistance the breakout level of 2.326% is key before the combination of 9-, 21-, and 40-day moving-averages which come in at 2.26% to 2.27%. Through there is last week’s low-yield close of 2.224% and the isolated yield low of 2.204%.

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FX

Via Marc Chandler at Brown Brothers Harriman:

Dollar Firms Amidst Much Noise, Weak Signal

• The dollar was firm before its Brainard-induced gyrations, and it has regained its footing
• China reported firm August IP and retail sales
• The UK and Sweden both reported lower than expected August CPI
• South Africa’s current account gap narrowed; Brazil reports July retail sales

The dollar is broadly firmer against the majors as risk off trading picks up again.  The Norwegian krone is the exception and is outperforming while the dollar bloc and sterling are underperforming.  EM currencies are mostly weaker.  THB and TWD are outperforming while MYR, MXN, and ZAR are underperforming.  MSCI Asia Pacific was down 0.1%, with the Nikkei rising 0.3%.  MSCI EM is up 0.2%, with Chinese markets falling 0.1%.  Euro Stoxx 600 is up 0.1% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 2 bp at 1.65%.  Commodity prices are mixed, with oil down 2-2.5%, copper up 0.7%, and gold up 0.1%.

The dollar was firm before its Brainard-induced gyrations, and it has regained its footing.  It was technically notable that the euro remained confined to the previous session’s range. It requires a move above the $1.1270-1.1300 band to lift the tone.  On the downside, initial support is pegged at $1.1200.  The dollar was pushed a bit lower in Asia against the yen, falling to nearly JPY101.40.  It stopped shy of the objective we saw near JPY101.20.  The JPY102.15 area marks the first hurdle.  

Sterling remains in narrow ranges around $1.3300.  The dollar-bloc is under some pressure.  The Australian dollar rally yesterday has been pared and it is back probing support in the $0.7500 area.  A break of $0.7480 may shake out some of the late longs.  We continue to look for the greenback to test CAD1.3150 on its way to CAD1.32.

Our approach to Fed-watching is clear.  Among the cacophony of voices, the Troika of Fed leadership Yellen, Fischer, and Dudley provide the clearest signal.  They are most often on message, and their comments have been the best indications of policy.  

Remember at the end of last summer; Dudley said a rate hike was less compelling.  This foretold the lack of hike last September.  Earlier this year, as several regional presidents were talking up a rate hike, Yellen pushed against it.  

Governor Brainard is the newest member of the Board of Governors.  Well, technically, Fischer was confirmed at the same time, but his experience is vastly superior.  Brainard has completed a little more than 2 years of her 12-year term.  This is not to impeach her comments.  They are thoughtful and well considered.  They were thoughtful and well considered six months ago too.  She has not changed her assessment, though circumstances have changed.  

First, the global risks appear to have eased.  The UK referendum has come and gone.  The global capital markets have become decoupled to a large extent from what happens to the Chinese yuan and stocks.  It is the politics of several emerging market countries (like Brazil, Mexico, Turkey, and South Africa), not the economics that has been the source of consternation by investors.  

Second, the nine-month soft-patch in which the US economy grew less than 2% appears to be ending now.  We are familiar with three regional Federal Reserve’s GDP trackers.  The St. Louis Fed’s and the Atlanta Fed’s models point to an annualized pace of more than 3% here in Q3.  The NY Fed says the economy is tracking 2.8%.  

Third, the fact that the Fed does not have conventional monetary tools at its disposal is an argument that has been developed to encourage policymakers to gradually raise interest rates.  However, Brainard turns this argument on its head.  She suggests that the limited arsenal should make the Fed even more cautious about taking risks, such as raising rates.

Brainard argued that guarding against downside risks is preferable to preemptively raising rates to guard against upside risks.  This seems to misunderstand the purpose of raising rates.  It is not to ward off too tight of a labor market or too strong of growth or too high of inflation.  A series of several rate hikes over the next couple of years would give it the interest rate tool again.  

We can agree with Brainard that there is no hurry and the Fed should be cautious as macroeconomic relations may have changed, such as employment and inflation.  However, given the forward momentum of the economy, the improvement in the labor market, the modest upward pressure on prices, the Fed has arguably been cautious and patient.  Would a second rate hike in two years change that assessment?

We wonder too if the significance of 25 bp increase in the Fed funds target range is not being exaggerated.  The real funds rate remains below zero, which is a measure of the monetary stance, even on a 25 bp increase.  It is hard to see the impact of the December 2015 rate increase.  Three-month LIBOR has risen nearly as much due to the reforms in the US money market as it did in response to the Fed’s hike.   At the end of the day, we agree with Brainard.  Monetary policy should be cautious and prudent.  A 25 bp hike does not make the Fed incautious or imprudent.  

Nevertheless, Brainard is the second Fed Governor (Tarullo being the other) that seemed to demur from the Troika (Yellen, Fischer, and Dudley).  The market downgraded the chances of a Fed hike in September.  Bloomberg’s calculation (WIRP) fell from 30% before the weekend to 22%.  The CME (where the contract is traded) saw the probability falling to 15% from 24%.  For the record, the probability shift was a function of the implied yield falling three-quarters of a basis point to 41 bp.  

The US two-year note yield fell a little more than a single basis point on Monday.  The decline in response to Brainard was less than 4 bp from the 80 bp level that was seen as the pre-weekend move was continued.  The Financial Times called this a “plunge” but this is clearly hyperbolic.  Recall that as recently as the middle of last week, the yield was near 71 bp.  

While the dollar and US interest rates were little changed at the end of the session, the S&P 500 sustained a strong bounce.  The S&P 500 open below the pre-weekend lows.  This created a gap that was soon filled.  The gap created by last Friday’s sharply lower opening is key.  It is found between 2169.06 and 2177.49.  To repair the technical damage, the S&P 500 would ideally close above the top of that range.  Most bullish would be a gap higher on Tuesday, which simply does not look to be in the cards.  

Asian stocks performed poorly in light of the US equity rally and Chinese economic data.  The MSCI Asia-Pacific was down 0.1%, while MSCI EM is up 0.25% in the European morning.  China reported a series of data that lend credence ideas that the world’s second-largest economy is stabilizing.  In turn, that keeps speculation of easier monetary policy in check.  

China’s industrial output rose 6.3%, a little better than expected and a bit faster than the 6.0% pace in July.  Retail sales rose 10.6% after a 10.2% gain in July.  Fixed investment rose 8.1% in the first eight months.  This is steady from the rate reported in July, but it is a little above expectations.    

Some economists use power output to generate insight into growth, with the GDP figures seen as suspect.  Power output rose 7.8% in August from a year ago.  Just like capital investment in China has reached a point of diminishing returns, so too has energy output. There may be a gap between energy output and consumption.  It may also be that low energy costs have deterred efficiencies.  Also, the increase power output may reflect more industrial activity.  

One detail that caught our attention was China’s steel output.  Recall that excess capacity in that industry is sufficiently salient to make it into the G20 statement.  Chinese officials have indicated intentions on shuttering some capacity.  They have around half of the world’s steel capacity.  However, today’s data showed steel output was 3% higher in the year through August.

The UK reported August CPI.  Headline inflation was 0.6% y/y vs. 0.7% expected, while core inflation was 1.3% y/y vs. 1.4% expected.  UK consumer prices were flat in 2015 (December CPI was zero year-over-year).  It stood at 0.5% in June and rose to 0.6% in July.  The core rate has been essentially flat.  It was 1.4% at the end of last year, and in August it edged up from 1.3% in July.  

The UK reports labor market data tomorrow and retail sales Thursday, but so far, the impact from the Brexit vote remains limited.  As such, the BOE is widely expected to remain on hold Thursday.

Germany ZEW survey for September came in at 0.5 vs. 2.5 expected.  The current situation components fell to 55.1 from 57.6, while 56.0 was expected.  ZEW President noted that “The current ambiguity of economic impulses from Germany and abroad means that forecasts for the next few months are difficult.”  Yet it’s clear from recent data that the eurozone’s largest economy is slowing, despite Draghi’s more upbeat economic assessment last week.

Sweden reported August CPI.  Headline inflation was 1.1% y/y vs. 1.2% expected, while CPIF remained steady at 1.4% y/y vs. 1.5% expected.  The next Riksbank meeting is October 27.  A lot can happen between now and then, but for now, markets see steady policy then.  However, further disinflation in the coming months would suggest that the Riksbank may eventually have to do more.  

South Africa reported Q2 current account gap at -3.1% of GDP.  The Q1 deficit was revised to -5.3% of GDP from -5.0% previously.  While the narrower current account gap would normally be considered ZAR-supportive, the improvement is being driven by weak consumption.  Indeed, with the economy remaining weak, the SARB is likely to keep policy on hold at 7% at its next policy meeting September 22.  The rand is the wild card going forward, as weakness could feed into higher inflation.  The rand is also one of the most vulnerable currencies in this risk off environment.

Brazil reports July retail sales, which are expected at -5.1% y/y vs. -5.3% in June.  The economy remains weak, but inflation may be too high to start the easing cycle at the next COPOM meeting October 19.  With fiscal and monetary policies remaining tight, the economic outlook is not so good near-term

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liquidity Squeeze in China

Via Bloomberg:

Yuan Liquidity Squeeze a Bad Sign for China’s Equity Market
Justina Lee
justinaknope
September 12, 2016 — 12:00 PM EDT
Updated on September 13, 2016 — 5:51 AM EDT

China focusing on currency at expense of stocks: Hao Hong
Yuan loan rates in Hong Kong surge to seven-month high

The outlook for one of the world’s worst-performing stock markets is getting dimmer.

China’s benchmark equity index was jolted out of its inertia on Monday when the cost of borrowing the yuan in Hong Kong jumped the most in seven months, exacerbating concern about a global selloff. The Shanghai Composite Index tumbled as much as 2.6 percent after having gone 19 trading days without a 1 percent closing move in either direction.

Higher funding costs will weigh on the nation’s shares as the People’s Bank of China seeks to squeeze bears betting against the yuan amid rising odds of a U.S. interest-rate increase, according to Bocom International Holdings Co. The yuan is set to enter the International Monetary Fund’s Special Drawing Rights on Oct. 1 in a validation of the government’s efforts to open up the nation’s financial markets.

“They want the currency to be relatively steady because we’re getting into SDR and they don’t want it to depreciate substantively before that,” said Hao Hong, chief China strategist at Bocom in Hong Kong, one of the few who predicted the start and peak of China’s equity boom. “So you have to give up the equity market. Of all the asset markets, I think the equity market is the least of concern now” to China’s policy makers, he said.

The Shanghai Composite dropped 1.9 percent on Monday, the most since July 27. The three-month Hong Kong Interbank Offered Rate climbed 95 basis points to 4.21 percent, the highest since March, according to Treasury Markets Association data. Gains in the yuan Hibor in January and last August coincided with routs in China’s gauge of so-called A shares as the PBOC sought to defend the currency against further weakness.

“The Hibor rate is a reference for A-share investors,” said Wu Kan, a fund manager at JK Life Insurance Co. in Shanghai. “Its surge means an increase in capital costs and that’s bad for equities.”

The Shanghai gauge is down 15 percent this year after last year’s $5 trillion selloff burnt investors. Monday’s losses came as shares were buffeted globally amid concern central banks in the world’s biggest economies are questioning the benefits of loose monetary policy. The Hang Seng China Enterprises Index plunged 4 percent in Hong Kong on Monday, the biggest loss since February, and another 0.9 percent on Tuesday.

There’s already concern China won’t ease monetary policy further. Capital outflows spurred by dollar strength will constrain the room for cutting benchmark rates or banks’ reserve requirements, according to Citic Securities Co., the country’s biggest brokerage.
Curbing Risks

China has shown a renewed focus on curbing financial risks lately, with a slew of proposals to tighten rules on wealth-management products, restructuring of listed firms and leverage in the bond market. The nation should take steps to restrain bubble-like expansion in housing markets and tame excessive financial inflows into property, Ma Jun, chief economist of the PBOC’s research bureau, said in an interview with China Business News published Sunday.

Monday’s jump in Hibor came as 12-month non-deliverable forward contracts on the yuan signaled traders were the most bearish on the yuan in almost four months. The currency is Asia’s worst performer this year with a 2.8 percent drop against the greenback to 6.6798 a dollar. Yuan interbank rates dropped in Hong Kong on Tuesday after the city’s monetary authority said in an e-mail on Monday that it has provided yuan liquidity support to banks.

“The PBOC squeezed offshore yuan supply and thus pushed up Hibor, in an effort to increase the costs for bears to bet against the currency,” said Ken Peng, an Asian investment strategist at Citi Private Bank in Hong Kong. “Hibor will likely remain elevated around the current level” until the U.S. raises borrowing costs, which Peng said would likely come in December.
Liquidity Demand

The rise in Hibor is probably due to increased demand for liquidity before the end of the quarter, according to Wing Lung Bank treasurer Terry Siu. China’s markets are closed for holidays on Thursday and Friday, as well as during the first week of October.

The increase in borrowing rates comes at a bad time for mainland shares, which have lagged behind their Hong Kong-listed equities.

“Psychologically, the Hibor surge will affect stocks,” said Steven Leung, executive director at UOB Kay Hian (Hong Kong) Ltd. “When interest rates go up, stocks suffer.”

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Credit Pipeline

Via Bloomberg:

IG CREDIT PIPELINE: 5 Triple-A Names to Price; List Grows Again
2016-09-13 10:02:16.250 GMT

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

* World Bank (IBRD) Aaa/AAA, to price $bench Global 5Y, via
managers C/DB/JPM/RBC; final spread MS +20
* Bank Nederlandse Gemeenten (BNG) Aaa/AAA, to price $bench
144a/Reg-S 2Y, via Daiwa/MS/RBC/TD; spread set at MS +8
* Bank of Nova Scotia (BNS) Aaa/AAA, to price $bench 144a/Reg-
S 5Y Covered Bond, via Barc/GS/HSBC/Sco/UBS; IPT MS +65 area
* Canadian Pension Plan Investment Board (CPPIB) Aaa/AAA, to
price $bench 144a/Reg-S 3Y, via BAML/DB/GS/HSBC; guidance MS
+26 area
* Kommunalbanken (KBN) Aaa/AAA, to price $1b 144a/Reg-S 5Y,
via JPM/Miz/Nom/TD

LATEST UPDATES

* Air Liquide (AIFP) A3/A-, plans $4.5b bond sale this week to
buy Airgas
* KEB Hana (KEB) A1/A, mandates C/CA/JPM/SCB/UBS for investor
meetings from Sept. 26; 144A/Reg S transaction may follow
* Ingredion (INGR) Baa2/BBB, files debt shelf; last issued in
Sept. 2012
* Activision Blizzard (ATVI) Baa2/BBB-, hires BAML/JPM/WFS for
investor calls Sept. 8; last seen in 2013
* Shire (SHPLN) Baa3/BBB-, plans 5-part bond offering to
partially fund Baxalta deal
* Investor meetings Sept. 12-15, via Barc/BAML/MS
* LafargeHolcim (LHNVX) Baa2/BBB, hires banks for investor
meetings Sept. 13-14; 144a/Reg-S 10Y-30Y offering may follow
* MTN Group (MTNSJ) Baa3/BBB-, mandates Barc/BAML/C/SCB for
roadshows from Sept. 9; 144a/Reg-S may follow
* Danaher (DHR) A2/A to buy Cepheid for ~$4b; sees financing
deal with cash and debt issuance
* BRF (BRFSBZ) Ba1/BBB, to hold investor meetings Sept. 12-13,
via BBSecs/Bradesco/Itau/JPM/SANTAN; 144a/Reg-S deal may
follow
* Banco Inbursa (BINBUR) na/BBB+/BBB+, mandates BAML/C/CS for
investor meetings Sept. 7-12
* Fitch says may price $1.5b 10Y
* NVIDIA (NVDA) Baa1/BBB-, to holdinvestor calls Sept. 7-8,
via GS/MS/WFS; $bench issue(s) may follow between 3-10 years
* Southern Company (SO) Baa2/BBB+, hires JPM/Miz/MUFG/STRH for
investor meetings Sept. 7
* Brunswick (BC) Baa3/BBB-, files automatic mixed shelf; last
issued in 2013
* Woolworths (WOWAU) Baa2/BBB, to hold U.S. debt investor
update call Sept. 7; last priced a new deal in 2011
* Sydney Airport (SYDAU) Baa2/BBB, to hold investor conference
calls Sept. 6-7, via BA,L/JPM/Sco; last issued in April,
$900m 144a/Reg-S 10Y
* Transurban Group (TCLAU) Baa1/BBB+, mandates BAML/C/JPM for
investor meetings Sept. 8-14; debt issuance may follow
* Municipality Finance (KUNTA) Aa1/AA+, to hold Green Bond
roadshows over the coming weeks, via BAML/CA/HSBC/SEB; plans
$500m 5Y-10Y 144a/Reg-S deal
* Kingdom of Saudi Arabia (SAUDI), may raise more than $10b
following roadshows in late Sept.
* Said to have hired 6 banks to lead first intl bond sale
(July 14)
* Korea National Oil (KOROIL) Aa2/AA, has mandated
C/GS/HSBC/SG/KDB/UBS for investor meetings to begin Sept. 6;
144a/Reg-S deal may follow
* Pfizer (PFE) A1/AA, to buy Medivation (MDVN) for ~$14b;
expects to finance deal with existing cash
* Moody’s maintained its negative outlook on PFE, saying
low cash levels may “lead to future debt issuance for
US cash needs.”
* Couche-Tard (ATDBCN) Baa2/BBB, expects to sell USD bonds
related to ~$4.4b acquisition of CST Brands (CST) Ba3/BB
* Enbridge (ENBCN) Baa2/BBB+, files $7b mixed shelf Aug.22;
$350m matures Oct. 1
* General Electric Company’s plan to take on additional $20b
of debt could pressure ratings, Moody’s says
* Industrial Bank of Korea (INDKOR) Aa2/AA-, mandates HSBC/Nom
for roadshow from Aug. 22; 144a/Reg-S deal may follow
* Israel Electric (ISRELE) Baa2/BBB-; said to hire C, JPM for
at least $500m bond sale in 4Q

MANDATES/MEETINGS

* Sumitomo Life (SUMILF) A3/BBB+; investor mtg July 19
* Woori Bank (WOORIB) A2/A-; mtgs July 11-20

M&A-RELATED

* Analog Devices (ADI) A3/BBB; ~$13.2b Linear Technology acq
* To raise nearly $7.3b debt for deal (July 26)
* Bayer (BAYNGR) A3/A-; said to review Monsanto (MON) A3/BBB+
accounts as bid weighed (Aug. 4)
* $63b financing said secured w/ $20b-$30b bonds seen
* 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

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

OTHER

* 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)
* GE (GE) A3/AA-; may issue despite no deals this yr (June 1)
* 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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