If You Need to Diversify Your Portfolio….

July 12th, 2016 3:07 pm

Via Bloomberg:

July 11, 2016 — 5:01 PM EDT
Updated on July 12, 2016 — 11:52 AM EDT

 

The global search for bond returns has pushed Ukrainian government debt to highs not seen since before the first bullets were fired amid anti-government protests in Kiev’s central square more than two years ago.

The yield on the country’s three-year dollar debt fell below 8 percent on Monday for the first time since January 2014, before the ouster of pro-Russian President Viktor Yanukovych and the annexation of Ukraine’s Crimean peninsula. Yields have tumbled more than four percentage points and the local currency has rallied since the peak of a government standoff in February this year before the appointment of a new prime minister diffused a fresh political crisis.

The rally signals investors are wagering on the country’s recovery after a $15 billion debt restructuring last year and as the government edges closer to unlocking the next payment in a $17.5 billion bailout from the International Monetary Fund. Investors worldwide are also looking for higher-yielding assets at a time when bets for a new bout of central bank stimulus push almost $10 trillion in securities tracked by Bloomberg to yield less than zero.

For more on Ukraine’s challenge to revive it’s economy click here

“Ukraine looks attractive in the ongoing search for yield,” said Fyodor Bagnenko, a managing director for fixed-income trading at Dragon Capital in Kiev, who says the nation’s Eurobond market is dominated by international investors. “The country is moving toward receiving the next tranche of IMF funds as well as $1 billion covered by a U.S. government guarantee.”

The yield on Ukraine’s dollar-denominated bonds maturing 2019 increased 17 basis points to 7.88 percent by 6:39 p.m. in Kiev, rising from the lowest for three-year borrowing costs since January 2014. The hryvnia, which is supported by the central bank’s capital controls, was little changed at 24.8325 per dollar, leaving it 8.3 percent stronger than at the end of February.

 

The pro-European Union protests in the capital’s Independence Square, known as Maidan, more than two years ago led to the toppling of Yanukovych’s government and spurred a separatist insurgency, pushing the country to the brink of default and forcing a restructuring that took Ukraine’s bonds to trade as low as a third of their face value. The deal included compensation for a 20 percent reduction to principal via warrants that tie payments to the nation’s economic performance.

Slowing consumer-price growth is also signaling recovery and boosting chances the central bank will cut its benchmark rate, currently at 16.5 percent, for a fourth consecutive month when it meets on July 28. Inflation slowed for a seventh month to 6.9 percent in June.

Policy makers have stepped up dollar purchases that helped boost sovereign reserves more than twofold to $14 billion last month from as low as $5.6 billion in February last year. The IMF may unlock as much as $4 billion this year under the country’s bailout, Prime Minister Volodymyr Hroisman said in an interview earlier this month.

While Vladimir Miklashevsky, a senior strategist at Danske Bank A/S in Helsinki, doesn’t recommend holding the notes given the possibility for political turbulence to return, he said some investors may be tempted.

“Ukraine’s economy is starting to look better on the extremely low base effect in 2014 and 2015, while geopolitical tensions have stayed away,” he said. “I see this moment as a window to benefit from high yields on lower risk. Any geopolitical escalation would quickly close that window.

Overnight Data Preview

July 12th, 2016 2:58 pm

Via Robert Sinche at Amherst Pierpont Securities:

At 10am Wednesday the Bank of Canada will release its Monetary Policy Report and, at the same time, is widely expected to hold its policy rate at 0.50%.

CHINA: Over the next week the PBOC will release its monetary report for June; the Bberg consensus expects that Aggregate Financing Activity to have picked up to CNY 1,100bn from a 7-month low of CNY659.9bn in May. The Trade data is expected during the next 2 days and the focus will be on Exports. Denominated in USDs, Exports fell steadily in 2015 but have steadied in recent months; the Bberg consensus expects a -5.0% YOY drop in June following a -4.1% YOY decline in May.

S. KOREA: The Bberg consensus expects the UR to have held at 3.7% in June, signaling a stabilization after a surge early in 2016.

JAPAN: The Industrial Production report is often subject to a large revision; the original -0.1% YOY decline reported for May was the 5th decline in the final 6 months.

INDIA: During the remainder of the week Trade data for June is expected to be released. In May, Exports slipped only -0.8% YOY, the smallest annual decline since November 2014.

EURO ZONE: Following weak reports in a number of countries, the Bberg consensus expects May Industrial Production to be reported down -0.8% MOM, which would bring the YOY gain down to 1.3% from 2.0% in April.

FRANCE: The Bberg consensus expects the EU Harmonized CPI to be confirmed at 0.3% YOY.

ITALY: The Bberg consensus expects the EU Harmonized CPI to be confirmed at -0.3% YOY.

SPAIN: The Bberg consensus expects the EU Harmonized CPI to be confirmed at -0.9% YOY.

Atlanta Fed GDP

July 12th, 2016 2:56 pm

Via FRB Atlanta:

Latest forecast: 2.3 percent — July 12, 2016

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2016 is 2.3 percent on July 12, down from 2.4 percent on July 6. The forecast of the contribution of inventory investment to second-quarter real GDP growth ticked down from -0.50 percentage points to -0.55 percentage points after this morning’s wholesale trade report from the U.S. Census Bureau.

The next GDPNow update is Friday, July 15. Please see the “Release Dates” tab below for a full list of upcoming releases.

Treasury Market Update

July 12th, 2016 6:58 am

Some interesting stuff overnight. Risk is back on as  global equities continue their surge and the pound sterling recovers. One commentator suggests that the surge is mostly short covering and partly a response to the modicum of stability which has emerged with the naming of new Prime Minister now a certainty. The Yen continues to weaken and that has buoyed Japanese equities.

The Treasury yield curve steepened as it cheapened. The 5s 10s spread moved to 43.1 from 41 just before midnight New York time. The 5s 30s spread widened to 115.7 from 112.8 in that same time frame. The 2s 5s spread climbed to 38.7 from 37.7. That spread traded at 34.1 yesterday morning.

The US has 10 year has received a pummeling versus some other sovereign bonds which I follow. In recognition of the risk off mentality Italy and Spain have significantly outperformed the US. Yesterday morning at this hour Spain was 21 rich to US (1.17 vs 1.36). As I compose this narrative that spread is now 36 with Spain at 1.12 and US at 1.48. Italy has moved from 24 through US to 33 rich. The US has cheapened to Bunds but not as dramatically as that spread has widened to 160 from 157.

More FX

July 12th, 2016 6:46 am

Via Marc Chandler at Brown Brothers Harriman:

Easing Political Uncertainty Encourages Animal Spirits

  • Sterling is leading the new appetite for risk as one element of political uncertainty has been lifted
  • Abe does not need a super-majority to implement his economic program
  • Italy and the EU appear to be moving toward an agreement that could see new state funds
  • The Permanent Court of Arbitration has ruled that China’s claim on nearly 80% of the South China Sea is not valid
  • India reports June CPI and May IP; Brazil reports May retail sales

The dollar is broadly weaker against the majors.  Sterling and the Antipodeans are outperforming while the yen and Swiss franc are underperforming.  EM currencies are firmer.  ZAR and MXN are outperforming while IDR and THB are underperforming.  MSCI Asia Pacific was up 1.2%, with the Nikkei rising 2.5%.  MSCI EM is up 0.7%, with Chinese markets up 2%.  Euro Stoxx 600 is up 1% near midday, while S&P futures are pointing to a higher open.  The 10-year UST yield is up 5 bp at 1.48%.  Commodity prices are mixed, with oil up 2%, copper up 2%, and gold down 0.2%.

Sterling is leading the new appetite for risk as one element of political uncertainty has been lifted.  It is moving higher for the third consecutive session today, advancing by more than 1.5 cents to reach $1.3180.  It staged an impressive recovery yesterday after trading down to $1.2850, nearly a retest of last week’s 30-year+ low just below $1.28.  Recall last week’s high was set near $1.3340.  

Although we did not see any convincing technical sign that a recovery was imminent, we warned that after three consecutive weekly declines and dropping in five of six weeks, only a slight provocation was needed to spur a short-covering bounce.  The key issue is whether this is a one-day wonder (short-term move) or whether sterling has legs (low of some importance is in place, and sustained recovery is at hand).  

We had thought sterling would bounce around the BOE meeting, and we had been inclined to see a recovery after a rate cut.  The Bloomberg survey is almost evenly divided between those who expect a 25 bp cut and those who don’t.  The argument for waiting was that the new post-referendum forecasts would be made next month, and these would provide cover (justification/explanation) for the change in policy.  However, the BOE had a thought-out risk scenario in case of Brexit, and this becomes the base case.  

Sterling has hardly pulled back during its run-up today, and there is scope for a further squeeze.  However, we are not convinced this is anything but a short-term correction.  Surely, to be convincing, sterling has to move outside of last week’s range and this does not look likely, at least at this juncture.  The next technical target is near $1.3255.

The UK is not the only one expected to provide more stimulus.  Japan also appears to be moving toward new measures.  Traditional LDP policy is loose monetary policy, fiscal stimulus, and a weaker yen.  Abenomics was that but on steroids.  Abe appears to want to go to the well again and has been encouraged to do so by recent visits by Bernanke, Stiglitz, and Krugman.  

Abe does not need a super-majority to implement his economic program.  Given the low levels of public support for Abenomics, it is a stretch to claim that the weekend election was an economic mandate.  The super-majority is needed for constitutional changes.  These are divisive issues, even within the ruling coalition.  

The dollar has extended its gains against the yen.  The greenback is at its highest level against the yen since June 24, poking through the JPY103.60 area briefly.  We recognized a break of JPY101.50 could propel a move to JPY103.  The JPY103 area should offer initial support.  There is much talk today about sterling-yen crosses being unwound by levered participants.  Sterling had been the weakest of the majors, and the yen the strongest.    

The yen’s pullback coincides with a strong two-day advance in Japanese equities.  The Nikkei tacked on another 2.5% to yesterday’s nearly 4% gain.  It is the strongest two-day advance in five months.  Helped by a new record high in US stocks and better than expected Alcoa earnings after the close, MSCI’s Asia-Pacific Index rose 1.2%.  All the markets in the region advanced, with Japan and China the leaders.  

European bourses are following suit.  The Dow Jones Stoxx 600 is up 1% near midday in London, led by consumer discretionary and financials.  Of note, the FTSE Italian bank index is extending its advancing streak into a fourth session with a 5.3% gain today, after recovering yesterday to close 1.2% higher.  The ban on short sales has been extended until early October.  

Italy and the EU appear to be moving toward an agreement that could see new state funds.  Some creditors will be bailed-in, as required, but the latest reports suggest that investors in a particular instrument could be exempt.  Monte Paschi issued subordinated debt in 2008 for an acquisition, and those bonds were marketed and sold to retail investors in 1000 euro increments.  They are selling for about 50 cents on the euro now.  Exempting those bonds may make good politics and economics, but it is crucial that in exchange for new funds, the bad loans must be dealt with.

The Permanent Court of Arbitration has ruled that China’s claim on nearly 80% of the South China Sea is not valid.  China has refused to recognize the legitimacy of the proceedings, and the Court lack enforcement mechanisms.  However, the case should be regarded as another move in a long chess game rather than checkmate.  It is not clear what the next move is.  Other countries may bring similar cases against China.  China could retaliate in various ways in the region.  Even though China is an old civilization, in its new incarnation it is relatively new on the international stage.  Its relationship with international law is not always clear, and as with other large countries, it may not always be consistent.  Still, its response will be closely scrutinized for insight to get a measure of President Xi.  

The main feature from the US today are the two Fed officials (Tarullo and Bullard) who speak during the North American morning, followed by Kashkari and Mester after the markets close.  Also, the market is waiting for the EU finance ministers’ decision on whether to sanction Spain and/or Portugal over excess deficits.  

India reports June CPI and May IP.  The former is expected to rise 5.8% y/y, while the latter is expected to fall -0.4% y/y.  India then reports June trade Wednesday and June WPI (expected to rise 1.3% y/y) Thursday.  Price pressures are picking up, and so the RBI is likely to keep rates on hold for now.  The next policy meeting is August 9, and no change is seen then.  That will be Governor Rajan’s last meeting, and we suspect Modi will appoint someone more dovish to replace him.  Press reports suggest that his successor could be named this week.

Brazil reports May retail sales, which are expected at -6.3% y/y vs. -6.7% in April.  It then reports the monthly GDP proxy for May on Wednesday, which is expected at -3.9% y/y vs. -5% in April.  While the economy seems to be bottoming, we think robust growth won’t be seen until 2017 at the earliest.  COPOM next meets July 20 and is unlikely to start the easing cycle then.  The meeting after that on August 31 may be a better bet.

Some Corporate Bond Stuff

July 12th, 2016 6:43 am

Via Bloomberg:

IG CREDIT: High Volume Monday Session as Spreads Tighten
2016-07-12 10:06:58.307 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $15.9b vs $13.1b Friday. IG trading was 6th highest of
any Monday since July 2005.

* 10-DMA $15.2b; 10-Monday moving avg $13b
* 144a trading added $2b of IG volume vs $2.3b on Friday

* Most active issues:
* ORCL 4.00% 2046 was 1st; client buying was twice
selling, together accounting for 98% of volume
* SF 4.25% 2024 was next with client buying taking 79% of
volume
* VZ 4.862% 2046 was 3rd with client selling 6x buying
* DELL 6.02% 2026 was most active 144a issue with client
buying NEAR twice selling

* Bloomberg US IG Corporate Bond Index OAS at 153.6 vs 156.4
* 2016 high/low: 220.8, a new wide since Jan. 2012/150.8
* 2015 high/low: 182.1/129.6
* 2014 high/low: 144.7/102.3

* BofAML IG Master Index at +155 vs +157
* 2016 high/low: +221, the widest level since June
2012/+152
* 2015 high/low: +180/+129
* 2014 high/low: +151/+106, tightest spread since July
2007

* Standard & Poor’s Global Fixed Income Research IG Index at
+199, its first time below +200 since May 5, vs +209
* +262, the new wide going back to 2013, was seen
2/11/2016
* The widest spread recorded was +578 in Dec. 2008

* S&P HY spread at +644 vs +660; +947 seen Feb. 11 was the
widest spread since Oct. 2011
* All-time wide was +1,754 in Dec. 2008

* Markit CDX.IG.26 5Y Index at 72.2 vs 73.0
* 73.0, its lowest level since August, was seen April 20
* 124.7, a new wide since June 2012 was seen Feb. 11
* 2014 high/low was 76.1/55.0, the low for 2014 and the
lowest level since Oct 2007

* Current market levels vs early Monday, Friday levels:
* 2Y 0.661% vs 0.629% vs 0.609%
* 10Y 1.483% vs 1.376% vs 1.388%
* Dow futures +74 vs +68 vs +28
* Oil $45.51 vs $44.80 vs $45.32
* ¥en 103.84 vs 102.31 vs 100.66

* IG issuance totaled $3.6b Monday

* Pipeline – 4 to Price, More Wed., More Expected

Credit Pipeline

July 12th, 2016 6:42 am

Via Bloomberg:

IG CREDIT PIPELINE: 4 to Price, More Wed., More Expected
2016-07-12 09:49:59.466 GMT

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

* KfW (KFW) Aaa/AAA. to price $bench Global 3Y, via managers
DB/JPM/TD; guidance MS +11 area
* SMBC Aviation Cap Fin (SMBCAC) na/BBB+, to price $bench
144a/Reg-S 5Y, via C/JPM/RBC/SMBC; IPT +200 area
* KT Corp (KOREAT) Baa1/A-, to price $bench 144a/Reg-S 10Y,
via BNP/BAML/C/Nom; guidance +110-115
* Yapi Kredi Bankasi (YKBNK) Baa3/na, to price $bench
144a/Reg-S 7Y, via BAML/DB/HSBC/ING/UniCr; IPT 4.75% area

TO PRICE TOMORROW:

* Japan Bank for International Cooperation (JBIC) A1/A+, to
price 2-part deal, via managers BNP/BAML/C/Nom

LATEST UPDATES

* European Bank for Reconstruction & Development (EBRD)
Aaa/AAA, mandates BAML/CrAg for a new USD 3Y Green Bond;
investor calls today
* Dai-ichi Life Insurance (DAIL) A3/A-, has mandated
C/GS/JPM/Miz/MS to arrange a series of investor calls July
11-12; USD 144a/Reg-S Perp/NC10 subordinated step-up
callable may follow
* Tengizchevroil (TCOKZ) Baa2/BBB, to hold investor meetings,
via C/HSBC/JPM July 12-19; USD 144A/Reg S may follow
* Danone (BNFP) Baa1/BBB+; ~$12.1b WhiteWave (WWAV) Ba2/BB acq
* Co. Says deal 100% debt-financed, expects to keep IG
profile (July 7)
* Teva Pharmaceutical Industries (TEVA) Baa1/BBB+, said to
consider accelerating $22b bond sale plan
* Some expectations this deal may be as soon as this week
* TEVA ~$40.5b Allergan generics buy
* $22b bridge; $5b TL commitment (Nov 18)
* Woori Bank (WOORIB) A2/A-, mandates BAML/C/Cmz/CA/HSBC/Nom
for investor meeting July 11-20
* Thermo Fisher (TMO) Baa3/BBB, gets loans for FEI (FEIC) buy
via 21 banks
* Investment Corp of Dubai (INVCOR), weighs bond sale; last
issued in May 2014
* Kingdom of Saudi Arabia (SAUDI), said to tap C/HSBC/JPM for
its first international bond sale; kingdom will probably
wait until after summer to sell at least $10b of bonds and
may replicate Qatar’s recent sale by issuing 5y, 10y, 30y
tranches, sources say
* Potash Corp Of Saskatchewan (POT) A3/BBB+, files automatic
debt shelf; last issued March 2015
* Monsanto (MON) A3/BBB+, may see higher bid from Bayer
(BAYNGR) A3/A-
* Microsoft (MSFT) Aaa/AAA, added to list of possible issuers,
says Morningstar; also notes PG, DOV as potentials
* Sumitomo Life (SUMILF) A3/BBB+, to hold an investor meeting
July 19, via BofAML; focus to be on hybrid capital
* It last priced a USD deal in 2013
* Dubai’s Emaar Properties (EMAAR) Ba1/BBB-, plans potential
USD bond sale
* USAID Ukraine (AID) heard to be in the works with possible
full faith & credit deal
* General Electric Company (GE) A3/AA-, has yet to issue YTD;
parent GE Co has $11.1b maturing this year, $2.3b matured in
May
* GE may be among high grade industrials to add leverage
in 2016, BI says in note

MANDATES/MEETINGS

* Kookmin Bank (CITNAT) A1/A, held investor meetings June
13-17, via BAML/CA/HSBC/Miz
* National Grid (NGGLN) Baa1/na, hired JPM to hold investor
meetings that ran June 1-3

M&A-RELATED

* Shire (SHPLN) Baa3/BBB-, closed $18b Baxalta acquisition
loan; facilities to be refinanced through capital market
debt issuance
* Zimmer Biomet (ZBH) Baa3/BBB, to acquire LDR for ~$1b; co.
said it plans to issue $750m of sr unsecured notes after
deal completion
* Air Liquide (AIFP) A3/A-, held calls regarding Airgas
refinancing; planned to refinance $12b loan backing the deal
via combination of USD, EUR long-term bonds
* Bayer (BAYNGR) A3/A-, said to secure $63b financing, via
BAML/CS/GS/HSBC/JPM, for Monsanto (MON) A3/BBB+ bid; co.
likely will issue $20-$30b bonds to refinance part of the
bridge loan
* Great Plains Energy (GXP) Baa2/BBB+ to issue long-term
financing including equity, equity-linked securities and
debt prior to closing of Westar Energy (WR) A2/A deal; says
financing mix will allow it to maintain investment-grade
ratings
* 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)
* Duke Energy (DUK) A3/A-; $4.9b Piedmont Natural buy
* $4.9b bridge (Nov 4)
* Anthem (ANTM) Baa2/A-; ~$50.4b Cigna buy
* $26.5b bridge (July 27)

SHELF FILINGS

* ERP Operating LP (EQR) Baa1/A-, filed an automatic debt
securities shelf June 28; last issued $450m 10Y notes May
2015
* 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+, files 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

* Discovery Communications (DISCA) Baa3/BBB-; may revisit bond
market this yr, BI says (May 18)
* Ford Motor Credit (F) Baa2/BBB; may have ~$7b issuance this
yr (May 10)

Early FX

July 12th, 2016 6:40 am

Via Kit Juckes at SocGen:

<http://www.sgmarkets.com/r/?id=h10ea87f1,179f2f23,179f2f24&p1=136122&p2=3d35ba1320859814ff44a42c6e223901>

Really, market folk should know that those all-important father-son conversations need to happen before it’s too late. You know, like “Son, can you explain the business model of an app which asks people to wander the earth in search of imaginary pocket-sized monsters?”                                                                                                                    I think io learnt as much as I want to on the way home from my youngest’s work experience yesterday. This morning, the sun’s shining and even if the weather forecasters warn of rain later, the mood at the start of the day is bright and risk is ‘Go’. That will remain the case until (or unless) bond yields get a good bit higher. Bond traders and investors have been bludgeoned into submission by the mediocre global growth rate, the lack of any meaningful inflationary pressures and the dovish bias to major central policy-making committees, but you can get too much of a good thing . CFTC data suggest longs were getting extreme last week….

10yr positioning getting stretched, yields don’t bounce

[http://email.sgresearch.com/Content/PublicationPicture/228820/1]

In a super-low-yield world, risk on/off is played out mostly in Yen crosses. As TIIPS yields move higher against JGBs, the USD/JPY rally continues, to say nothing of other yen crosses which have historically correlated both with risk sentiment and with falling volatility (GBP/JPY is today’s drama-queen). As the markets wait and see what is done next on both fiscal and monetary policy in Japan, we will go on squeezing yen longs. The TIIPS sell-off needs to go a whole load further before I’m comfortable but the lack of significant US economic data (NFIB small business confidence and JOLTS job opening are all we’ve got on offer today) suggest the yen sell-off still has legs.

USD/JPY still has bounce-ability

[http://email.sgresearch.com/Content/PublicationPicture/228820/2]

UK politics took a twist as the timetable for electing a new Prime Minister was moved forward by a couple of months. A source of uncertainty was re moved but it’s like peeling an onion- beneath each layer there’s another. Theresa May has stated repeatedly that ‘Brexit means Brexit’ and there will be non second referendum. The rest of the EU doesn’t want to make any concessions on the terms under which the UK leaves, doesn’t want negotiations to start until Article 50 is invoked and is in a hurry for that to happen as soon as possible. Mrs May is in no hurry, would like concessions and would like informal discussions. Let the diplomatic horse-trading begin! Overnight, BRC data were mediocre, but that won’t prevent the market squeezing out more sterling shorts. We’ll get short again before we see GBP/USD 1.35, but…

With oil prices flagging other commodities (and stuck under USD 50/bbl), our preference for the CAD over AUD and NZD (and RUB over ZAR for that matter) may be a source of headache more than joy for now. We still believe in CAD longs, but won’t get any help today. As for the Euro, it isn’t doing much to please either bulls or bears. Last summer, when yield differentials were last this Euro supportive, EUR/USD got to 1.16. I don’t suppose we’ll get that far, but range-bound makes it sound more exciting than it is….

Regarding Mortgage Convexity

July 11th, 2016 9:12 am

Via Bloomberg:

For MBS, It’s Different This Time: U.S. Rates/Credit Week Ahead
2016-07-10 11:00:00.1 GMT

By Christopher Maloney
(Bloomberg) — With mortgage rates ~50bp lower since the
end of 2015 and production coupon (3s, 3.5s) TBA speeds at their
highest since at least the first half of 2015, primary risks to
the MBS market are a pick-up in supply and convexity flows – but
this is not the same mortgage market as in pre-QE days; which
brings us to this week’s MBA refinance index release.

* As the Federal Reserve holds so much of the outstanding MBS
float (~$1.752t) and will simply reinvest any paydowns, the
sector will likely see relatively muted convexity flows
compared with previous refi waves
* As of the end of May, Fed holdings of the 30-year
outstanding universe was 41% of FN30, 40% of FH30 and
30% G2SF; there is no historic precedent for this
* The majority of 30Y agency MBS’s unpaid balance is
concentrated in lower coupons, 3s through 4s, (~78% for
conventionals, ~85% for G2SF), exactly the coupons where
the Fed’s holdings are highest, according to Wells Fargo
data
* Broken down into 3s, 3.5s, and 4s coupons, the Fed holds
57%, 42%, and 43% of FN30; 54%, 43%, and 40% of FH30;
and 41%, 32% and 26% of G2SF
* Broken down into 2015, 2014, 2013 vintages, it holds
36%, 49%, 58% of FN30; 35%, 58%, 57% of FH30; and 28%,
47%, 48% of G2SF; its holdings in the 3s, 3.5s, and 4s
coupons in this period run from 28% (G2SF 2015) to 58%
(FN30 2013/FH30 2014); click for FN30, FH30 and G2SF
breakdowns
* The disproportionate size of the Federal Reserve’s footprint
in the 2014 and 2013 vintages (the 2015 footprint is very
large as well) has reduced volatility within the sector as
the Fed does not hedge and is profit/loss indifferent
* G2SF 3s and 3.5s have been paying faster than conventional
cohorts since late 2013 due to higher LTVs and average
credit scores that are 50 points lower than seen for Fannie
Mae borrowers
* Higher coupons (4.5s and above) and older vintages (from
2011 and earlier) are suffering from burnout as these
borrowers have already decided not to refinance despite
multiple opportunities to do so; their speeds will be more a
function of housing turnover
* Mortgage originators are managing their pipelines by
widening the primary/secondary spread: the 50 DMA has risen
to +116bps from +90bps year-to-date
* Still, in the near term, supply pressures will build as
there is a delay between paydowns from the Fed’s balance
sheet and subsequent repurchases; in addition housing
seasonals are entering the summer period, when turnover
rises, adding to supply

* NOTE: MBA refinance index scheduled for release Wednesday,
July 13 at 7:00am New York time; for more data releases due
next week, click here

FX

July 11th, 2016 6:33 am

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

  • Many observers are emphasizing that the weekend election in Japan has given a super-majority to those parties that want to change the constitution
  • Two major central banks meet in the week ahead:  the Bank of Canada and the Bank of England
  • The US data highlights typically include consumption and price readings after the employment report
  • The US Q2 corporate earnings season formally kicks off with Alcoa today
  • The central banks of Korea, Malaysia, Chile, and Peru all meet this week

The dollar is broadly firmer against the majors.  The Swiss franc and Norwegian krone are outperforming while the yen and Kiwi are underperforming.  EM currencies are mixed.  KRW and MYR are outperforming while RUB and PHP are underperforming.  MSCI Asia Pacific was up nearly 2%, with the Nikkei rising 4%.  MSCI EM is up 1.5%, with Chinese markets up 0.4%.  Euro Stoxx 600 is up 0.6% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is up 2 bp at 1.38%.  Commodity prices are mixed, with oil down over 1%, copper up 1.5%, and gold down 0.5%.

Investors are under siege.  A growing proportion of bonds in Europe and Japan offer negative yields.  The German and Japanese curves are negative out 15 years, while one cannot find a positive yield among any tenor of Swiss government bonds.  Despite a string of robust data, US Treasury coupon yields are at record lows.

The UK referendum hit an already vulnerable banking system in the eurozone.  Italian banks are on the front burner, but the temperature is rising in Portugal, and this is not to mention the slow boil at some of the largest European banks, specifically singled out by the IMF as posing the greatest systemic risks.

Politics add an additional wrinkle.  Both of the two main parties in the UK are divided.  The leader of the UK’s Independent Party resigned.   If Labour was not doing a fine job of destroying itself, Cameron (among his last acts as Prime Minister) will give it a helping hand.  He will have parliament vote on the renewal of the UK nuclear deterrent (Trident), and it will further split Labour.  Corbyn has been long opposed, while the Labour MPs typically favor it.  There is an attempt by the Labour MPs to block Corbyn’s name from even appearing on the leadership ballot.  

The US political parties hold their conventions over the next few weeks, though it is possible that Trump announces his vice-presidential running mate in the week ahead.  Indiana Governor Pence appears to be edging out former Speaker of the House Gingrich.  Perhaps to prevent the Republican Party from dominating the news cycles, it would not be surprising if Sanders were to endorse Clinton either in the week ahead or the following week.

Economy Minister Macron in France may declare his candidacy to challenge Hollande in the coming days.  Meanwhile, Hollande is going to make a rare television address to the French people this week.  Italy is on its third unelected Prime Minister, and even before the next parliament election, the country’s political outlook is deteriorating.  If the Italian constitution referendum, scheduled for October, would be held today, it would likely lose, which would incite a political crisis if Renzi resigned as promised.  Polls suggest that the anti-EMU (but less hostile to the EU) Five Star Movement is has replaced Renzi’s.

Meanwhile after its second election in six months, Spain still does not have a new government.  There are several configurations that could work, but the personalities and programmatic demands are deterring the formation of a government.  The political stalemate is paralyzing reform efforts.  Austria will have to run its presidential election over due to voting irregularities.

Many observers are emphasizing that the weekend election in Japan has given a super-majority to those parties that want to change the constitution, relaxing the restraints on the military.  We suspect it is not so easy, as the LDP’s coalition party is not nearly as sympathetic.  Moreover, it is clear that Abenomics has still not won the hearts and minds of the Japanese people.  The first focus is not on changing the constitution, but on reviving the economy.  The poor machinery orders (-1.4% in May vs. Bloomberg median of +3.2%) illustrates the need to action.

We have often argued that Abenomics was a largely traditional LDP medicine of stimulative fiscal and monetary policy with a weaker yen.  Between as much as JPY20 trillion (~$200 bln) and BOJ efforts expected at the end of the month, it appears we have come in a full circle.    

There are two key decisions this week.  Though they will not be made by politicians, they will have serious implications.  The first decision will be made by the eurozone finance ministers.  They will decide if Spain and/or Portugal should be sanctioned for the excessive deficits the EU judged.  

The sanctions could include fines and the suspension of some regional funds.  If the rules are not enforced, they lose credibility.  If they are enforced, it appears discretionary and selective.  Consider that despite repeated violations and expressions of concern, the German external imbalance has not been addressed.  In the European political theatre, it might be best to sanction Spain and Portugal, and then suspend the judgment when the countries appeal under “exceptional circumstances” and  make a “reasonable request.”

The second important decision will come from a five-person panel at the Permanent Court of Arbitration at The Hague.  At issue is a territorial dispute between the Philippines and China.  It is the first case of its type.  China has refused to participate. The Philippines want rulings on three aspects.  First, what is the dispute over:  islands, reefs, low tide elevations, etc.?  An island (not man-made) comes with certain rights.  Second, the Philippines wants the Court to specify what is rightfully the Philippines under the UN Convention on the Law of the Seas.  Third, it wants the Court to determine if China has violated its rights.  The ruling is expected July 12 near midday at The Hague.

In addition to the two political decisions, there are two major central banks that meet in the week ahead:  the Bank of Canada and the Bank of England.  The Bank of Canada faces an economy that is struggling to sustain positive momentum.  In 2015, Canada’s monthly GDP fell in six of the twelve months.  The pattern is intact this year, with two contracting months in the first four.  May’s GDP will come out toward the end of the month.  Labor market improvement has stalled.  Net exports appear to be a drag as record large trade deficits were recorded in the April-May period, and non-energy exports contracted in May.

Over the past two months, the implied yield on the December BA futures contract has fallen almost 25 bp (to 82.5 bp).  The market has begun to price in the chances of a rate cut.  However, investors would be surprised if the Bank of Canada were to deliver a rate cut now.  The Canadian dollar, at least initially, would fall, especially as it would come as the market upgrades (on the margins) the risk of another December Fed hike.  Rather than a rate move, expect a more pronounced dovish slant in the central bank’s forecasts and rhetoric.

On the other hand, the Bank of England is the more likely of the two to cut rates.  BOE Governor Carney has already acknowledged that this may be necessary.  The central bank has already canceled the anticipated increase in banks’ capital buffers.  The market appears to have discounted a 25 bp base rate cut.  The implied yield of the September short-sterling futures contract has fallen from nearly 60 bp before the referendum to 33 bp at the end of last week, having briefly touched a low point of 28 bp.

Some economists anticipate the Bank of England will bring the base rate down from 50 bp to 10-15 bp over time.  While this is possible, we suspect that at 25 bp, officials would have gotten as much stimulus from lowering the base rate as possible.  Should further stimulus be judged necessary, and we suspect it will, new asset purchases would seem to be a more promising measure than another cut in the price of money.  

To be clear, if a 25 bp rate cut is not delivered at this week’s meeting, sterling would likely act positively, at least initially.  It would be seen as a sign of caution.  It would likely signal more emphasis on the new forecasts that are provided with the Quarterly Inflation Report next month.  However, the Bank of England, apparently more than many others, took seriously the risk of Brexit, and what was once a risk forecast, now becomes the base case, more or less.  

It still needs to calibrate its response, but perhaps the most surprising thing that has happened since the referendum is the resilience of the FTSE 250.  We appreciate that the FTSE 100’s stronger performance is a function of its heavy dependence on foreign earnings which are all the more valuable in a weak sterling environment.  The FTSE 250 finished last week at roughly the midpoint of the referendum induced drop.  Parts of the UK economy looked to be softening before the referendum, but economic readings outside of consumer surveys, are not in real time.  

The freezing up of the several property funds is instructive.  Although the problem looks contained, there are still risks of unforeseen contagions.  Also, the interlocking ownership of some of the funds, pose concentration risks that regulators may want to investigate.

One of takeaways from the Great Financial Crisis experience is the most effective policy response comes early and forcefully.  The Bank of England has every reasons to suspect that the Brexit decision will hit an economy that may have already been slowing.  The political firestorm does not help matters.  The BOE can act, or it can react.  We suspect it will act.  This does not preclude the BOE from doing more later.  It can cut rates now and launch QE next month, with the Quarterly Inflation Report.  We envision a modest purchase program (~GBP50 bln) that would be completed in a few months.  

The eurozone economic data calendar looks interesting but it is not.  Many countries have reported the national industrial output figures, so a significant month-over-month (~-0.8%) decline would not be surprising.  It would be the third contraction in four months.  The final CPI reading is likely to confirm the preliminary 0.1% year-over-year increase.  The first above zero print since January, but is still nothing.  The May trade balance also aggregates already released reports, and in any event, typically does not move the market.  

Two other issues dominate the discussions about the eurozone.  The first is the Italian banking situation, where its third largest bank is the subject of much official and investor pressure.  The debate is not whether the state can inject funds into its banks.  It can.  

At stake is who must take losses first.  Partly due to the idiosyncratic nature of Italy’s way (though ironically shared by Portugal) is that the bank bonds were widely treated by borrower and lender alike as a form of deposit in the bank.  That is to say as much as half of the bank bonds in some institutions are owned not by institutional investors or foreign investors, but by retail savers, who are also known as taxpayers and voters.  A resolution does not seem imminent, but the pendulum of market sentiment may have begun anticipating new capital as the FTSE Italian bank shares index jumped nearly 10% before the weekend.  

The second issue that has emerged and will continue to be debated ahead of the ECB meeting on July 21 is about the pending shortage of assets that qualify for purchase under its QE program.  Presently the purchasing is being done according to the “capital key”, which is a function of GDP and population.

This means that it buys more German bunds than bonds from any other country.  At the same time, German is running a balanced budget and paying down debt.  Also, given fears that Brexit could trigger a sequence of events lead to the fracturing of the monetary union, Germany bunds have an embedded call option (for the new German mark).  

The ECB adopted two rules that increase the apparent shortage of Germany bunds.  No security can be included in the purchase program whose yield is lower than the discount rate (-0.40%).  There is also a cap on any issuer of 33%.  Almost two-thirds of German bunds have yields below the deposit rate.

Recall too that the purchases were initially were to end in September, but have been extended to next March.  We suspect that later this year, the ECB may extend it another six months.  To sustain the buying, the ECB can move away from the capital key, remove the deposit floor, or lift the issuer limit.  Many reports have focused on shifting from the capital key to the size of the debt market.  Under such a rule, Italy with its large stock of debt would be the single biggest beneficiary, while the amount of bunds that would be purchased would be almost halved.  

However, the capital key may be an important principle in decision-making as a compromise between large and small countries.  It seems that it may have too much gravitas to overrule as the first attempt.  We suspect the story itself may not be what it seems.  Tactically, such leaks often are aimed to hurt precisely that view or interest it appears to represent.  It may be more helpful to think about those kind of leaks being plants rather than dogged reporting or careless officials.

The US data highlights typically include consumption and price readings after the employment report.  However, the retail sales and CPI reports that will be reported at the end of the week may offer little than headline risk.  It is a busy week for Fed officials.  No few than ten Fed officials speak this week, but not any from the Troika (Yellen, Fischer, and Dudley) from which we argue policy emanates.  The fact of the matter is that this month’s FOMC meeting will come and go with little fanfare.

If the Fed is to move in September, which the market says is highly unlikely, it will not be because of June retail sales and consumer prices.  Retail sales may be held back by the serial decline in auto sales (which are still at elevated levels), but the story of Q2 is the recovery in consumption.  Consumer prices likely remain firm.  The core rate is expected to remain steady at 2.2%.  It has been above 2% since last October.  The headline rate is expected to tick up to the top of the narrow (0.9%-1.1%) range that has prevailed since February.  

We note that since the UK referendum, the Fed funds rate has firmed to around 40 bp.  This is 3-4 bp rich compared with the rates that prevailed previously.  The October Fed funds futures contract (the best gauge in the futures market for the September 21 meeting which is held late in the month) closed before the weekend at an implied 40 bp and the December Fed funds futures closed at 41 bp.  

The US Q2 corporate earnings season formally kicks off with Alcoa today.  Q2 is expected to show the sixth consecutive quarterly decline in sales and the fifth straight decline in earnings.  If there is good news to be found in the aggregate, it is that the pace of decline is slowing.  S&P 500 earnings are projected to fall about 5.5% after a 6.6% decline in Q1, while sales are expected to slip 0.9% after easing 1.5% in Q1.  With the market at record highs, it appears liquidity rather than earnings has been the driver.  

The China data cycle hits high gear in days ahead.  The data is expected to show a continued gradual slowing of China’s economy, in which, nevertheless, the lending is accelerating with diminishing returns.  The dollar has risen in ten of the last twelve sessions against the yuan. It has risen in eleven of the past thirteen weeks.  And it is falling faster against the basket the PBOC said it adopted at the end of last year.  The operational policy remains of a “reasonably stable” exchange rate.  Something must be lost in translation.  

However, we are not convinced Chinese officials are engineering the depreciation of the yuan.  Market forces can explain the pressure on the yuan.  Chinese officials appear to have simply reduced its resistance.  In fact, it seems much more likely that if China were adopt a truly free-floating currency, the yuan could fall further and faster than it has done.  On a broad trade-weighted basis, the yuan appreciated nearly 30% from the middle of 2011 through the middle of last year.  Over the past year, it recouped a little more than a third of its decline.  

Many have expressed concern about the deflationary spillover that the yuan’s depreciation will cause.  We suggest the decline in bond yields is not being driven by Beijing but by Frankfurt, London, Brussels, and Tokyo.  The yuan’s depreciation against the yen is really more a function of the yen’s side of the equation.  Also, remember the space China occupies in global supply chains.  Valued-added costs incurred in yuan for exports still appear low by global standards.  

Our concern about a rapid or significant depreciation of the yuan is two-fold.  First, it would aggravate the debt burden of companies that borrowed in dollars (or other foreign currencies). Second, it would make it more seductive for China to dump its surplus industrial capacity (steel, aluminum, glass, cement, etc., etc.) on foreign markets.  Europe is expected to decide soon whether to recognize China as a market economy, which for WTO purposes, means it would be more difficult, but not impossible, to resist dump practices.

EM and other risk assets rallied on Friday after the strong US jobs data.  It appears that markets are pricing in a benign backdrop for risk near-term; that is, the US economy is recovering but not by enough to warrant an imminent Fed rate hike.  The July 27 meeting seems unlikely, and so the next window could be September 21.  Yet EM typically weakens in the run-up to FOMC meetings and so investors should be very careful about taking on too much risk.

The central banks of Korea, Malaysia, Chile, and Peru all meet this week.  No action is expected from any of them, but there are small dovish risks from Korea and Malaysia.  Indeed, most in EM are leaning dovish in response to the uncertainty regarding Brexit.