FX

June 13th, 2016 6:23 am

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

  • The risk that the UK votes to leave the EU next week is the dominant force in the capital markets
  • The May employment data pushed expectations away from this week’s meeting
  • To what extent does the Fed keep the July meeting live?
  • To what extent does the Fed’s Summary of Economic Projection (dot plot) continue to see the appropriateness of two rate hikes this year?
  • None of the four central banks that meet this week are expected to do anything, but the BOJ would be the most likely to surprise
  • MSCI is expected to formally announce its decision whether to include China’s mainland A-shares into its global EM indices

The dollar is mixed against the majors.  The yen is outperforming while sterling is underperforming.  EM currencies are mixed too.  RUB and SGD are outperforming while KRW and TWD are underperforming.  MSCI Asia Pacific was down 2%, with the Nikkei falling 3.5%.  MSCI EM is down 1.7%, with Chinese markets down 3-5% upon reopening after holiday.  Euro Stoxx 600 is down 1.5% near midday, while S&P futures are pointing to a flat open.  The 10-year UST yield is down 3 bp at 1.61%.  Commodity prices are mixed, with oil down 1% and copper up 0.5%.  

The risk that the UK votes to leave the EU next week is the dominant force in the capital markets.  It is a continuation of what was seen at the end of last week.  Sterling fell 1.4% against the US dollar before the weekend and is off another 1% today.  A week ago, it traded as high as $1.4530.  Now it is nearing $1.41.

There have been several polls showing those wanting to leave as ahead.  The event markets show an elevated risk, but still favor those that want to remain in the EU.  The bookmakers in the UK have also tightened the odds, but also favor the remain camp.  In the week through last Tuesday, speculators piled into short sterling positions by the most in five years.  Short-dated implied sterling volatility is soaring.  Consider that before the weekend, two-week volatility stood at 31%, which was double the previous close as the referendum moved within the two-week time frame.  The vol is now quoted near 38%.

A couple of weeks ago, the four central banks that meet in the coming days were thought to be a big deal.  Numerous Federal Reserve officials were preparing the market for a summer hike.  Risks of a new downturn in Japan spurred speculation that BOJ would ease policy.  

On the other hand, neither the Bank of England nor the Swiss National Bank was expected to move ahead of the UK referendum on June 23.  Besides providing extra liquidity to the banks in the ahead of the vote, the BOE was understood as being in a reactive posture, as was the SNB.  

A June hike by the Federal Reserve seemed like a stretch to us.  The risks posed by the possibility of a Brexit vote, we thought, forced the FOMC to wait six week for its next meeting, even if the May jobs data was not so poor.  A move in July, when a press conference is not pre-scheduled, would have the added advantage of securing more degrees of freedom for the Fed, which is clearly reluctant to hold a press conference after every meeting like the ECB and BOJ.  Until proven otherwise, the Fed moves appear limited to the quarterly meetings which include updated forecasts and are followed by a press conference.  

The May employment data pushed expectations away from this week’s meeting.  Yellen’s speech on June 6 sketched out the Chair’s views and confidence that the overall thrust of the economy is positive.  Does this mean that the FOMC meeting is a non-event?

There are two issues that may determine the market’s response to the FOMC meeting.  First, to what extent does the Fed keep the July meeting live?  We expect the FOMC statement and Yellen’s press conference to indicate that the Fed could raise rates in July.  The Federal Reserve is unlikely to be as dovish as some might expect given the disappointing 38k increase May’s nonfarm payrolls, the 59k downward revision of job March and April, and the fall in the participation rate that reversed this year’s gains.

Second, to what extent does the Fed’s Summary of Economic Projection (dot plot) continue to see the appropriateness of two rate hikes this year?  We expect the median dot to continue to be consistent with two hikes this year.  Where there may be some tempering is in next year’s projection of four hikes.  The market impact may not be particularly significant.  The implied yield of the December 2017 Fed funds futures contract is 67.5 bp.  Most recently the average effective Fed funds rate, which is what the contract settles at, 37 bp.  That is to say that this market is fully pricing one hike between now and the end of next year and no more than a 20% chance of another hike.  

The US reports economic data almost every day this week.  Although the PPI and CPI reports straddle the FOMC meeting, we suggest that the most important information will come from retail sales.  The only way the disappointing jobs data could be a prelude to a recession as some are suggesting, is if it were to undermine household consumption.  Retail sales account for about 40% of consumption, which itself accounts for about 70% of GDP.  

Headline retail sales are expected to build on April’s 1.3% increase by rising another 0.3%.  It would be the first back-to-back gain this year.  It would put the two-month average at 0.8%, which is the highest since April 2014.  The component that feeds into GDP is expected to be up 0.3%, which would match the 12-month average, after rising 0.9% in April.  The retail sales data coupled with April business inventories will likely spur revisions to Q2 GDP estimates.  The Atlanta Fed’s model has it tracking 2.5%.  

The industrial sector has been a drag on the economy in recent quarters.  The 3-, 6-, and 12-month IP averages peaked between April and July 2014.  They have all bottomed out and turned higher.  However, following the strong April bounce, some payback is anticipated.   Industrial output is expected to slowed by 0.2% after rising 0.7% in April.  Similarly, manufacturing production rose 0.2% in April and is expected to have slipped 0.1%.  The Fed and investors will see these reports before the FOMC decision on June 15.  

None of the four central banks that meet this week are expected to do anything, but the BOJ would be the most likely to surprise.  The BOJ’s meeting concludes the day after the Fed’s.  A Fed rate hike could reduce some demand for yen while a signal that the Fed is less confident about the economy than before could see the yen could strengthen.  

Last week, the US dollar recovery coincided with the rally in bonds.  Foreign demand for US debt appears to be increasing as more Japanese and European yields move deeper into negative territory. Japanese, German, and UK yields fell to new record lows.  That foreigner investors or investors who would have invested in JGBs or core European bonds are drawn to the positive returns available in the US is not surprising.

What is surprising is that foreign investors continue to buy Japanese bonds.  The weekly MOF data shows that barring March when foreigners sold Japanese bonds in three of the four weeks; foreign investors have been consistent buyers since the middle of January.  The most recent data covered the week ending June 3.  Foreign investors bought JPY611 bln of Japanese bonds, which is the most since mid-April.  

We see three reasons why even with negative yields some foreign investors could be attracted to Japanese bonds.  First, many asset managers cannot take naked currency positions.  The return on Japanese debt instrument will be driven by the exchange rate.  

Second, given the deflation and weak growth Japan continues to experience, some investors may conclude that the BOJ ease policy further, which will drive down rates.  They may be willing to accept a minus 26 bp yield on a five-year JGB if they thought the rates would fall to minus 40 bp, for example.  

Third, there may be some financial arbitrage opportunities, like using cross currency swaps to move from dollars to yen to invest in a JGB.  Sometimes, given a particular set of market conditions, a lucrative return can be secured.  

The BOJ has surprised the market under Kuroda’s leadership.  It is at least in part a communication issue, but whatever the cause, investors must be attentive.  The case for easing is there if perhaps the BOJ was not so deep already in the rabbit hole of a rapidly growing central bank balance sheet and negative interest rates.  

There is reason to be patient, including that Q1 GDP surprised investors to the upside and was subsequently revised higher.  The proximity of the early July upper house election may give cover as well for a stand-pat policy.  The focus is squarely on fiscal policy with Abe’s formal decision to postpone next year’s sales tax increase.  A larger fiscal package is expected to be unveiled shortly.  

The fact that central bank’s do not apply the negative deposit rates to all deposits creates a new tool that can be used.  The rules can be tweaked.  This seems like a potential option for the BOJ, where the negative rate currently applies to only a small part of deposits.  The SNB could explore this, as well.  

Some observers who saw the recent reported increase in Swiss reserves as a sign of intervention must be surprised by the recent price action.  Last week the Swiss franc strengthened the most against the euro since the cap was lifted in January 2015.  The franc’s 2.1% rise is more than twice as large as any other weekly increase this year.  The franc rose every day last week against the euro and has risen in 12 of the last 15 sessions.  

There are three strategies that could account for such price action.  First, participants can be simply buying francs and selling euros.  Second, participants could be selling the euro and ignoring the franc.  Third, participants could be selling the euro more than they are selling the franc.

Of course, it is not wholly one thing or another.  Most narratives emphasize the first strategy.  The adjustment of speculative positioning in the futures market suggests the third strategy.  Speculators trimmed gross long positions and increased gross short positions by a little more than a third. Speculators have the largest short franc position in four months.  

Before the Bank of England meets on Thursday, the latest prints on prices, consumption, and labor markets will be available.  The strength of the April industrial production and manufacturing output, contrary to the PMI, warns against exaggerating the weakness of the economy to prove a point in the debate over the EU.  Carney may wax on at the Mansion House Dinner about some financial matter, but Osborne will not miss the opportunity to paint the risks of Brexit.  

The by-election in Tooting South England on June 16 may be scrutinized for clues about the referendum outcome.  However, there are other forces at work in the district that was previously represented by Khan, the new Mayor of London.  Khan had carried the seat last year with 47% of the vote.  However, the Tories improved from 2010 and garnered 42% of the vote.  It is also the first by-election since Corbyn become head of the Labour Party.  In his mayoral campaign, Khan distanced himself from Corbyn.

In the middle of the week ahead MSCI is expected to formally announce its decision whether to include China’s mainland A-shares into its global emerging market indices, against which an estimated $1.7 trillion of investments are tracked.   Many Chinese shares that trade in Hong Kong (H-shares) and in the US (ADRs) are already included.  

Chinese officials are eager for the A-shares to be included for two reasons.  First, capital inflows would help offset the capital outflows that China is experiencing, and would help broaden the investor base.  Second, it is yet another badge of honor like being included in the SDR.  It is recognition of the significance of China.  China A-share market accounts for 1/10 of global market capitalization.  

However, China’s stock market is dominated by retail investors.  Is it really ready for global institutional investors?  A year ago MSCI said no.  Chinese regulators have been rushing through numerous reforms to facilitate a yes answer this year.  It is a close call, and we lean against it.  There is no harm in waiting another year, especially after last summer’s experience.  On the other hand, a premature decision could cost the MSCI credibility.  The limit on capital repatriation to 20% a month remains and this alone makes many skeptical.  

There has been much anticipation of the MSCI decision.  Activity in the options on the some ETFs for China’s large cap index increased markedly last week, for example.  Yet, the immediate impact of any decision is likely to be minimal.  A decision not to include the A-shares yet would leave the status quo.  

Fund managers would have a year to adjust to a decision to include the A-shares.  This would be a gradual process.  At first, about 5% of the A-share market cap is anticipated to be included.  This would give the A-share weighting about 1% in the MSCI Emerging market equity index.  Still, many asset managers will face an information challenge as this would still mean the inclusion of some 400 companies, whose reports and other data are primarily in Mandarin.  

Eventually, China may account for as much as 40% of the emerging market equity index.  Half may be accounted for by the offshore market (H-shares and ADRs) and half by the A-shares.  This process may take several years to complete, and it is set to begin slowly regardless of this week’s decision.  

EM ended last week under pressure.  With two potentially disruptive events (FOMC meeting and Brexit vote) still in play, we think that EM softness should carry over into this week.  Markets remain especially jittery about the June 23 Brexit vote, as a vote to leave would be very negative for risk assets such as EM.  

Some Corporate Bond Stuff

June 13th, 2016 6:06 am

Via Bloomberg:

IG CREDIT: Trading Volume Lower as Spreads Leak Wider
2016-06-13 09:42:42.567 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $10.7b Friday vs $15.8b Thursday, $12.1b the previous
Friday. 10-DMA $14.5b; 10-Friday moving avg $12.1b.

* 144a trading added $1.7b of IG volume Friday vs $3.2b
Thursday, $2.3b last Friday

* The most active issues:
* AET 4.375% 2046 was 1st with client trades accounting
for 96% of volume; buying was near twice selling
* FITB 2.25% 2021 was next with client flows taking 85% of
volume
* VALEBZ 5.875% 2021 was 3rd with dealer-to-dealer trades
taking 60% of volume
* DAIGR 1.125% 2017 was most active 144a issue with client
flows took 100% of volume

* Bloomberg US IG Corporate Bond Index OAS at 156.1 vs 154.5
* 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 +156 vs +154
* 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

* Markit CDX.IG.26 5Y Index at 77.4 vs 75.8
* 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
* 2Y 0.718%
* 10Y 1.616%
* Dow futures -64
* Oil $48.56
* ¥en 105.89

* IG issuance totaled $530m Friday vs $8.875b Thursday,
$10.85b Wednesday, $9.35b Tuesday, $4.55b Monday; June now
stands at $54b
* May ended at a record $209.51b; stats and recap
* YTD IG issuance now $857b; YTD less SSAs $715b

Credit Market Pipeline

June 13th, 2016 6:04 am

Via Bloomberg:

IG CREDIT PIPELINE: KOREAT Added to List, TAQA May Be Soon
2016-06-13 09:23:03.283 GMT

By Robert Elson
(Bloomberg) —

LATEST UPDATES

* KT Corp (KOREAT) Baa1/A-, schedules investor meetings June
16-24, via BNP/BAML/C/Nom, for possible USD 144a/Reg-S
* Abu Dhabi National Energy (TAQAUH) A3/A, investor meetings
via BNP/C/FGB/HSBC/NBAD/SG end today; $bench 144a/Reg-S 5Y
and/or 10Y issues may follow as soon as Monday, June 13
* Ooredoo (QTELQD) A2/A-, has mandated
ANZ/BAML/Citi/DBS/HSBC/Miz/MUFG/QNB to arrange investor
meetings to begin June 10; USD 144a/Reg-S transaction may
follow
* Shire (SHPLN) Baa3/BBB- completes takeover of Baxalta (BXLT)
Baa2/BBB-, now lowered by S&P, in ~$32b deal buy $18b loan
to be refinanced via debt issuance (Jan 18)
* ITC Holdings (ITC) Baa2/BBB+, to hold investor meetings June
13-14, via BAML/JPM/WFS; it filed an automatic debt
securities shelf; last issued May 2014
* Kookmin Bank (CITNAT) A1/A, mandates BAML/CA/HSBC/Miz to
arrance investor meetings June 13-17; issuance may follow
* SMBC Aviation Capital (SMBCAC) has mandated
C/CA/JPM/RBC/SMBC to hold investor calls June 8-9; a
potential US$ 144a/Reg-S offering may follow
* Dubai’s Emaar Properties (EMAAR) Ba1/BBB-, plans potential
USD bond sale
* 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 the $12b loan backing the
deal via a combination of USD, EUR long-term bonds
* Raymond James Baa2/BBB, has engaged BAML/JPM/RayJ to arrange
investor meetings June 13-15; last priced a new deal in 2012
* USAID Ukraine (AID) heard to be in the works with possible
full faith & credit deal
* 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
* Omega Healthcare Investors (OHI) Baa3/BBB-, to hold investor
meeting, via BAML/JPM, June 14
* Poinsettia Finance Baa2/BBB+, mandates MS to arrange
investor meetings June 6-9; USD 144a/Reg-S deal may follow
* Kingdom of Saudi Arabia (SAUDI), weighing sale of $10b-$15b
after end of Ramadan in July
* May replicate Qatar’s $9b sale by issuing 5y, 10y, 30y
bonds, sources say
* 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
* Merck & Co (MRK) A1/AA; has not priced a new issue since
Feb. 2015, $1.5b matured May 18
* 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 (see point 3)

MANDATES/MEETINGS

M&A-RELATED

* 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)
* Molson Coors (TAP) Baa2/BBB-; ~$12b MillerCoors buy
* $9.3b bridge (Dec 17)
* Teva (TEVA) Baa1/BBB+; ~$40.5b Allergan generics buy
* $22b bridge; $5b TL commitment (Nov 18)
* 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

* 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)
* Wal-Mart (WMT) Aa2/AA; 2 maturities in April (April 1)
* GE (GE) A1/AA+; $25b debt possible for M&A, buybacks (Jan
29)

Which labor Market Indicator is Correct?

June 13th, 2016 6:02 am

Via the NYTimes:

Which Labor Market Data Should You Believe?

When the unemployment rate falls below 5 percent, it usually means things are going pretty well. It was 4.7 percent in May, a level last seen in November 2007.

A different measure of the economy’s health, however, is beeping and flashing red. It says that labor market conditions have deteriorated with each passing month this year. In May, it fell to its lowest level in seven years.

Called the Labor Market Conditions Index, it has been billed as a more complete measurement than that old war horse, the unemployment rate. There are two possible explanations for the index’s decline: one somewhat comforting, and the other scary.

Let’s do comfort first. It’s possible we’re not making progress because we’ve more or less arrived at our destination — what economists call full employment. This somewhat misleading term doesn’t mean that everyone has a job. It means that the reservoir of people seeking work has receded to a historically normal level.

There is some evidence for this. Notably, the low unemployment rate.

But there are also some pretty strong reasons for skepticism. My personal favorite: In 2007, about 88 percent of men between the ages of 25 and 54 were working. Now, roughly 85 percent of such men are working.

That’s a difference of about two million men, most of whom probably would like jobs.

The scary explanation? Job growth is slowing because the economy is losing steam.

Fed officials, and other economists, have been grappling with the divergence between relatively weak reported economic growth and relatively strong job growth. Those at the Fed have largely taken the view that labor market data is more accurate, which has been true over time.

But this time, some economists say, the broader economic data may be closer to the truth. “Of course, the bond market understands this perfectly clearly,” Michael Darda, chief economist at MKM Partners, noted recently. Investors have continued to discount the Fed’s hints that it plans to raise rates this summer, and again later this year. They are betting the Fed will once again be forced to wait longer than it wishes.


(It has not escaped the notice of these pessimists that the Fed’s labor market index started showing weakness after the Fed increased rates in December.)

The truth may be somewhere in between.

The Federal Reserve introduced the new measure of labor market health a few months after Janet Yellen became the Fed’s chairwoman in 2014. It created the index because the unemployment rate is too simple. Even the name is too simple. It doesn’t actually measure unemployment; it counts only people who are actively looking for work. Moreover, a low unemployment rate doesn’t tell you how many part-time workers would like full-time gigs. It doesn’t tell you how many full-time workers would like a better job at higher pay.

In short, particularly in the aftermath of the Great Recession, the unemployment rate has improved much more quickly than the actual labor market.

The Fed’s corrective, however, is also imperfect. The central bank mashed together 19 kinds of labor data, including high-profile stalwarts like the unemployment rate and less familiar esoterica like the Conference Board’s “help-wanted advertising index.” And it tried to clean that data, scrubbing away the noise to reveal the underlying trends. But there is no perfect method for telling the difference, and a recent Goldman Sachs analysis suggests the Fed scrubbed too hard.

Daan Struyven and Zach Pandl, economists at Goldman, concluded that the Fed is scrubbing away some of the economy’s actual progress. But they caution that is only a partial explanation: Economic growth still appears to be slowing.

“This is not to say that the labor market is still firing on all cylinders,” they wrote. “The labor market is still making progress, but at a meaningfully slower pace.”

So there you have it.

The economy isn’t great. The economy isn’t terrible. We’re just chugging along, and apparently that’s about as good as it gets.

Morgan Stanley and Goldman Sachs Clash on Rates

June 13th, 2016 5:54 am

Via Bloomberg:
June 12, 2016 — 8:09 PM EDT
Updated on June 13, 2016 — 1:47 AM EDT

Morgan Stanley says 2016’s bond market rally has further to run. Goldman Sachs Group Inc. says benchmark Treasury yields may be poised to jump.

The biggest stories of the day, every day.

The two fixed-income powerhouses are at odds as bonds surge this year. Yields from Japan to New Zealand tumbled to records Monday, while benchmark Treasuries advanced for a fifth day. Investors are rushing to debt as the U.K. debate over leaving the European Union drives demand for the safest assets. The Federal Reserve meets Tuesday and Wednesday, following data that showed the slowest job growth in almost six years. Bank of Japan officials gather June 15-16.

“The year started with a bullish tone, and we think that tone is reasserting itself now,” Morgan Stanley analysts including Matthew Hornbach, the head of global interest-rate strategy in New York, wrote in a June 10 report. The Fed will probably make the case for a gradual, cautious approach to raising interest rates, and the BOJ will likely ease monetary policy, the analysts said.
‘Very Stretched’

Goldman Sachs strategist Francesco Garzarelli warned his clients that U.S. Treasury yields may climb “sharply” in the second half of 2016, in a note also June 10. The payrolls figure “seems like an outlier” and bond valuations are “very stretched,” wrote Garzarelli, who is based in London.

Treasury 10-year yields dropped two basis points to 1.62 percent as of 6:46 a.m. in London on Monday. They have fallen from 2.27 percent at the end of 2015. A Bloomberg survey of economists conducted Dec. 4 to Dec. 9 projected the yield would climb to 2.55 percent by June 30.

Japan’s 10-year yields fell to a record minus 0.165 percent. Those in South Korea, Taiwan’s and New Zealand also dropped to all-time lows, following Germany and the U.K. last week.

Goldman’s Garzarelli has been negative on Treasuries throughout 2016, while Morgan Stanley’s Hornbach has stuck to his bullish views. The two companies are both primary dealers, among the 23 banks that trade directly with the Fed and underwrite the U.S. debt.

 

Bonds in the U.S., the U.K., Germany and Japan all stand to benefit in this year’s rally, Morgan Stanley said. Government debt is surging around the world, sending the yield on the Bloomberg Global Developed Sovereign Bond Index to a record low of 0.58 percent last week.

The gauge has gained 10 percent this year, versus 1.9 percent for the MSCI All Country World Index of shares including reinvested dividends.

Peripheral Pressure

June 13th, 2016 5:51 am

I have just marked prices as the new day dawns and European peripherals remain under pressure. I specifically follow 10 year Spain and 10 year Italy versus US. ten year Spain is opening 15 rich to the US. At this hour on Friday the spread was 24 and on Thursday morning at this time that spread was 29. Similarly, 10 year ital is 28 rich to the US. That spread was 36 on Friday morning and 40 on Thursday morning.

Early FX

June 13th, 2016 5:45 am

Via Kit Juckes at SocGen:

<http://www.sgmarkets.com/r/?id=h10b3f115,17496f3b,17496f3c&p1=136122&p2=b1ee35b127bb3b47b68b31093b511a00>

The release of an opinion poll on Friday showing the widest margin so far in favour of the UK leaving the EU resulted in the pound getting a drubbing ahead of the weekend, and while the most recent poll I’ve seen shows that gap in favour of leaving down to 1% (i.e., far too close to call) the pound remains under pressure this morning. Bookmakers’ odds have narrowed to 2/1 against leaving (2/5 for staying). That still shows a puzzling degree of confidence in the outcome, but the odds have tightened. There’s a lot of UK data due this week too, with CPI tomorrow (exp 0.4% headline, 1.2% core), unemployment Wednesday (5k increase in unemployment rate steady, and ex-bonus earnings up 2.2%), and retail sales on Thursday (expect +1% ex auto fuel, m/m), as well as an MPC meeting. The retail sales data, like the manufacturing output numbers last week, look strong, but have no real chance of displacing the referendum as the main market focus. The pound is likely to remain under pressure despite positioning.

UK EU referendum polls are frightening the Pound.

[http://email.sgresearch.com/Content/PublicationPicture/227263/1]

The FOMC meeting is billed as the week’s main event, but the market prices a zero percent chance of a hike and a 2% chance of a cut in rates. The challenge for the Fed is how to continue laying the groundwork for an eventual hike if the data bounce back from the disappointment of May payrolls, against the backdrop of nervous markets. Caution and data dependency are likely to be stressed. The fact that the S&P has now broke above 2100 7 times since making its 2131 high in may 2015 without reaching new ground will probably weigh on sentiment and support the dollar and the yen, at the expense of high-beta currencies in general.

S&P – pushing on a string above 2100?

[http://email.sgresearch.com/Content/PublicationPicture/227263/2]

The yen’s latest surge will increase pressure on the BoJ to ‘do something’ though we suspect they will hold fire. In any case, if the BOJ wants to get to avoid the risk of acting and finding markets unresponsive, it needs to do so ion less risk-unfriendly markets. These are not easy conditions to undermine a safe haven currency. I’ve been pretty hopeless son the yen in recent weeks, and I see no value in fighting this move. Softish data in China (fixed investment in particular was on the weak side) will help the yen, as will a dip in oil prices, while it’s clear that the yen is a beneficiary of the uncertainty surrounding the UK referendum.

Appearances can be deceptive <http://www.sgmarkets.com/r/?id=h10b3f115,17496f3b,17496f3e>

Aging Baby Boomer Alert

June 12th, 2016 10:49 pm

Via the BBC:

Eric Clapton ‘struggles to play guitar’

  • 12 June 2016
 

Rock star Eric Clapton has said damage to his nervous system is making it difficult to play the guitar.

The acclaimed musician told Classic Rock magazine he “can still play” but added it was “hard work”.

“I’ve had quite a lot of pain over the last year. It started with lower back pain, and turned into what they call peripheral neuropathy.

“[It’s] hard work to play the guitar and I’ve had to come to terms with the fact that it will not improve.”

But he added that given his life had been fraught with addiction “I consider it a great thing to be alive at all”.

“By rights I should have kicked the bucket a long time ago,” said the 71-year-old star, who recently released his 23rd studio album, I Still Do.

Clapton achieved global fame in the 1970s with acclaimed songs including Crossroads and Layla, but his widely-acknowledged talent was tainted by addiction, first to heroin and later to alcohol and prescription drugs.

“I don’t know how I survived – the Seventies especially,” said Clapton. “For some reason I was plucked from the jaws of hell and given another chance.”

In 2013, Clapton was forced to cancel several tour dates because of back pain. In the interviews, he likened the pain to “electric shocks going down your leg”.

Peripheral neuropathy develops when nerves in the body’s extremities – such as the hands, feet and arms – are damaged. There are a number of possible causes, including excessive alcohol consumption.

“I mean, it’s hard work sometimes, the physical side of it – just getting old, man, is hard,” said the guitarist.

Eight Years at Zero is Unnatural

June 12th, 2016 4:14 pm

Via the WSJ:
By Harriet Torry
Updated June 12, 2016 1:10 p.m. ET

While Federal Reserve officials debate when to next raise short-term interest rates, they are also wrestling with the question of how high to lift them in coming years.

Signs point toward the new normal being much lower than in the past, which has broad implications for when the Fed should tighten monetary policy, how quickly, and how far.

Fed officials disagree about their likely end point, in part because they are struggling to understand why another underlying interest rate—the mysterious natural rate—has fallen in recent years. And for that many are turning to the musings of Knut Wicksell, a Swedish expert on the subject who died 90 years ago.

According to the textbooks, this so-called natural rate is the inflation-adjusted rate that’s consistent with the economy operating at its full potential, expanding without overheating. Also known as the equilibrium or neutral rate, it balances savings and investment.

The natural rate can’t be observed directly; the Fed knows it has been reached only by how the economy responds. “It’s like discovering Pluto: you can only see the effect of the gravitational pull,” said Eddy Elfenbein, an investor and blogger at the site Crossing Wall Street, comparing it to the dwarf planet whose existence was inferred from the orbits of Uranus and Neptune.

This matters in part because the natural rate guides how the Fed sets its benchmark fed-funds rate, which influences other borrowing costs throughout the economy. If the Fed pushes rates too high, it could undermine investment and cause a recession. If it holds rates too low, demand could grow too quickly, producing inflation or financial bubbles.

“The practical implication is when a Fed person talks about the natural rate of interest, what they’re telling you is what they think is the terminal rate of the next hiking cycle,” said Adam Posen, president of the Peterson Institute for International Economics and a former member of the Bank of England’s monetary policy committee.

Most economists figured the natural rate was around 2% just before the financial crisis. Today, seven years after the recession, most estimates are around or just below zero.

“We’re seeing no pickup, none whatsoever, in the natural rate even as the economy has gotten back to full strength,” John Williams, the San Francisco Fed president who has spent years studying it, said in a recent interview with The Wall Street Journal.
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This implies the central bank won’t be moving its benchmark federal-funds rate up much from its current level between 0.25% and 0.50% over the next few years. This, in turn, means lower rates for borrowers and lower returns to savers.

Policy makers are likely to leave their benchmark rate unchanged Wednesday at the conclusion of their two-day policy meeting, and could consider moving in July or September if the economy improves. They also will release Wednesday new projections for where they think the rate will rest in the long term.

The Fed’s estimate of its long-run fed-funds rate has been falling. In March, when officials released their most recent estimates, the median was 3.3%. Adjusted for their expectation of 2% inflation, that suggests a natural rate of 1.3%, down from 1.75% in June last year.

One risk for the Fed and the economy is that a low natural rate leaves less room for the central bank to cut rates if it wants to spur faster growth during a recession or boost inflation to meet its 2% target.

“This is a huge challenge for us,” Mr. Williams said.

The problem is economists don’t fully understand why the natural rate is so low. That makes it hard to know whether the shift is permanent or temporary, and therefore whether the rate will rebound and by how much—and in turn where the long-term fed-funds rate will rest.

“I think the current level of neutral or normal rates is pretty low,” Fed Chairwoman Janet Yellen said in Philadelphia last week. She expects it will rise over time, but said “that is something we’re uncertain about and have to find out over time.”

Economists have offered several theories for why the natural rate has fallen. Former Fed Chairman Ben Bernanke has cited a glut of savings world-wide. Harvard University economist Lawrence Summers blames ‘secular stagnation,’ or a chronic shortfall in investment demand.

Ms. Yellen has said temporary headwinds that have restrained growth since the financial crisis may be responsible, such as economic uncertainty, a strong dollar, and slower growth of productivity and the labor force.

For guidance Fed officials have been revisiting the work of Mr. Wicksell, a famed Swedish economist who did much of the seminal thinking on the subject more than a hundred years ago. Speeches by senior policy makers, including Ms. Yellen, have referenced Mr. Wicksell five times in the past year alone, and Mr. Bernanke has blogged about the Swede’s ideas about the relationship between interest rates, economic growth and inflation.

Mr. Wicksell characterized the natural rate of interest as “a certain rate of interest on loans which is neutral in respect to commodity prices, and tends neither to raise nor to lower them.” But the natural rate isn’t observable and depends on “a thousand and one things which determine the current economic position of a community,” and those factors—such as productivity, unemployment, and technological and demographic change—are constantly in flux, he said.

Fed Vice Chairman Stanley Fischer this year predicted the natural rate will remain low for the next few years, and warned that factors governing the rate are “extremely difficult” to forecast.

“The answer to the question, ‘Will [the natural rate] remain at today’s low levels permanently?’ is that we do not know,” he said in a January speech. “Eventually, history will give the answer.”

Write to Harriet Torry at [email protected]

Conventional Wisdom Holds That Rates Can Grind Lower

June 12th, 2016 4:10 pm

This WSJ story lays out all the reasons why rates can move lower. Inflation is low and there is no credible case for it to surge. Global economies are less than festive. Central bank quantitative ease has taken bonds off the market and has forced investors into alternatives such as US Treasuries.

I would suggest that many times the conventional wisdom does triumph but at the moment this seems to be a very crowded trade and unless there is some impulse to confirm it I would wager that there is a corrective trade before this lower rate scenario ensues.

Via the WSJ:
By Min Zeng
June 12, 2016 2:21 p.m. ET
2 COMMENTS

Record-shattering declines in government-bond yields are forcing investors to reassess once again just how low interest rates can go.

The 10-year German government-bond yield closed at an all-time low of 0.028% Friday, putting it on the cusp of expanding the record global pool of negative-yielding sovereign debt. The yield on the 10-year U.S. Treasury note settled at 1.639% Friday, the lowest closing since May 2013.

The plunge is the latest shocker for analysts and investors who have spent much of the postcrisis period predicting a liftoff for U.S. and global interest rates. They have been spectacularly wrong. The 10-year U.S. yield has dropped more than 0.6 percentage point in 2016 and is close to its record low four years ago.

The average yield on the Barclays Global Treasury index was 0.73% Thursday, down from 1.17% at the start of the year and 3.46% a decade ago, according to Barclays PLC.

“It has been contagious and relentless,’’ said Richard Gilhooly, head of interest-rate strategy at CIBC World Markets Corp., pointing to the downward spiral in yields. ”It is like a vacuum sucking bonds into a black hole.’’

Even now, yields have a clear path lower, traders and portfolio managers said. Economic growth appears soft, inflation remains low, and central banks are purchasing large amounts of corporate and government debt. Few said they expect rates to rise significantly this year, citing economic slack afflicting labor markets around the globe.

Some analysts said the U.S. 10-year yield could break its all-time closing low of 1.404%, set in the summer of 2012, if the market faces a shock that prompts investor flight to safe bonds.

“The enormous demand for Treasurys will remain robust until inflation rears its head, which I cannot see happening due to the global deflationary spiral,’’ said Tom di Galoma, managing director at Seaport Global Securities LLC. Mr. di Galoma said he expects the 10-year Treasury yield to test record lows in coming months.

Some even said they wouldn’t rule out that the U.S. 10-year yield could fall to 1% or below, especially if the U.S. economy lost momentum and headed into a recession. “There is no limit to how low 10-year yields in Treasurys or German bunds can go,’’ said Ian Lyngen, senior government-bond strategist at CRT Capital.

The Federal Reserve is expected to leave interest rates steady at its policy meeting Tuesday and Wednesday, reflecting the soft May U.S. jobs report as well as lingering anxiety over the planned June 23 U.K. referendum on European Union membership. The Bank of England, the Bank of Japan and the Swiss National Bank will hold policy meetings later this week.

The sharp decline in yields has many fund managers warning of the risk of a sudden reversal. Some said an unexpected event could set off a stampede for the exits in government-bond markets.

Analysts also have warned that buyers of long-term government debt at these slim yields could suffer large capital losses if yields march higher.

Goldman Sachs Group Inc warned in a report earlier in June that a one-percentage-point “upward shock to interest rates would translate into over $1 trillion in capital losses’’ to investors holding U.S. Treasury and other fixed-income debt.

Hedge funds and money managers nevertheless have piled into government-bond markets using computer-driven and automated trading strategies. Traders said this strategy played a role in the large decline in the two-year Treasury yield over the past week, as diminished expectations for a summer rate increase from the Fed prompted traders to buy short-term debt to close out bets on rising yields.

The two-year yield, highly sensitive to the Fed’s policy, fell to 0.739% Friday, down from 0.875% at the end of May.

Bets on rising rates via Treasury bond futures fell to $31.4 billion for the week that ended June 7, down from $50.1 billion a week earlier, according to Cheng Chen, U.S. rates strategist at TD Securities, citing data from the Commodity Futures Trading Commission. That is the lowest since March.

Tumbling yields have been rippling through markets in an idiosyncratic fashion. Low yields since the financial crisis have been associated with a seven-year-old bull market in stocks, but the S&P 500 index has repeatedly struggled to surpass a record high set in May 2015, most recently pulling back Thursday and Friday after coming within a dozen points of a new high. Gold prices, which have generally been soft for several years, have been resurgent this year, most recently rising 5.3% since the weak U.S. jobs report on June 3 fueled a wave of Treasury buying.

The U.S. Treasury debt market overall has handed investors an accumulated total return—including price gains and interest payments—of 38.3% since the start of 2008, according to data from Barclays. Over the same period, the S&P 500 has fared even better, with a return of 78.5% that includes dividend payments, according to FactSet.

But this year through Friday, Treasury debt has posted a return of 4.32%, and debt maturing in at least 25 years has returned 13%, according to Barclays. Both have outpaced a 3.6% total return on the S&P 500.

Many investors are willing to accept low or even slightly negative yields because they aren’t confident that major central banks will be successful in their efforts to boost economic growth or inflation. Events such as the British vote on whether to exit the EU still pose a threat.

“A vote to leave could, at least in the short term, push European rates lower, exacerbate the risk-off trade, and send U.S. yields even lower,’’ said Donald Ellenberger, head of multisector strategies at Federated Investors, which had $370 billion in assets under management at the end of March.

Supply issues are also helping keep U.S. bond yields low. A shrinking fiscal deficit has reduced government-funding needs and the Treasury has reduced issuance of long-term Treasury debt in recent months. The diminished issuance puts upward pressure on prices, driving down yields.

Meanwhile, weak growth and other factors are bolstering demand. Tighter regulations requiring banks to hold more high-quality assets have helped fuel rising Treasury holdings at U.S. financial institutions.

“The natural expectation is that interest rates will revert to where they’ve been over the last 30 years,’’ said Erik Schiller, senior portfolio manager for global government bonds at Prudential Financial Inc. ’s fixed-income unit, which manages $575 billion. ”But the global and secular forces continue to point in the other direction.”

Write to Min Zeng at [email protected]