Across the Curve

Safe Haven Demand for Bunds

Via Bloomberg:

European bonds rallied with counterparts across the world in the week after a U.S. report released June 3 showed the weakest payrolls in almost six years, damping wagers the Federal Reserve will raise interest rates in the next few months. Euro-area sovereign bonds returned 1.2 percent on average in the month through June 9, more than twice the 0.5 percent gain on Treasuries, Bloomberg World Bond Indexes show.

A report due June 16 will confirm that annual consumer prices in the euro area declined in May for a second consecutive month, according to a Bloomberg survey of economists. The European Central Bank, which is pumping 80 billion euros ($90 billion) a month through its asset-purchase program into the bond market, started buying corporate debt this week.

Record Lows

Benchmark German 10-year bund yields fell five basis points, or 0.05 percentage point, this week to 0.02 percent as of the 5 p.m. close in London on Friday, having dropped to 0.009 percent, the lowest since Bloomberg started collecting the data in 1989. The 0.5 percent security due in February gained 0.465, or 4.65 euros per 1,000-euro face amount, to 104.635.

Last year’s rally pushed the yield to as low as low as 0.049 percent in April, before they surged to as high as 1.06 percent on June 10, 2015.

Bill Gross, the manager of the $1.4 billion Janus Global Unconstrained Bond Fund, said in a tweet this week that central banks have created “a supernova that will explode one day.” In April 2015, Gross, a former chief investment officer at Pacific Investment Management Co., said bunds were the “short of a lifetime.

The slide in German yields widened spreads with Italian and Spanish peers as the U.K.’s upcoming referendum on its European Union membership fueled demand for havens.

The extra yield that investors get for holding Italian 10-year bonds instead of similar-maturity bunds jumped to 1.36 percentage points Friday. That’s the most on a closing price basis since February and up from less than a percentage point at the end of last year. Spain’s 10-year yield spread with Germany was at 1.41 percentage points, compared with 1.14 percentage points on Dec. 31.

“There is probably limited upside from here but also limited prospects of bunds selling off,” said Standard Life’s Lawson. “We expect most of the gain from being long European bonds to come from peripheral spread narrowing.”

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IMF Warns on China Debt Mountain

Via the WSJ:
By Mark Magnier
Sexta-Feira, 10 de Junho de 2016 22:45 EDT

BEIJING—Soaring corporate debt is a serious and worsening problem in China that needs to be tackled quickly if Beijing wants to avoid potential systemic risk to itself and the global economy, a senior International Monetary Fund official warned.

While China’s total debt of around 225% of gross domestic product isn’t particularly high by global standards, its corporate debt at approximately 145% of GDP is high by any measure, the multilateral lending agency said.

“Mounting corporate debt is a key fault line in the Chinese economy,” David Lipton, the IMF’s First Deputy Managing Director, said in remarks prepared for delivery at a conference in the southern Chinese city of Shenzhen on Saturday. “Corporate debt remains a serious—and growing—problem that must be addressed immediately and with a commitment to serious reforms.”

The experiences of countries who saw a massive buildup in debt in the past underscore the need to act quickly and effectively to deal with both creditors and debtors, and to tackle governance problems in the corporate and banking sectors that led to the problem in the first place, Mr. Lipton said.

A defining characteristic of China’s situation is its state-owned enterprises, which by IMF calculations account for around 55% of corporate debt but only produce 22% of economic output. Last year, SOE profits fell 6.7% year on year while their total revenue fell 5.4%, according to Chinese government data.

In an environment of slowing economic growth—China’s economy grew 6.7% in the first quarter, its slowest pace since the global financial crisis—declining earnings and rising debt undermine the ability of companies to pay suppliers or service their debt, leaving banks holding more nonperforming loans, according to Mr. Lipton. China’s potential level of bad corporate-debt is at a “conservative estimate” equal to around 7% of GDP, the IMF said.

“The past year’s credit boom is just extending the problem,” Mr. Lipton said in a speech prepared for the China Economic Society Conference on Sustainable Development in China and the World. “Already many SOEs are essentially on life support.”

Debt-for-equity conversion may play a role in addressing the debt buildup, but banks need to be able to conduct triage and have the authority to distinguish between firms worth saving and those that should be allowed to fail, otherwise their equity will have no value, he said. Any use of public asset-management companies, meanwhile—a vehicle Beijing has used in the past—should involve their working down bad loans rather than simply warehousing them, he said. Mr. Lipton also questioned Beijing’s proposed idea of merging weak and stronger state companies, which he said doesn’t solve the problem but instead undermines the better company’s profitability.

China, which went through a debt crisis at the beginning of this century, could face a similar threat again less than two decades later. “If a country doesn’t address the governance issues at the heart of a debt problem, then that problem will inevitably recur,” Mr. Lipton said. “The lesson that China needs to internalize, if it is to avoid a repeating cycle of credit growth, indebtedness, and corporate restructuring, is to improve corporate governance,” he added.

That includes enhanced rule of law, transparent accounting systems, improved implementation and an end to subsidies that favor well-connected players, he added.

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Period Careening Toward Same Fate As Dodo Bird

Via the NYTimes:

LONDON — One of the oldest forms of punctuation may be dying

The period — the full-stop signal we all learn as children, whose use stretches back at least to the Middle Ages — is gradually being felled in the barrage of instant messaging that has become synonymous with the digital age

So says David Crystal, who has written more than 100 books on language and is a former master of original pronunciation at Shakespeare’s Globe theater in London — a man who understands the power of tradition in language

The conspicuous omission of the period in text messages and in instant messaging on social media, he says, is a product of the punctuation-free staccato sentences favored by millennials — and increasingly their elders — a trend fueled by the freewheeling style of Facebook, WhatsApp and Twitter

“We are at a momentous moment in the history of the full stop,” Professor Crystal, an honorary professor of linguistics at the University of Wales, Bangor, said in an interview after he expounded on his view recently at the Hay Festival in Wales

“In an instant message, it is pretty obvious a sentence has come to an end, and none will have a full stop,” he added “So why use it?”

In fact, the understated period — the punctuation equivalent of stagehands who dress in black to be less conspicuous — may have suddenly taken on meanings all its own

Increasingly, says Professor Crystal, whose books include “Making a Point: The Persnickety Story of English Punctuation,” the period is being deployed as a weapon to show irony, syntactic snark, insincerity, even aggression

If the love of your life just canceled the candlelit, six-course, home-cooked dinner you have prepared, you are best advised to include a period when you respond “Fine.” to show annoyance

“Fine” or “Fine!,” in contrast, could denote acquiescence or blithe acceptance

“The period now has an emotional charge and has become an emoticon of sorts,” Professor Crystal said “In the 1990s the internet created an ethos of linguistic free love where breaking the rules was encouraged and punctuation was one of the ways this could be done”

Social media sites have only intensified that sense of liberation

Professor Crystal’s observations on the fate of the period are driven in part by frequent visits to high schools across Britain, where he analyzes students’ text messages

Researchers at Binghamton University in New York and Rutgers University in New Jersey have also recently noted the period’s new semantic force

They asked 126 undergraduate students to review 16 exchanges, some in text messages, some in handwritten notes, that had one-word affirmative responses (Okay, Sure, Yeah, Yup) Some had periods, while others did not

Those text message with periods were rated as less sincere, the study found, whereas it made no difference in the notes penned by hand

Geoffrey Nunberg, a linguist who teaches at the University of California, Berkeley, noted that the 140-character limit imposed by Twitter and the reading of messages on a cellphone or hand-held device has repurposed the punctuation mark

“It is not necessary to use a period in a text message, so to make something explicit that is already implicit makes a point of it,” he said “It’s like when you say, ‘I am not going – period’ It’s a mark It can be aggressive It can be emphatic It can mean, ‘I have no more to say’

Can ardent fans of punctuation take heart in any part of the period’s decline? Perhaps.

The shunning of the period, Professor Crystal said, has paradoxically been accompanied by spasms of overpunctuation

“If someone texts, ‘Are you coming to the party?’ the response,” he noted, was increasingly, “Yes, fantastic!!!!!!!!!!!”

But, of course, that exuberance would never be tolerated in a classroom

At the same time, he said he found that British teenagers were increasingly eschewing emoticons and abbreviations such as “LOL” (laughing out loud) or “ROTF” (rolling on the floor) in text messages because they had been adopted by their parents and were therefore considered “uncool”

Now all we need to know is, what’s next to go? The question mark

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Dealer Positions

Via Bloomberg:

IG CREDIT: Corporate Dealer Positions Rose, Led by 5Y-10Y Area
2016-06-10 10:29:20.158 GMT

By Robert Elson
(Bloomberg) — Dealer positions in corporate bonds rose
$3.5b to $19.5b as of June 1, according to Fed NY release.

* $6.5b low Oct. 2015; high $45.9b March 2014.

* Investment grade positions:
* Very short issues rose $1.2b to $4.5b; $4.7b, seen Nov.
19, 2014 was the high for the series that began in April
2013; $1.2b low Aug. 2013
* Positions between 13 months and 5Y fell $13m to $2.8b;
$1.2b, the series low was 11/11/2015, $7.2b, the series
high was 3/18/2015
* Positions 5-10Y rose $1.5b to $1.4b; -$3.1b, a new low
for this series was seen Oct. 28; the high of $4.2b was
5/20/2015
* Positions longer than 10Y fell $1.2b to -$539m; $3b,
seen Nov. 11, was a new high since Fed changed its
report groupings 1/7/2015; -$2.9b, seen 5/6/2015, was
the low

* Commercial paper positions rose $2.9b to $10.1b; $1.8b, the
low for the series, was seen 12/30/2015; $19.9b, the series
high, 3/5/2014

* High yield positions fell $724m to $1.3b
* -$110m the series low 4/15/2016; high of $8.4b was seen
6/5/2013

* Total dealer positions in all Treasuries fell $9.4b to $73b
* 2016 high/low is $121b/$71.4b
* 2015 high/low is $91.8b/$9.3b
* In a look-back to Jan. 1997 the high was $146b in
10/16/2013, -$194b was seen 7/18/2007

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Some Corporate Bond Stuff

Via Bloomberg:

IG CREDIT: Volume Lower, Spreads Steady
2016-06-10 09:57:42.473 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $15.8b vs $18.3b Wednesday, $18.6b the previous
Thursday. 10-DMA $15.1b; 10-Thursday moving avg $17.2b.

* 144a trading added $3.2b of IG volume vs $3.5b Wednesday,
$3.7b last Thursday

* The most active issues:
* ABIBB 3.65% 2026 was 1st with dealer-to-dealer trades
accounting for 52% of volume
* CS 3.80% 2022 was next with client flows taking 100% of
volume; client buying twice selling
* WFC 4.40% 2046 was 3rd with client trades taking 71% of
volume; client selling 2.3x buying
* DHR 6.02% 2026 repeats as most active 144a issue with client
and affiliate flows took 84% of volume; client selling near
3x buying

* Bloomberg US IG Corporate Bond Index OAS at 154.5 vs 154.6
* 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 +154, unchanged
* 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
+201, unchanged
* +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 +632, unchanged; +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 75.8 vs 73.6
* 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 0.755%
* 10Y 1.658%
* Dow futures -93
* Oil $49.77
* ¥en 106.82

* IG issuance totaled $8.875b Thursday vs $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

* Pipeline – Expect More Heavy Issuance Next Week

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FX

Via Marc Chandler at brown Brothers Harriman:

Dollar Remains Firm, Yen May Be Drawing Support from Brexit Fears

• In an otherwise light North American economic calendar, Canada reports May jobs data
• In Europe, the main economic data were French and Italian industrial output figures for April
• A combination of Brexit anxiety and more signs that make last week’s US jobs report an outlier appear to be weighing the on the euro
• Equities are weak and bond yields are lower; these two considerations also support the yen
• The Russian central bank is expected to cut rates 50 bp to 10.5%

The dollar is mostly firmer against the majors.  The yen is outperforming while the Aussie and the Scandies are underperforming.  EM currencies are mostly softer.  THB, INR, and PHP are outperforming while ZAR, TRY, and PLN are underperforming.  MSCI Asia Pacific was down 1%, with the Nikkei falling 0.5%.  MSCI EM is down 1.1%, with Chinese markets still closed for holiday.  Euro Stoxx 600 is down 1.5% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 3 bp at 1.65%.  Commodity prices are mostly lower, with oil down 1.5% and copper down 0.6%.

The US dollar weakened in the first half of the week as participants continued to react to the shockingly poor jobs report and shift in Fed expectations.  However, it recovered smartly yesterday and is seeing some modest follow through buying today.  

The main exception today is the Japanese yen, the only major currency besting the dollar.  For the week, it is the dollar-bloc and the franc that have maintained weekly gains.  And those dollar-bloc gains look vulnerable.  The New Zealand dollar is the star.  It is still up nearly 2% on the week, following the RBNZ’s decision to leave rates alone and to issue a less dovish statement than expected.  Its small losses today appear simply consolidative in nature.  

The Australian dollar is a different kettle of fish.  It staged a key reversal yesterday by making a new high for the move (poked briefly through the $0.7500 target) and then proceeded to sell off through the previous day’s low.  There has been follow through selling today which pressed the Aussie through $0.7400.  If the bounce from late May is being retraced, the initial target is near $0.7365 and then $0.7325.  

The Canadian dollar’s performance puts it between the two Antipodean currencies.  It is holding on to about a 1.5% gain this week coming into today’s North American session.  Three considerations may see these gains pared.  First, oil prices are easing and are already about 3% off yesterday’s highs.  Second, in an otherwise light North American economic calendar today, Canada reports May jobs data.  The median calls for a small gain in jobs after a small loss in April.  We suspect the risk is on the downside.  Also, the unemployment rate may tick up from 7.1%.  Third, technical considerations suggest that if the US dollar cannot be pushed back below CAD1.27, the risk is that corrective forces lift the greenback toward CAD1.2850 initially.  

In Europe, the main economic data were French and Italian industrial output figures for April.  Both beat expectations.  This follows the slightly better than expected German report earlier in the week. Some observers see in the data the basis for an industrial recovery.  

While hopeful, we do not think that today’s reports are convincing, but another month’s would be and here is why.  There has been a distinct pattern in French and Italian industrial production figures for the past several quarters.  Every quarter, both countries see industrial output only rise in one month.  The gains reported earlier today are consistent with this pattern.  For Italy, the pattern goes back to Q1 15.  For France, the pattern appears to have begun in Q2 15.

This is not to deny the strength in the April figures.  The 0.5% rise in Italian output is the first increase since January.  The median estimate was for a 0.3% increase.  The French surprise was larger.  The median expected output to rise by 0.4% and instead it jumped 1.2%.  Manufacturing production itself rose 1.3% compared with expectations for a 0.8% gain.  The French report was particularly surprising given that the manufacturing PMI in April fell to 48.0 from 49.6.  

The euro found little succor in the reports.  The euro posted a key reversal yesterday, and there has been modest follow through selling today.  At $1.1295, the euro retraced 38.2% of the gains since May 30.  The intraday technicals warn that the 50% retracement (~$1.1260) can be approached before the weekend.  

A combination of Brexit anxiety (as the opinion polls suggest a tight contest) and more signs that make last week’s US jobs report an outlier (including a larger than expected fall in yesterday’s weekly jobless claims) appear to be weighing the on the euro against the dollar.  Also, many expect the most Fed officials will likely keep their dot plots consistent with two rate hikes this year.  

Brexit angst may also be a factor helping drive down interest rates in Germany and Japan, where new record low bond yields are being recorded.  Sterling is trading a little heavier but found a bid in front of $1.44.  It finished last week near $1.4520.  The spot market is not showing the full strain of Brexit fears.  One-month implied volatility is near 23.5% today.  It finished last week just above 20% and was near 16.5% two weeks ago.  Following Lehman’s demise, implied one-month sterling volatility reached 30%.  Also, the premium of sterling puts over calls equidistant from the money (25 delta) continued to increase.  Today, the premium stands near 7.8%.  At the end of last week, it was near 6.2% and the week before it was around 5.5%.  

Equities are weak and bond yields are lower.  These two considerations also support the yen.  The dollar managed to bounce a full yen off the JPY106.25 low seen in Asia yesterday.  While the greenback may head back towards that low, barring a large drop in US equities, it is unlikely to reach it in North America today.  

US participants may be reluctant to take the dollar lower than where Japanese money ostensibly took it yesterday, especially ahead of the weekend, and perhaps ahead of next week BOJ meeting.  Most do not expect a change in the BOJ stance ahead of the July 10 upper house election, but given Governor Kuroda’s willingness to surprise the market, many are not ruling it out entirely.

The Russian central bank is expected to cut rates 50 bp to 10.5%.  However, the market remains split.  Of the 42 analysts polled by Bloomberg, 20 see no move and 22 see a 50 bp cut to 10.5%.  The central bank has been on hold since the last 50 bp cut to 11% back in July 2015.  With the ruble firm, we think the bank will deliver a rate cut.  Russia also reports April trade.    

Mexico reports April IP, which is expected to rise 0.8% y/y vs. -2.0% y/y in March.  Price pressures remain limited, with May CPI rising only 2.6% y/y.  We downplay talk of another rate hike to help shore up the peso and limit second round impact on inflation.  Next policy meeting is June 30, no change is expected.

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Credit Pipeline

Via Bloomberg:

IG CREDIT PIPELINE: Expect More Heavy Issuance Next Week
2016-06-10 09:36:25.149 GMT

By Robert Elson
(Bloomberg) —

LATEST UPDATES

* 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
* 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
* 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)

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Mystery Buyer of Two Year Notes

Via Bloomberg;

Eliza Ronalds-Hannon
@elizahannon
Alexandra Scaggs
alexandrascaggs
June 9, 2016 — 7:00 PM EDT

U.S. doesn’t identify category of miscellaneous investors
Bond-market strategists see clues to buyers in Fed data

Who were those masked Treasuries buyers?

A mystery came with the Treasury Department’s allotment data for its blockbuster $26 billion two-year auction on May 24 that left primary dealers with the lowest award on record. For just the second time in data going back to 2009, a catch-all category of miscellaneous bidders bought more than $2 billion of two-year debt at auction. Any bid from that segment is relatively rare — purchasers labeled “other” haven’t bought any two-year debt at all in 41 of the past 80 sales.

The Treasury’s website only offers a list of what the “other” bidders aren’t: central banks, commercial banks, individuals, bond dealers, pensions, insurers, investment funds or foreign buyers. That doesn’t leave many options, and spokesman Rob Runyan declined to comment.

But after a bit of sleuthing, Treasury-market strategists including Credit Agricole’s David Keeble said a couple of groups could be behind the purchases. It may be state and local governments, which owned $632 billion of Treasury securities at the end of the first quarter, according to the Federal Reserve’s flow of funds data, and nonfinancial businesses, which held $95 billion.

If the mystery buyers came from either of those groups, it may be their cash-management divisions, since pension holdings are reported separately. Cash managers usually stick to Treasury bills, but three-month bills now yield less than the effective overnight federal funds rate. Of course, two-year notes would leave the mystery buyers exposed to higher risk of losses if the Fed raises interest rates.

“It makes a lot of sense with the baseline assumption being the Fed’s not going — that’s the only way it makes any sense,” said Aaron Kohli, a fixed-income strategist in New York for BMO Capital Markets, a primary dealer. “If they’re happy with a 76-basis-point yield over the next two years, you could have a mark-to-market loss for a while.”

Two-year notes yielded 0.77 percent as of 5 p.m. in New York Thursday.

That nominal loss would be a worthwhile price to pay for U.S. companies besieged with excess cash, said Tom di Galoma, managing director of government trading and strategy at investment bank Seaport Global Holdings LLC in New York.
Floating-Rate Notes

There’s more evidence to support the idea that the “other” bidders are corporate and state cash managers: That group has also been active at sales of two-year floating-rate notes, buying an average of 9.6 percent since the securities were introduced in January 2014.

Those notes’ interest payments rise and fall based on the discount rates at auctions of 13-week bills. So the securities give cash managers similar exposure without needing to take on expenses related to purchasing new bills every 13 weeks, said Blake Gwinn, a U.S. rates strategist with RBS Securities in Stamford, Connecticut.

“Floaters are the perfect cash-management tool,” Gwinn said. “For people who are really just passively managing cash who would just be rolling a bill over and over, that’s a great spread. You’re avoiding transaction costs.”

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Data Dependent Fed

This Bloomberg article highlights the problem with the Fed’s communications strategy. The concept of transparency made some sense at the height of the financial crisis when we first visited the zero bound. Nearly eight years later the FOMC would do markets a favor if it did not tell us what it is doing and just let markets figure out what policy actually is. This would make for more prudent risk taking and would lesson the possibility of bubbles.

Via Bloomberg:
June 10, 2016 — 5:00 AM EDT
n

Investors say they’re puzzled after Fed chair ends guidance
Vague statements stem from compromise, says former Fed insider

Janet Yellen says she doesn’t want investors to rely on the Federal Reserve for explicit guidance on the next interest-rate hike — a communication strategy that’s leaving some flatly confused about the path of monetary policy.

Speaking Monday in Philadelphia, the Fed chair said “only on rare occasions” will the central bank spell out when it’s going to move. “I really think the best we can legitimately do is explain what factors are guiding our thinking,” she told the audience, referring to the Fed’s intention to make policy data dependent.

The challenge with that approach is that it seems to be making it harder to understand the U.S. central bank’s plans. Their intentions are signaled in statements issued after each rate-setting Federal Open Market Committee meeting, as well as subsequent comments by its 17 policy makers that don’t necessarily add up to a coherent explanation of Fed action.

Case in point: Investors were wrong-footed by the Fed’s statement in April, reading it as relatively dovish and then reacting with surprise when minutes published three weeks later showed most officials were inclined to raise interest rates in June.

Investors face another comprehension test at 2 p.m. on June 15 after the next FOMC meeting, when it issues a fresh statement and updates its economic forecasts. Investors can also tune in to Yellen’s quarterly press conference for more clues.

“There is a problem here,” said Charles Plosser, a former Philadelphia Federal Reserve Bank president. “Vacuous” FOMC statements have become the norm as competing camps on the committee thrash out a compromise, he said.

“The desire to reach consensus on the statement makes it more vague and uncommunicative,” said Plosser. “That means it doesn’t reveal the true nature of the debate as it could or it should.”

To be fair, the Fed has spent a lot of time thinking about how to improve its messaging. It has a subcommittee on communications, and the FOMC in January discussed changes to its quarterly economic projections to illustrate how much uncertainty lies around the forecasts, according to minutes of that meeting.

St. Louis Fed President James Bullard has also argued for holding a press conference after every FOMC meeting, instead of every second one as is currently the case, though Yellen hasn’t so far shown any inclination to move in that direction.

Yellen and her colleagues have backed away from hinting a rate hike would be considered in June after the U.S. added just 38,000 jobs in May, the weakest in almost six years. Those hoping June’s statement will clarify what to expect in July shouldn’t hold their breath.

“I know market participants really want to know exactly what is going to happen,” Yellen said Monday. “There is, as I have said about 18 times, no pre-set plan.”

For an analysis on Yellen’s latest remarks on Fed policy, click here.

Investors see no probability of a June move and a 20 percent likelihood of a hike in July, according to pricing in federal funds futures contracts.

The Fed “is struggling to find the right combination of written and spoken signals that signal intentions but not pre-commitment,” said Ward McCarthy, chief financial economist at Jefferies LLC in New York.

April’s statement miscue wasn’t the Fed’s first. The FOMC also confused investors last year with “dovishness at the September meeting that had to be corrected at the October meeting,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.

These lapses recall the so-called taper tantrum in May 2013 when then-Fed Chair Ben Bernanke jarred bond investors with plans to scale back asset purchases.

The Fed’s own poor forecasting record may be making matters worse. In particular its quarterly economic forecasts, including the so-called dot plot projection of what officials view as the likely pace of future fed rate hikes, have attracted critics.

“The FOMC has fairly consistently signaled a tighter path of policy than the markets expected, and the markets turned out to be right,” said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore. “Communications have tended to err on the side of being more hawkish than what is ultimately done.”

For example, the Fed in March halved the number of rate hikes it expects this year to two compared to projections in December.

Plosser, who dissented three times in 2014 in favor of tighter policy, said that hurts credibility. “It has been a repeated problem. They keep saying we are getting close and then finding a reason not to do it,” he said.

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Messages From the Yield Curve

Via WSJ:
By Justin Lahart
Updated June 9, 2016 3:03 p.m. ET
1 COMMENTS

The Treasury market’s message on the U.S. economy may be more noise than signal. But the Federal Reserve still needs to listen to it.

Rarely have investors been so willing to loan money to the U.S. government and get so little in return. With worries about global growth festering, and uncertainty about the coming referendum on the U.K.’s membership in the European Union further clouding the picture, the yield on the 10-year Treasury slipped to around 1.68% on Thursday. The last time it was so low was February, when markets around the world were in panic mode.

Traders aren’t nearly as nerve-wracked now. But this latest drop in the 10-year yield has caused a flattening of the yield curve—the difference between short-term and long-term interest rates—that is disconcerting. With the two-year Treasury note yield at 0.76%, the difference between it and the 10-year yield has slipped to about 0.9 percentage points. That is the smallest gap since just before the recession started in 2007.

Because investors typically demand to get paid more for locking up money for longer periods, the yield curve is usually positive. When the curve gets flatter, it is a sign investors don’t think future investment returns will be all that good. That usually means a slower economy.

For the Fed, which is hoping for the economy to grow more rapidly in the quarters ahead, the flattening in the yield curve would historically suggest that it dial back any plans it has to raise rates.

There are, however, some reasons why the old interpretation of the yield curve might no longer hold.

One is that views on the neutral rate—where the Fed should set overnight rates once both inflation and employment are at its target—have fallen. That alone lowers expectations of what overnight rates will average over the next 10 years, and lowers the yield on the 10-year note as a result.

Another is that the overseas influence on the Treasury market has become increasingly pronounced. Most long-term government bonds in the developed world sport significantly lower yields than Treasurys, and that has increased Treasurys’ attraction for global investors.

The yield on the German bund Thursday was just 0.03 percentage point. Ten-year Japanese government bonds, meanwhile, have a yield of minus-0.13 percentage point. That exerts a downward gravitational pull on Treasurys. That is particularly so since central bank bond-buying programs in Europe and Japan are cutting into supply, pushing investors to look elsewhere.
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The problem for the Fed is that even though the yield curve may not be as reflective of the U.S. economy as it once was, it can still affect the economy. Banks fund long-term loans with money borrowed in short-term markets; when the yield curve compresses, that business becomes less lucrative. As a result, their willingness to extend credit could be curtailed.

And that could give the Fed one less reason to raise rates.

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