Trading Treasury Auctions
February 15th, 2015 4:09 pmThis is an interesting research piece from the Quants at SocGen on strategies for trading Treasury auctions.
Impact of Negative Rates
February 15th, 2015 3:12 pmInsurance companies and pension funds and others driven to hedge liabilities with interest paying assets face a problem in Europe as rates dive below zero.
Via the FT:
February 15, 2015 1:46 pm
Negative rates to shake up financial system, say experts
Ralph Atkins and Elaine Moore in London
Falls in European interest rates into negative territory could profoundly affect the workings of the financial system and there is little chance of benchmark borrowing costs rising in the year ahead, top investment managers and strategists have warned.
Yields, which move inversely with prices, have this year dropped below zero on a rapidly expanding range of European governments’ bonds — and even some corporate bonds. The declines, which are driven by the European Central Bank’s “quantitative easing”, mean historically low borrowing costs. But senior finance experts interviewed by the Financial Times saw worrying side-effects.
“This could be the makings of a completely new environment for global bond markets,” said Andrew Milligan, head of global strategy at Standard Life Investments, at the FT’s debt capital markets conference in London. “If it actually becomes permanent . . . There could be some very significant capital flows.”
“It has a huge impact on a lot of simple things like pension funds and insurance companies, and how their whole model works,” said Henry Cooke, executive director at Gryphon Capital Investments. “It is putting them under a lot of pressure . . . and when people are put under a lot of pressure, they take a lot more risk.”
Negative interest rates mean investors, in effect, pay to lend their money. Jerome Booth, former head of research at Ashmore Group, said: “It is perfectly acceptable for a government to try to get a negative yield — it sounds a good deal. The problem is: why would investors do it?”
The ECB’s action has forced countermoves by central banks outside the eurozone. Danish and Swedish five-year bond yields ended last week at minus 0.48 per cent and minus 0.04 per cent.
Neil Williams, group chief economist at Hermes Investment Management, said: “It smacks, surely, of the first signs of what you could call a currency war. Not all central banks can push their currency down sufficiently to stoke up demand . . . I am not so sure it is the solution.” Some $2tn of European government bonds over more than one year’s maturity have negative yields, according to JPMorgan.
Yields are also negative on Swiss government bonds, and earlier this month turned negative on some euro-denominated debt issued by Nestlé, the Swiss food manufacturer.
Finance experts did not have high expectations of an early end to the era of ultra-low interest rates in continental Europe. German 10-year yields ended Friday at 0.34 per cent, compared with 0.54 per cent at the start of the year. “Near zero for the 10-year yield for Germany is not unlikely,” said Pascal Duval, chief executive for Europe at Russell Investments.
The investment specialists expressed concern on whether QE would boost economic growth in Europe, but argued it was needed to fight deflation threats. “It creates the best opportunity for a good outcome in Europe,” said Martin Reeves, head of global high yield at Legal & General Investments.
However, UK and US market borrowing costs could increase this year on the back of possible interest rate rises by the Federal Reserve and Bank of England, the experts reckoned. Mr Reeves said wage inflation in the US and UK would “push up government bond yields around the world — and probably quicker than people think because everyone has got so bearish.”
Draghi on Deflation
February 15th, 2015 3:03 pmVia Bloomberg:
Deflation Risk Low, Higher Than a Year Ago, Draghi Tells ABC
2015-02-15 17:03:32.256 GMT
By Charles Penty
(Bloomberg) — Deflation risk remains low, certainly higher
than it was a yr ago, ECB President Mario Draghi tells Spanish
newspaper ABC’s magazine in interview.
* Drop in oil prices is a good thing, can cease to be so if it
has negative impact on inflationary expectations: Draghi
* Inflation is easier to fight than deflation
* Draghi declines to answer question on what would be bad
about Greece leaving the euro because any statement by him
could be used politically; it makes no sense to speculate
about a possible exit from single currency
* Euro is irreversible: Draghi
* ECB policy not about punishing German savers or compensating
weaker countries; it’s sometimes hard to explain this to the
Germans: Draghi
* Draghi tells ABC magazine he feels misunderstood by the
Germans; some people don’t want to understand him
Greece Negotiations
February 15th, 2015 3:01 pmVia Bloomberg:
EU Official: Brussels Greek Talks End Ahead of Feb. 16 Meeting
2015-02-15 15:39:10.883 GMT
By Rebecca Christie
(Bloomberg) — Technical talks between Greece and euro-area
authorities were not negotiations, EU official says Sunday.
* Greece, euro-area authorities held “exchange of views to
better understand each other’s position,” official says on
condition of anonymity because talks were private
* Technical talks between Greece and euro-area authorities
concluded as planned on Saturday night
* All parties will report to euro-area finance ministers
meeting on Monday in Brussels
* Technical talks took place at European Commission offices in
Brussels
* NOTE: Greece Locked in Creditor Talks in Search for
Compromise
Aging Baby Boomer Alert
February 13th, 2015 8:41 pmThe internet is rife with reports that Don MacLean will auction the original manuscript and notes to his monster hit “American Pie”. The documents are expected to fetch between $ 1million and $1.5 million.
He has never revealed the meaning of the vignettes he offer in that song but the lyrics contain allusions to a variety of events and people of the 1950s and 1960s.
This might be a reach but that piece of music is a great work of art. I once heard a priest at my local Catholic Church use that song when he preached on a reading from the Book of Revelations. He noted how the language of the song was descriptive yet only familiar and accessible to people of 20th century America. He suggested that if someone reads that song several centuries hence it will make little sense without a thorough understanding of the context within which MacLean wrote it.
The preacher’s point was that for those of us in 20th century America to sit and read Revelations without understanding the 1st century author and the social context of that time is foolish.
MacLean wrote a classic piece of rock and roll and something universal as that priest was able to employ it to make his point on the final book of the Christian Bible.
Great lyrics and great song.
Will History Repeat Itself?
February 11th, 2015 10:21 pmHoisington Asset Management is a modest sized money manager with some very strong views. Van Hoisington and Lacy Hunt provide the reader with an excellent study of the 1920s and the parallels to the current global macro economy. It is a very interesting read.
Overnight Data Preview
February 11th, 2015 8:18 pmRobert Sinche of Amherst Pierpont Securities on the spate of data scheduled for release this evening:
AUSTRALIA: The BBerg consensus expects notably-unreliable Employment Report for January to show a -5K decline following a strong +37.4K gain in December, with the UR picking up to 6.2% from a 3-month low of 6.1% last month. Also to be released will be the February survey of Consumer Inflation Expectations, which slipped to a still-high 3.2% in January.
CHINA: The January monetary data is due sometime this week, with our focus on Aggregate Financing Activity, which picked up in late 2014. However, Aggregate Financing has a strong seasonal, with large increases normally reported in January, a factor impacted by new Bank Loan quotas as the new year begins. The gain in Aggregate Financing in Jan 2014 was CNY2,600.4bn, with a BBerg consensus of CNY2,100bn this January. If the data are weak it would add to pressure on the PBOC to ease further as inflation fell to +0.8% YOY in January.
INDIA: The BBerg consensus expects YOY Industrial Production growth to slip to 1.8% YOY, near the 12-month average of 1.4% over the year ended November. Meanwhile, the consensus expects the YOY CPI to rise further to 5.5%, up from a cycle low of 4.4% in November.
JAPAN: The Machinery Orders data for December is expected (BBerg consensus) to post a solid 5.6% YOY gain from -14.6% drop in November in this highly volatile series. It does appear orders are beginning to show a modest recovery from 2Q2014 lows.
RUSSIA: The weekly update on Gold & FX reserves is likely to show a continued decline.
EURO ZONE: With signs that growth conditions are improving modestly, the BBerg consensus expects YOY Industrial Production growth to rebound to +0.3% YOY in December, but it will hold below the +0.8% average over the last 12 months.
UK: The Bank of England Inflation Report should provide guidance on future BoE policy decisions, with the BoE no longer likely to hike rates before the FOMC, although further easing is unlikely and the GBP should maintain strength versus both the JPY and EUR.
Bank of America on Spread Widening
February 11th, 2015 8:12 pmVia Bank America Merrill Lynch Research:
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Benefits of ECB Bond Buying
February 11th, 2015 8:04 pmVia Greg Ip at the WSJ:
By
Greg Ip
Feb. 11, 2015 7:17 p.m. ET
When the threat of Greek insolvency first erupted in 2010, the worries rapidly spread to the eurozone’s other peripheral economies, sending borrowing costs skyrocketing.
This time around, what’s happened in Greece has stayed in Greece. While yields on Greek bonds hover around 11%, they’re below 2% in Ireland, Spain and Italy—less than what the U.S. Treasury pays to borrow.
This matters for more than just the markets. It is also critical to the eurozone’s most indebted members’ efforts to fix their finances. As European Central Bank President Mario Draghi said last month in unveiling a much-anticipated plan to purchase government bonds: “All monetary-policy measures have some fiscal implications.”
That would be an understatement. By driving rates so low and promising to buy government bonds, the ECB makes it much easier for peripheral economies to stabilize their crushing debts. It obviates the need for added short-term austerity, which could provoke a political backlash that derails the economic reforms essential to bringing down debt in the long run. In other words, monetary policy is central to the success of fiscal policy.
To understand why, consider some simple arithmetic. A stable debt is one that stays the same as a share of gross domestic product. If the interest rate the country pays on its debt is higher than the growth of nominal GDP (that’s real GDP plus inflation) that debt ratio automatically goes up—unless the government runs a surplus in the budget excluding interest. Conversely, when the interest rate a country pays on its debt is below its growth rate, the ratio automatically drops, unless there’s a deficit in the budget, excluding interest.
The latter scenario—having interest rates below the growth rate—is like having the wind at your back. And that’s the situation Spain, Ireland and Portugal should all be in this year. Italy is close.
A few years ago, those countries were in the opposite situation, with soaring interest rates and shrinking GDP. What changed?
Investors typically don’t worry that a government will default on debt issued in its own currency; in a pinch, the central bank can print the money needed to repay that debt. That option, though, isn’t necessarily available to members of the euro, who can’t order the ECB around.
After European governments bailed out Greece in 2010, they wanted investors to share the pain and so embraced the principle that government bonds could be subject to a “haircut”—or a repayment of less than 100 cents on the euro. The prospect of Greek default or exit from the euro sent Italian and Spanish yields over 6%, Portuguese and Irish yields above 10%, and Greece’s over 30%. At such punishing interest rates, fear of default becomes self-fulfilling.
Mr. Draghi largely put an end to those fears in 2012 by promising to do “whatever it takes” to save the euro. So long as a country abides by the terms of a bailout, the ECB vowed to not let it be forced out of the euro.
Those actions helped narrow, though not eliminate, the difference in yields between peripheral and what is seen as safe German debt. Then, last spring, Mr. Draghi opened the door to quantitative easing—the outright purchase of government bonds with newly created money—in an effort to push the region’s inflation rate back up. QE will soon begin.
That has brought yields throughout the region down even further, to levels that significantly improve the region’s debt dynamics. Goldman Sachs estimates that a one percentage point drop in interest rates reduces the deficit cuts needed for Italy to stabilize its debt by 1.3% of GDP, and Spain by 1%. That won’t happen immediately: Existing debt has to be refinanced. It helps, then, that QE could have several years to run. Investors are betting that Spanish and Italian yields will remain around 2.5% five years from now, notes Zsolt Darvas of Bruegel, a Brussels-based think tank.
Because Italy already runs a sizable budget surplus excluding interest, that means it needs no new austerity for its debt-to-GDP ratio to drop. Spain still has a deficit excluding interest, but the task of stabilizing its debt is now nearly complete.
It’s not enough for peripheral countries just to stabilize debt, of course; eventually the debt-to-GDP ratio has to come down. But the ECB has given them breathing room to ease austerity and give structural reform the necessary time to raise long-term growth. All that assumes no contagion from Greece.
There are big caveats to this upbeat picture.
First, the reason the ECB has acted on QE is because eurozone growth is so weak and inflation is running well below its target of near 2%. If even modest growth fails to materialize, or low inflation turns to deflation, stabilizing the debt as a share of GDP becomes much harder. As Angel Ubide and Adam Posen note in a recent report for the Peterson Institute, a U.S.-based think tank: “The high level of euro-area debt is not sustainable with weak nominal GDP growth.”
The second big risk is political. Austerity-weary voters may follow the path of Greece and abandon not just near-term austerity but long-term reform.
The ECB could well abandon them then, and the deadly dynamics of 2010 would be back. The ECB is a crucial player in solving the euro zone’s fiscal woes; but it won’t do it on its own.
Popular on WSJ
Ten Year Note Auction
February 11th, 2015 10:20 amVia CRT Capital:
We have a mixed outlook on this afternoon’s 10-year auction and expect non-dealer interest to be significant, as it has in recent refundings, but are cognizant that might still occur with a tail. Recent history shows all eight of the last 10-year auctions have tailed and average of 0.9 bp (including reopenings and refundings). While the refunding-only stats are closer to 50/50, we still don’t have a strong reason to fade the tendency to tail. We anticipate a more meaningful concession either ahead of 1pm or at the auction itself in the form of a modest tail.
On the other hand, we have seen improving foreign and investment fund awards at the last four refundings, leaving these bidders as the major wildcard. Tactically, we’d like to buy at the auction for a post-supply rally as we expect the process to be met by a solid non-dealer reception and improve into the long weekend as the policy (Greece/EU) and geopolitical risks remain elevated and we’re technically getting to attractive levels.
* The WI at 1.990% suggests the second lowest yielding 10-year auction since May 2013; an auction that tailed 1.2 bp. This might further limit aggressive bidding interest. Last month’s 10-year also yielded <2.0% and tailed 1.4 bp.
* Foreign awards at 10-year refundings have increased over the last four auctions, taking 23% or $5.5 bn vs. 19% or $4.4 bn at the prior four. In addition, investment fund interest has increased over the same period, taking 38% or $9.0 bn vs. 32% or $7.6 bn prior.
* Indirect bidding has increased, taking 48% at the last four refunding auctions vs. 39% at the prior four. Over comparable periods, direct bidding has fallen, averaging 16% during the last four reopenings vs. 19% prior.
* Technicals remain bearish although momentum is moving into oversold territory. We’ve been watching the 50% retracement of the range since late November at 2.02% and its psychological impact – tested and held on Monday. Resistance comes in at about 1.96%, the 40-day MA and the NFP-day close of 1.953%. There is weaker resistance at 1.86+% — high-volume breakout/breakdown area. Below all that is 1.77+%, also an area of volume.