Supply Consideration

David Ader at CRT Capital comments on this week’s auctions auctions of 3s 10s and 30s. He notes the accelerated schedule with auctions Monday through Wednesday rather than the normal Tuesday through Thursday. That is a function of Thursday being the 15th which is settlement day so an auction that day would be difficult to settle for cash.

Separately, the auctions total $58 billion against $57.5 maturing. That means new cash being raised is a meager $500 million. Mr Ader makes the point that much of that maturing money will seek safe sanctuary in the three year note which should see strong bidding interest.

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FX

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

– The greatest risk to the divergence theme is that the consensus would swing against ideas that the Federal Reserve will raise rates near mid-year
– The preliminary negative inflation print in the euro area is likely to be confirmed this week
– On Wednesday, the Advocate General of the European Court of Justice will offer a preliminary opinion about the Outright Market Transaction scheme
 – UK CPI is likely to fall below 1.0%, forcing the BOE to write a letter to Chancellor of the Exchequer Osborne to explain the undershoot  
– Although oil prices have been falling for six months, the world is still in the early days of the adjustment process
– Investors continue to closely watch European political developments, from Greece to Italy

Price action:  The dollar is broadly stronger, quickly shaking off the post-jobs data softness.  Kiwi and Nokkie are underperforming, while the Loonie and Stockie are outperforming.  The euro is trading back below $1.18, while cable is flirting with the $1.51 area again.  Dollar/yen has moved back above 119.  EM currencies are mostly softer, though KRW, IDR, and TRY are bucking the trend and are up on the day.  RUB and the CEE currencies are the worst performers today.  MSCI Asia Pacific was down 0.3%, and follows two straight days of strong gains.  The Shanghai Composite was down nearly 2%. Euro Stoxx 600 is up nearly 1% around midday, while S&P futures are pointing to a higher open. Oil prices continue to fall, with Brent oil making a new low for this move today.

• The greatest risk to the divergence theme is not that the BOJ and ECB would abandon their to pursuit unorthodox monetary policy.  It was that the consensus would swing against ideas that the Federal Reserve will raise rates near mid-year.  The continued drop in oil prices, and last week’s news that US average hourly earnings growth slowed to their weakest rate in two years, have fueled a dovish push back.  The string of US data in the days ahead will provide them with more ammunition.  Producer and consumer prices likely fell in December.  Retail sales likely slowed.  
• This may encourage some consolidation of the dollar’s recent gains, which means a heavier tone for the greenback.  Momentum already seemed to have stalled in the second half of last week.  The same is true for equities.  The quarterly earnings season starts in earnest with Alcoa.  Following the guidance, earnings expectations have continued to drift lower, and the strength of the dollar has already been cited by some, as a factor depressing the translation of foreign earnings into dollars.  
• Nevertheless, we are reluctant to be swayed.  These developments do not pose a serious threat to the divergence theme.  The Federal Reserve targets core inflation for good reason.  Headline inflation may fall, but core inflation is likely to prove sticky.  One of the important factors here is the rise in housing costs.  We already know that auto sales slowed sequentially from November, and the drop in gasoline prices will weigh on the headline retail sales report.  However, excluding autos, gasoline, and building materials, which are included in different measures that feed into GDP calculations, retail sales are still expanding at a respectable rate.  Moreover, it is being done largely without the use of revolving credit.  
• There is no getting around the disappointing hourly earnings growth.  However, it is only one measure of labor costs and one month.  We will be more concerned if it is repeated in the coming months and confirmed in other reports.  Broader measures of the labor market, which will also be reported next week, are expected to show continued improvement.  
• The preliminary negative inflation print in the euro area is likely to be confirmed this week.  It will strengthen investors’ conviction that the ECB will broaden the assets it purchases to include sovereign bonds as early as January 22.  Nevertheless it is important to remember that at his December press conference, Draghi made a point of not committing to that meeting (hinting that the March 5 meeting action was also possible).  
• Although it received considerably less attention, the core rate of inflation in the euro ticked up to 0.8%, its highest rate in three months.  The ECB has painted itself into a bit of a corner by not interpreting its mandate for price stability to mean core price rather than headline.  Such a focus led to policy miscues in the recent past.  What prevents it from correcting its course seems to be more inertia and ego than economic logic.  
• On Wednesday, the Advocate General of the European Court of Justice will offer a preliminary opinion about the Outright Market Transaction scheme.  Recall the ECB approved Draghi’s initiative over the Bundesbank’s objections.  Disgruntled Germans took the case to the national court, and Bundesbank President Weidmann testified, seeking through court action to do what he failed to convince a majority of fellow EMU central bankers to do.  Although the opinion to be issued this week will not be binding, it will reveal how the Court is likely to decide.  Its formal decision is expected near midyear.  It could shape some elements of the ECB’s bond buying program, like risk sharing elements.  
• Sweden and the UK will also report their latest inflation figures next week.  Sweden is expected to move deeper into deflation territory.  The year-over-year rate may fall to -0.5% from -0.2%.  This will likely push the Riksbank into unorthodox monetary policy at its February 12 meeting.  There does not seem to be a strong inclination to buy its sovereign bonds, which are yielding 81 bp at the end of last week.  It could use its forward guidance to push out the first rate hike from H2 2016 of its last indication, and link the decision to a specific level of inflation.  It could lengthen repo/loan facilities.  
• UK CPI is likely to fall below 1.0%. This would force BOE Governor Carney to write a letter to Chancellor of the Exchequer Osborne to explain the undershoot.  However, this is mostly political theater.  We would not expect a policy response.  Unlike the dissents at the Federal Reserve, the two dissents at the Bank of England actually advocate an immediate hike.  The dissents are unlikely to have been swayed by the drop in oil prices, though investors will have to wait until the minutes are released on January 21.  In addition, we recognize the risk that the core measure of UK’s CPI may tick up to 1.3% from 1.2%.  
• Japan’s economic data are unlikely to move the market much.  It begins the week with its November current account balance.  The November balance has deteriorated from October for the past seven years and it’s expected to do so again.  The trade deficit is expected to narrow slightly.  The dramatic drop in oil prices, even in yen terms, points to some improvement in Japan’s trade balance going forward.  
• The direction of the equity markets is key for the yen.  Simply looking at direction, the dollar moves against the yen in the same direction as the Nikkei 97% of the time (60-day rolling basis) and the S&P 500 88% of the time.  The correlation between the returns of dollar-yen and the returns of the Nikkei and S&P 500 (correlations run on percentage change of each) is 0.45 and 0.56 respectively, both of which are at the upper end of the ranges since Prime Minister Abe was elected in late 2012.  
• Although oil prices have been falling for six months, the world is still in the early days of the adjustment process.  Competition for market share is intensifying.  OPEC producers, led by Saudi Arabia, are still increasing discounts to the official selling prices for the US and Europe.  At the same time, the US government has informally eased rules to export lightly processed crude (condensate).  Canada’s exports to the US appear to be displacing some of Latam and African producers.  
• The US rig count continues to fall, but much more is likely to be seen if oil prices stay low and/or fall further.  There are still about 1482 oil rigs operating in the US (excluding rigs off-shore).  Based on past experience, some oil experts, like T. Boone Pickens, warn that the rig count could fall to 1000 before the end of the cycle.  In addition, because of the advent of horizontal drilling, the relationship between rig count and actually output might not be as tight as it has been in the past.
• Investors will also continue to closely watch European political developments.  In Greece, the latest polls continue to show Syriza winning a plurality of votes at the January 25 election.  Prime Minister Samaras’ New Democracy has not been able to close the 2-3 percentage point lead.  Even with the 50 bonus seats given to the party that gets the most votes, it appears Syriza may not secure a majority in parliament.  If it fails to do so after three days, the party with the second highest vote count will get a chance.  New Democracy may be able to do so, avoiding another election.  
• European politics will remain an important issue for investors after the Greek election.  Italy’s president will soon resign, and this will begin what could be a protracted process to pick his successor.  It is a more complicated process than in Greece, where a super-majority of parliament chooses the president.  In Italy, more than just parliament is involved.  In addition, given the fractious nature of Italian politics, the role of the President is more important than constitutional powers of the office.
• Spain holds local elections in May and national elections in November.  Investors have already begun monitoring the polls.  A poll out last week from La Razor, a conservative newspaper, showed the ruling PP in first place, followed by the Socialists and the insurgent Podemos in third place.  However, a poll over the weekend by Cadena Ser, a radio station, put Podemos in first place.  Another poll, conducted by Metroscopia for the left-center newspaper El Pais, published on Sunday also showed Podemos with a plurality of votes.
• In Japan, there was an election in the Saga prefecture.  We had noted that the election for governor pitted Hiwatashi, a reform candidate backed by Prime Minister Abe, against Yamaguchi, who enjoyed the support of the some local LDP and Japan’s Agricultural Cooperative (JA).  JA is seen as a powerful force against the agricultural reforms that Abe is pushing under the cover of the Trans-Pacific Partnership.  Yamaguchi’s victory in Saga illustrates the challenges facing Abe’s third arrow of structural reforms, despite the ruling coalition maintaining its super-majority in the December election.

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Winners and Losers in the Energy market

Via Merrill Lynch Research:

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Corporate Bonds

Via Bloomberg;

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January 12 2015 Opening

Prices of Treasury coupon securities have slipped from the robust levels which prevailed at the close of business on Friday. On Friday bond bulls took solace in the employment report as an examination of the entrails of that report showed that while growth in employment is solid wages are quite soft.Some see the weakness in wages as a reason to defer planned rate hikes. Tokyo was closed so the level of client and dealer activity in this session was subdued. The yield on the 5 year note edged up to 1.428 from 1.427 at the close on Friday. Similarly, the yield on the 7 year note increased to 1.749 from 1.731. The yield on the 10 year note remains well below 2 percent but did climb to 1.969 from 1.95. Finally the yield on the Long Bond jumped to 2.549 from 2.53 late Friday. On balance, the yield curve is a tad steeper. As we open trading in the US 5s 10s is at 53.1 versus 52.3 at the close. The 5s 30s spread is 111.1 versus 110.3 late Friday. Midweek last week I clocked that spread as narrow as 102.5. The 10s 30s spread is unchanged at 58. The 2s 5s 10s spread continues to richen and starts the week in New York at 33.4 basis points. That spread traded on January 5 (one week ago) at 44.6. In contrast 5s 10s 30s has retreated. That spread trades at -5.7 this morning which is a retreat from the -7.7 which prevailed last week.

One dealer reports central bank and fast money sellers of 10s and central bank buyers of short coupons.

Equity futures on the S and P are up about 10 points at this hour indicating stocks will enjoy a nice bounce at the open. European equities are also strong but I could not discern  a reason.  Oil futures are down about 2 percent currently and the recent pattern has been for the S and P to slavishly mimic the price action in the energy market.

There was no high profile data overnight. Australian home loan approvals declined 0.7 percent against an expectations for a 1.7 percent gain. This week the  global economic calendar is replete with inflation data with CPI and PPI in the UK and the US as well as CPI in Germany. In the US the other close watched data point will be the monthly report on retail sales.

The real test for the market this week in supply from the Treasury. Today we bid on $24 billion 3 year notes and tomorrow we bid $21 billion 10 year notes. On Wednesday we bid $13 billion Long Bonds. I will be shocked if we can take these bonds on the fly without additional curve concession. The corporate bond market will muddy the trading waters too as I have seen estimates for as much as $40 billion of supply n that market.

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Supply and Demand in the Oil Market

Professor James Hamilton is the proprietor of the highly regarded Econbrowser blog and in a recent post there he deconstructs the decline in the price of oil into supply and demand components. Here is the relevant excerpt:

That is, of the $55 drop in the price of oil since the start of July, about $24, or 44%, seems attributable to broader demand factors rather than anything specific happening to the oil market. That’s almost the same percentage as when I performed the calculation using data that we had available a month ago.

Here is a link to the entire piece.

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Ebullient Consumers

Wage growth  has been slow but that has not caused them to refrain from spending during the Christmas season. This story from the FT chronicles the strong pace of spending over November and December in the US.

Via the FT:

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Commodity Glut

According to this WSJ story the glut in commodities will be with us for quite some time.

Via the WSJ:

By
Georgi Kantchev,
Ese Erheriene and
Neena Rai
Jan. 11, 2015 4:47 p.m. ET
0 COMMENTS

Two years ago, Daniel Nilsson ’s family bought a hotel in the town of Pajala, Sweden, some 50 miles above the Arctic Circle.

The nearby Kaunisvaara iron-ore mine had just started production, and the Nilssons installed new meeting facilities and revamped the nightclub. “We wanted to give the locals and the people working in the mines a great hotel to come to,” said Mr. Nilsson, its 28-year-old manager. “That’s why we bought it—we saw a future for it.”

But the price of iron ore sank last year, and with it the Lapland River Hotel’s fortunes. In October, the mine’s owner, Northland Resources , stopped operations. Two months later, Northland filed for bankruptcy.

“I think we lost 75% of our business,” Mr. Nilsson said. “At the time, we thought it was unimaginable. But most of it was just gone overnight.”

Years of high commodity prices fueled a boom in investment around the globe by companies extracting resources—and by the many others, big and small, that depend on them. The ensuing slump has been devastating.

The mine and its servicing companies employed roughly 700 people in a town of 6,000, according to Andreas Lind, acting governor of surrounding Norrbotten County. Northland declined to comment.

Pajala isn’t alone. Commodities markets from oil to coal to sugar took a beating last year, with many prices falling to multiyear lows. The turmoil has led to job cuts, mine closures and losses for investors. It has spread to suppliers and contractors far bigger than the Lapland River Hotel: U.S. Steel Corp. said last week it would idle a plant in Ohio that makes steel pipes for the oil industry, laying off more than 600 workers.

Huge levels of output helped drive commodity prices down, and many analysts believe they will stay low: Large stockpiles remain, and some producers are carrying on despite lower prices.

China, for instance, had wheat stockpiles of 63 million metric tons at the end of last year, up from 46 million in 2008, according to U.S. Department of Agriculture data. It added 87 million barrels of oil to its stockpiles last year, according to Amrita Sen, chief oil analyst at consultancy Energy Aspects.

“Supply has been outstripping demand not because demand has been particularly weak, but because there was too much supply,” said Stephen Briggs, commodities analyst at BNP Paribas SA . “It looks like this won’t change anytime soon.”

Take copper. The worst performer among base metals last year, it has shed 14% of its value on the back more than four straight years of oversupply.

Yet, new mines, including the Sierra Gorda mine in Chile that was inaugurated in October, continue adding to the glut. The Constancia mine, set to begin operations in Peru next year, looks to add even more.

In the sugar market, four straight years of global oversupply pushed sugar prices to multiyear lows last year.

“In October, prices were heading down, but the market thought we were approaching the bottom. Instead, the market saw a brief rally, and then it collapsed,” said Matt Bradbard, who manages $300 million at Chicago-based RCM Asset Management. “We were working a trade back then and lost some money as a result from a position we were holding.”

But despite the price collapse, some sugar producers are adding capacity—the result of capital investments planned years ago. Iraq-based Etihad Sugar Co. is building a 900,000-ton refinery south of Baghdad that is due to come on line this year.

Producers of many commodities are hurting, and some are cutting back. Jerzy Podsiadlo, chairman of Poland’s Weglokoks SA—one of the largest exporters of hard coal in Europe—said his company expected to export 2.6 million fewer tons of coal in 2014 than the previous year, a drop of almost one-third.

“It is obvious that nobody in Poland is happy about the current low level of coal prices,” Mr. Podsiadlo said. Thursday, Poland’s government said it would close four state-owned mines despite heavy labor-union protests.

Australian miner Fortescue Metals Group Ltd. had a capital-expenditure budget of $1.3 billion for the 2015 fiscal year. In November, it cut it in half. “We deferred some investments, as we felt that it wasn’t prudent to expand production at today’s prices,” said Chief Executive Nev Power, in an interview. Australia is one of the world’s biggest suppliers of iron ore. Prices of the ore fell 50% last year.

Ivan Glasenberg, chief executive of mining giant Glencore PLC, recently criticized mining rivals for continuing to invest in and ramp up iron-ore production despite the rout in prices.

Speaking at an investor event in December, he said that “capital misallocation, not a lack of demand, remains a key issue for the sector.”

In Pajala, where tourists sometimes venture to see the Northern Lights in winter and the midnight sun in summer, the reckoning has been swift. Young people had been leaving the town in droves for decades before the mine opened.

“Pajala has experienced the wonderful aspects of a flourishing community as well as the brutal truth of what a bankrupt mining company really can set in motion—in a very short period,” said Mr. Nilsson, the hotel owner.

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Earnings Season for Equities

Earnings season begins this week for equities and the WSJ reports profits will be squeezed in the energy sector by the spectacular collapse in oil prices and across all sectors by the strength in the dollar. Stocks have been wobbly at the start of the year so it will be interesting to see how much of this is already factored into current prices.

Via the WSJ:

By
Dan Strumpf,
Saumya Vaishampayan and
Alexandra Scaggs
Jan. 11, 2015 4:59 p.m. ET
0 COMMENTS

As fourth-quarter earnings season gets under way, investors are bracing for the softest U.S. profit growth in years, pinched by collapsing oil prices and a strong dollar.

That double whammy, coupled with the highest valuations for stocks since the financial crisis, will test the market’s ability to prolong its extended bull run and will likely make for continued bumpy trading in the weeks ahead.

Over the past few months, the Dow Jones Industrial Average and S&P 500 have carved out new record highs, while suffering frequent setbacks. Both indexes hit fresh peaks in the final sessions of last year but have since experienced two straight weeks of declines.

Still, many investors and stock-market strategists say an improving U.S. economy, as evidenced by Friday’s stronger-than-expected jobs report for December, coupled with continued low interest rates means there will be enough momentum to keep the six-year-old bull market running.

That optimism will be put to the test by the earnings season that kicks off Monday when Alcoa Inc. reports results after the close of stock trading.

Overall, companies in the S&P 500 are expected by Wall Street analysts to report that profits rose 1.1% from a year earlier in the fourth quarter, according to FactSet. That would mark the slowest pace of growth since the third quarter of 2012, when earnings declined 1%. Revenue at S&P 500 companies is forecast by analysts to rise 1.1% from a year earlier in the fourth quarter, its slowest growth in a year.

Excluding the energy sector, which has been hit by the tumble in the price of oil, earnings at companies in the S&P 500 are projected to rise 3.6%, below the 5.2% average growth rate for earnings of all S&P 500 companies over the past eight quarters, according to FactSet.
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To a large degree, the weakness in fourth-quarter earnings is well-anticipated. That is because much of the blame goes to energy companies, whose profits are expected to fall 19.1% for the quarter thanks to the plunge in oil prices.

At the same time, a sharp rise in the value of the dollar is expected to reduce the value of revenue earned abroad by several percentage points, as well as cut into the businesses of U.S. exporters whose products have become less competitively priced. Slowing economic growth overseas is also pressuring profits for U.S. multinationals.

“There are a fair amount of headwinds that are beginning to really start to blow hard in the face of corporate America,” said Burt White, chief investment officer for broker-dealer LPL Financial. But Mr. White added that the expected earnings gains are “pretty good given the situation,” he said.

Mr. White is looking for good news from transportation stocks thanks to falling fuel costs. He is recommending the $2.2 billion iShares Transportation Average exchange-traded fund.

With profit growth slowing and stocks near record highs, share prices have been getting more expensive relative to earnings. Stocks in the S&P 500 are trading at 16 times the coming 12 months’ forecast earnings, according to FactSet. That is the highest since June 2007 and well north of the 10-year average of 14.1.

“Valuations are high,” said Jim Paulsen, chief investment strategist at Wells Capital Management, which oversees $345 billion. “The market’s in a more vulnerable state than it’s been at any point in this recovery.”

Still, Mr. Paulsen said the bull market that started in 2009 “will likely last several more years and probably rise considerably more before it ultimately peaks.”

As is generally the case, stock analysts have slashed profit forecasts in the weeks leading to earnings season. At the start of the fourth quarter, analysts had been expecting an overall profit growth rate of 8.4%.

That lowers the bar on profits, traders and investors said, making it easier for companies to beat forecasts and give their stocks a boost.

While the energy sector is seen as a drag on fourth-quarter profits, many investors say lower oil prices are a positive for the future.

In the longer term, investors say, costs should come down for energy-consuming companies ranging from manufacturers to transportation companies to chemical makers.

And in the short term, lower prices at the gas pump are expected to boost earnings among retailers and other companies whose sales get a lift when consumers have more money to spend.

“What you’re going to see is good holiday sales data from the retailers, and with gas prices [falling] even further since then, that benefit is likely to carry into” 2015, said Michael Scanlon, senior investment analyst at John Hancock Asset Management.

Mr. Scanlon said one fund he helps advise, the $1.4 billion John Hancock Balanced fund, has in recent months been reducing holdings of energy stocks and buying consumer discretionary shares.

Sam Peters, who manages the $2.8 billion ClearBridge Value Trust, thinks that a bad quarter for energy stocks could provide buying opportunities.

“They’re going to have an awful earnings season, but the carnage in the stocks is enough that, in certain cases, there’s definitely long-term value,” said Mr. Peters.

Mr. Peters owns shares of integrated oil giant Chevron Corp. and exploration and production firm Apache Corp.

The stronger dollar is likely to hurt profits of multinational companies. Thanks to big gains in the dollar against the yen and the euro, the Wall Street Journal Dollar Index—which tracks the U.S. currency’s performance against 16 other currencies—was on average 9.4% higher in the fourth quarter of 2014 than in 2013.

As a result of that currency move, a reduction in revenues for multinationals by “4% to 5% wouldn’t be out of line,” said Tom West, head of equity research at Columbia Management, which has $357 billion under management.

One question mark will be financial companies, which are expected to a show a 1.7% decrease in earnings and have blindsided investors with massive legal charges.

“The thought was that they would be done with the write-downs and all of that by now, but it’s been a slow process working out,” said Curtis Holden, senior investment officer at Tanglewood Wealth Management, which manages $850 million out of Houston. “That’s been a big drag on the earnings.”

Wells Fargo & Co. and J.P. Morgan Chase & Co. are set to kick off U.S. bank earnings season Wednesday.

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Weekend Data Preview

Via Robert Sinche of Amherst Pierpont Securities:

CHINA: Over the next few days the December monetary data and the yearend reserves report are set to be released. On the reserve data, we would note that reserves are reported in USD terms, so the decline of various currencies versus the USD suggests that the reported value of reserves is likely to fall (as reported in Japan today) compared to the BBerg consensus that reserves will increase to $3,900bn. Once again, within the monetary data we will focus on Aggregate Financing, which has been weak this year. The BBerg consensus is for a slight rise to RMB1,200bn, although that would simply match the Dec 2013 level.

INDIA: Over the next few days will get December Export and Import data. Exports were up a solid 7.3% YOY in November, strongest growth in 4 months, and another YOY gain above 5% would be encouraging.

RUSSIA: CPI data for December, with the BBerg consensus expecting a 10.4% YOY increase in the core CPI.

FRANCE: Bank of France Business Sentiment Indicator, which has been stuck in the 96-97 range for the last 8 months.

SPAIN: House Transactions data for November, which have increased by double-digit YOY rates for each of the prior 2 months as the housing market shows signs of a modest rebound and normalization.

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