June 8. A lack of volatility as the Fed ponders “financial stability”
–What used to be the biggest data of the month has now just become another bland Friday, with NFP 217k and rate of 6.3, right on expectations. Straddles that expire this Friday (13-June) were crushed. For example, Green June 9850 from 12.5 settle Thursday to 7.5 settle Friday. Blue June 9750 from 14 to 9.0. Ten year week 2 124.5^ was 58-60 late Wed, settled 49 Thursday, traded 44 prior to NFP, and was 31-33 shortly after the release, smoking a cigarette. However, by the end of the day on Friday, vol buyers came back in, with about 5k bought up to 34 (33s), and in TYU 124.5^ 5k bought 2’04 to 2’05. Ten year yield was up only 1.4 bps to 259.5.
–However, the green euro$ pack was down 4.5 on the day; the weakest part of the curve. 5/30 treasury spread fell 2 bps to just under 179. For the past three months 5/30 has been a bit over 190 to just under 170, so it’s just about mid-range going into auctions this week of 3’s, 10’s and 30’s.
–The explosive data Friday was Consumer Credit, which increased a whopping $26.8B. I almost think it’s a mistake, as Revolving Credit posted an annual rate of 12.3 in April vs recent growth of 1.9 in Q1, 2.0 in Q4, 0.9 in Q3 and 1.0 in Q2. Non-revolving accelerated as well, to 9.5 in April, vs 8.4 in Q1. Perhaps the wealth effect is finally kicking in, with households willing to borrow as Household Net Worth jumped $1.49T over Q1, yoy growth of 10.8%, and new highs in stocks. (Fed’s Flow of Funds was released Thursday). The other surprise on Friday was Banco De Mexico rate cut of 50 bps, from 3.5 to 3.0%. The Finance Minister said it’s “consistent with what other central banks are doing…” noting the ECB cut.
–But before sounding the all clear, let’s attempt to tie up a couple of other pieces of information. First, China Trade data showed a surplus surge in May to $36B, as exports grew 7% yoy while imports declined 1.6%. Perhaps not much of a surprise as the currency weakens, but a reminder that China is also seen as exporting deflation. The other note with regard to China are growing concerns about commodity based financing. ZeroHedge has written sev’l pieces about this, noting that banks are trying to confirm the existence of metal inventories posted as collateral. http://www.zerohedge.com/news/2014-06-07/western-banks-scramble-chinas-rehypothecation-evaporation-goes-global
I’m sure I am thinking too simplistically about it, but it seems to me an absolute necessity for inventories to be double posted as collateral for this “financing” to work. Let’s say you want to post copper as collateral to get a bank loan. How do you get the copper in the first place? You borrow to buy the copper. Then you post it as collateral for yet another loan and re-invest the proceeds in higher yielding dollar vehicles. Same inventory, two loans… and the more times you can post the same inventory the better. I don’t see any other way around it. Was all this copper just sitting around and fully owned? Then why is China importing it? If you look at the futures curve for copper, Friday settle for HGU’14 was 305.00 and for HGU’15 306.20. That’s just 40 bps over a year, not enough to compensate for interest and storage. Now, one might compare this situation to another example of over-levered assets, for example US housing in 2007. But in that case at least the collateral was thought to be going up in value. It all comes down to the confidence in the value of the assets and in the cash flows derived from those assets. Perhaps that’s why Larry Fink of Blackrock is warning about leveraged ETFs. I would also note that with the ECB cut, ten year yields in Spain, 2.65%, Italy 2.75% and France 1.70% are quite low. Then consider the perceived market “value” of Uber, at some $18B, justified by some due to the possibility of using the logistical infrastructure as a means of expansion into other areas. Really? So it’s worth 43% of Fed Ex? And double the amount of Expeditors (EXPD) And half the amount of American Airlines (AAL) ?? Maybe it should be considered more like Priceline at $65B… but maybe it’s just plain old stupid. And that’s where the whole idea of “financial stability” comes in. The Fed is beginning to emphasize this topic more and more. It will probably be a key area of discussion at Jackson Hole in late August. The last Flow of Funds Z.1 report shows that Corporate Borrowing is at a record $9.625T outstanding, having grown at a 9.3% rate in Q1. Total growth for all sectors was 5%. And from that derives Q1 GDP growth of zero? Well, if that funding is mostly going into stock buybacks and acquisitions as opposed to Capital Expenditures (which might actually drive future growth), then it all falls into place.
–So how does the Fed maintain financial stability and curtail a reach for yield which is unsupported by prospective asset cash flows? One way is through regulatory channels, for example not letting KKR get a bank loan for a leveraged buyout. But the other way is to raise short term financing rates as a reminder that it won’t all be free forever.
