August 12. Falling prices
–Another day, another, another devaluation by China (even though it was termed a “one-off” event yesterday). It’s like one of those big smiley faces in Walmart ads, that falls to reveal lower prices. New fresh lows today in many other Asian currencies vs USD, including Korean won, rupiah, baht, Indian rupee. US ten year yield fell 10 bps to 213.7 Tuesday, and is lower again this morning (last 207). Ten year yield should find strong support at 206 which is the 50% retracement of this year’s low to high yield (especially since there’s a ten year auction this afternoon). While some commodities are holding, copper edged to a fresh six year low. From a Business Insider piece: ‘ “Our commodity team has estimated that a 1% move in CNY is associated with a 0.5-0.6% decline in USD commodity prices,” said Bank of America in a note following the yuan devaluation.’ Also, I was surprised to see this in a BBG piece: “The IMF welcomed China’s move to devalue the yuan and said it doesn’t directly impact the country’s push to win reserve-currency status.”
–Fresh yearly lows yesterday in EEM and in hi-yield etf’s HYG and JNK. While China’s move is meant to be stimulative, the immediate impact is that of competitive devaluations and increased challenges for US exporters. US equities are lower this morning, (2057.00 last in ESU) though we need a couple of closes below 2030 to form a more decisive top.
–Weakness in export driven countries’ currencies is not good news for US wages, and of course the odds for a Fed hike in September have again been reduced, with EDU5 again touching the high of 9965 which occurred after ECI. Of course, since the FOMC is after EDU expiration, that contract can’t price certainty of a “no-go”. NY Fed’s Dudley may provide additional clues this morning…he speaks at 8:30 CST and is expected to take questions. Note as well that the UK employment report showed a decline of 63k. Could labor markets in the US and UK be decelerating simultaneously?
August 11. …if you go carrying pictures of Chairman Mao
“But if you go carrying pictures of Chairman Mao, You ain’t going to make it with anyone anyhow.” – John Lennon, “Revolution” 1968
–By devaluing (1.9%), China just removed another reason for the Fed to hike. From a Bloomberg article quoting Stephen Roach, China’s action “…raises the distinct possibility of a new and increasingly destabilizing skirmish in the ever-widening global currency war. The race to the bottom just became a good deal more treacherous.” As mentioned previously, by pegging to the dollar China was effectively ceding export share to other Asian competitors. Effects now should be deflationary. As I said in the weekend post, “Any indications of depreciation in the yuan would unleash a new global disinflationary wave.” Eventually, government intervention to control markets fails. If China was selling USD reserves (i.e. treasuries) in order to buy stocks and engage in other market propping activities, that source of treasury selling will now abate.
–With the world now depending on the strong US dollar and the propensity of the US consumer to buy more crap, yesterday’s NY Fed survey is unwelcome news. From the NY Fed: “While earnings and household income growth expectations were largely unchanged, median household spending growth expectations RETREATED SUNSTANTIALLY to their lowest level since the inception of the survey in 2013.” Today brings the NFIB small business optimism survey which took a tumble last month. Today’s reading is expected 95.0 from 94.1. Also out is Productivity, expected +1.6% and Unit Labor Costs, which were 6.7% last (! ), but expected at just 0.5 today. Retail Sales on Thursday.
–Everything that bounced yesterday- copper, stocks, currencies – are now giving back those gains. Well, not quite everything, as precious metals hang on to and improve on yesterday’s rally. In the US, auctions kick off with today’s three year, right into the face of safe haven demand.
Shades of 1997/1998
THEMES:
- Employment report ‘solid but unremarkable’; hike still on the table for Sept
- Curve crushed on Friday
- Factors behind long end rally
- Similarities in 1997/1998 — Interesting charts in this section
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Review of last week: The employment report was termed “solid but unremarkable” by the Washington Post, an apt description. The odds for a rate hike in September therefore increased, not too much of a surprise there. What is surprising is the aggressive flattening that occurred in the wake of the jobs data. On the other hand, we had a taste of that reaction when the Atlanta Fed’s Lockhart on Tuesday said “I think there is high bar right now to not acting” and 5/30 instantly fell 5 bps from 133 to 128. By the way, Lockhart speaks again Monday.
On the week, 2/30 spread fell 15 bps as the thirty year yield sank 10 to just 283. According to a post on ZH, that was the biggest weekly flattening since April 2013. And 5/30 fell 13.6 to 124.6, the biggest weekly flattening since Sept 2011. Back month Eurodollar calendar spreads all made new recent lows. For example, red/green Eurodollar pack spread on a rolling basis (2nd to 3rd year), closed at a new monthly low Friday of just 56.5 bps. The range this calendar year has been about ¼% from 51 to 73, and we are obviously near the lower end of that range despite what is generally referred to as a moderately growing economy with the Fed poised to raise rates. The deflating curve is starting to cause some pain.
In terms of outright yield levels, the ten year is at the 38% retrace of this year’s low in January to high in June (38% is 216.3, at the futures close I marked tens at 217.3). The thirty year bond is just below the 38% retrace which is 285, vs 282.8 close. These are important support areas. The 50% retrace levels are 206.3 and 273. I personally expect 281 to hold in the bond…why? Because, on May 20 I made a bet with a client (for a cold beer) that we’d see 325 before we reached 280. We did get to 324, but never closed above 325. I think perhaps we single-handedly defined the rest of the year’s range.
There are a myriad of reasons that treasury yields are falling. While economic growth has been good, it hasn’t been accompanied by inflation and strongly higher wages. In fact, the CRB index actually made a new low this week falling below 200…lower than the plunge in 2009, when oil got down to $35. Chart of CRB:
Additionally, there is lower global growth. Brazil is in recession; according to Markit, the 7th largest economy in the world “faces a bleak outlook.” Similarly, because China has decided to peg its currency to the dollar, it is encountering deteriorating trade conditions. Reuters: “[China’s] Exports to the European Union fell 12.3 percent in July while those to the United States dropped 1.3 percent. Demand from Japan, another big trading partner, slid 13 percent…Analysts say Beijing has been keeping its yuan strong to wean its economy off low-end export manufacturing. A strong yuan policy also supports domestic buying power, helps Chinese firms to borrow and invest abroad, and encourages foreign firms and governments to increase their use of the currency.”
I showed earlier this week that Brazil’s ten year dollar denominated bond yield had broken out to the upside. In other indications of increased credit risk, high yield ETF’s in the US, HYG and JNK closed at new lows for the year. Berkshire Hathaway’s net income “…fell to $4.01 billion, or $2,442 per share, from $6.4 billion, or $3,889 per share, a year earlier – a stunning 37% plunge.” ZH. I don’t know exactly what BRK holds besides Geico and railroads and Dairy Queen, but I do think it’s sort of a slice of Americana that is indicating a slowdown. On another anecdotal note, Fannie Mae’s National Housing Survey for July was also negative. From Fannie’s website: “The dip comes as more consumers reported a negative outlook regarding personal finances and the direction of the economy. The share of consumers saying the economy is on the wrong track rose by 3 percentage points to 54 percent in July.”
This is a fairly slow news week, although on Tuesday the Nat’l Federation of Independent Business Optimism survey is released, expected to bounce to 95 for July. The last report plunged 4.2 to 94.1. I suppose one negative print doesn’t necessarily change a trend, but here’s some commentary from the site’s economist: “June terminated a promising string of improvements in owner optimism during the first months of the year. While it is not a disaster or a signal of a looming recession, it is a disappointing sign that economic growth on Main Street is not set for a strong second half of growth. The weakness was substantial across the board, showing no signs of a growth spurt in the near future.” So Tuesday’s release might bear just a bit more scrutiny. Retail Sales on Thursday.
1997/1998
Let me just circle back for a minute to the emerging market problems. I already mentioned China and Brazil. I have thought for some time that the current environment of weak EM currencies and industrial commodities bears some real similarities to 1997/1998. The chart below doesn’t prove anything, but in my research I did think it was an astounding how charts from different periods can trace out such similar patterns over identical time frames.
(It might be a little difficult to see the text, but the green line is Bovespa from Sept 1996 to July 1997, it rallied 2.12x (peak is in July 1997). The red line is the Shanghai Composite which rallied 2.35x from August 2014 to June 2015. Both then traded lower, of course there has been significant and overt support by the Chinese authorities. What isn’t shown on this chart is that within another year, Bovespa had plunged well below the starting point of 6500, to 5000. Commonly known as a crash. Warning to China bulls?
At the end of 1997, many people recall that the emerging market currencies were under severe pressure, including the Indonesian Rupiah, the Thai Baht and the Mexican Peso. It is a similar circumstance now, and we can of course, throw the Brazilian Real, Turkish Lira, SA Rand, etc into the mix. Capital is fleeing these countries. What many people might not recall is that crude oil was tracing out a pretty similar pattern at that time to the current situation as well. Here’s a chart:
Where does this leave us in terms of treasury yields and monetary policy? Well, the first important lesson, in my opinion, is that not all the moves were simultaneous.
Thai baht bottomed in January of 1998, both the rupiah and crude oil bottomed in June 1998, SPX in September with a revisit in October, and MXN peso in Sept. It was July to September that SPX fell 20%. [20% from the high of this year would be 1700, SPX currently 2077]. From the end of July to the beginning of October the ten year yield went from 550 to 420, 130 bps. The FF target was 5.5% during this time period. The first cut came on Sept 29, 1998, 25 bps to 5.25, then again in mid-October and mid-November to bring the target to 4.75.
It was only after the Fed cut that both stocks and bond yields stabilized. By March 1999 the ten year yield was back up to 540. It doesn’t appear as though the Fed reacted to the emerging mkt crisis of 1997/98, until US equities started to plummet and ten year yield dropped simultaneously.
In the present case, we are seeing modest pressure on both long end yields and stocks. Almost certainly not enough at this point to forestall tightening. The FOMC is still 5 ½ weeks away. By the trend of economic data, I wouldn’t be surprised to see more signs of a stall, though with the quarterly refunding this week perhaps there will be a small yield concession. Again, tens and bonds are at support levels.
From a trading perspective, I think the odds this week favor a pretty quiet range in tens with a slight bias towards higher yields, though any back up toward 225 should be bought. The risks of course are that recent trends accelerate in oil and EM, spilling into US equities, which would cause support yields to give way, perhaps dramatically.
The other big factor to watch is China. Trade data indicate that by holding the peg to the USD, China has ceded export share to other Asian countries, and Germany. Any indications of depreciation in the yuan would unleash a new global disinflationary wave.
August 7. Deflationary winds vs US wages
–Employment report today with NFP expected 225k, avg hourly earnings +0.2 from 0, yoy expected +2.3%
–Yesterday saw yields ease slightly as the Bank of England pushed back rate hike expectations on a subdued inflation forecast and US stocks wobbled with notable weakness in entertainment and broadcasting. Yields were down about 3 bps across the curve, with tens down 3.3 at 223.2. Ten year note to inflation index spread hit a new recent low of just 168.
–Bill Gross is warning of emerging market problems, saying “deflationary winds are becoming stronger” and Grantham says stocks could see a major decline in 2016. High yield spreads are moving higher. HYG and JNK are testing the lows of the year that were put in just a couple of weeks ago, and the emerging market etf EEM closed at a new low for the year and is nearing the bottom of the range since 2010. I am including a chart of Brazil’s dollar denominated 10 year yield, which has broken out of a 5 year range to the upside. Dollar strength and higher corporate yields have acted as a quasi tightening in the US already. I suppose that lower raw material input prices somewhat offset increased corporate funding costs, which leaves labor as a swing factor. In any event, profit margins will remain pressured, as already evident in this earnings season.
August 6. Service job growth in focus going into payrolls
–Yesterday’s ADP was lower than expected at only 185k. However, that news was overwhelmed by an extremely strong non-mfg ISM of 60.3, vs expected 56.2. The ten year yield jumped 5.8 bps to 226.5. Going into Friday’s employment data, odds have again shifted toward a hike in September. Yesterday’s EDU5 settle of 9960 was the lowest settle since mid-June. A Gallup index of ‘job creation’ maintained a record high reading of +32 in July for the third month in a row, which, along with Service ISM could point to strong NFP. However, it’s interesting to note that Gallup’s other survey measures on the economy have not held their gains.
–Crude faded from its modest bounce and settled at a new low, now in the fifth Kubler Ross stage: Acceptance (of prices below $45/bbl). The Emerging Market ETF (EEM) is also mired near the year’s low as are many commodities. Interesting article by Wolf Richter notes that auto makers are all admitting that China’s auto market (23 million units!) has stalled at almost no growth. http://wolfstreet.com/2015/08/05/unnerving-thing-global-automakers-said-about-chinas-economy/ Likewise electricity consumption was reportedly up only 1.3% in the first half of 2015.
–I’ve read a few things recently that suggest that the lower prices for oil and other commodities are a great boost (eventually) for economic growth. I would agree, if it weren’t for the fact that the companies involved in many of those businesses carry debt, and the yields on that debt are going higher at the same time that end product prices decline, which can lead to bankruptcy. I used to have a client at Bankers Trust in the late nineties who was involved full bore in tech stocks, and I was citing my concerns about rising rates, and he said “It doesn’t matter. These companies don’t have debt, they’ve just issued shares.” Whether due to rates or just too much supply, the end result was the Nasdaq crash. In today’s economy, one could say it doesn’t matter what happens to commodities, we’re a SERVICE economy. Which may well be, but problems in one sector have a way of spilling into others.
–Jobless Claims today expected 273k. Bank of England meeting, minutes and inflation report also on tap.
August 5. Canada, China and Indonesia
–So Lockhart opens his big yap and says the bar is high to NOT tightening in Sept. 5/30 immediately plunges to a new low of 128.5 (futures close it was 129.3). Yields rose across the curve with tens up 6 to 220.7, and the green euro$ pack down just over 9 bps. The dollar strengthened. A BBG article notes that the rupiah is making new lows against the dollar as commodities and exports slump. Shades of 1997/1998 Asian crisis, when US stocks retreated by over 20%. Canada is also making new lows vs the dollar. The Bank of Canada had risen three times to 1% since the crisis and is now back at 50 bps. Same possible for the US Fed?
–Trade data released today, as is ADP, expected 210k, and non-mfg ISM 56.2. Trade deficit expected at $43 billion; both import and export yoy growth are negative and weakening. The strong dollar is a wet blanket on inflation and the curve reflects that factor with a relative bid for long dated dollar assets.
–The IMF staff recommended delaying inclusion of the yuan into the SDR, perhaps into next year. The tight yuan peg to the dollar that’s been in place since March is therefore likely to continue as it appears China’s goal of becoming a reserve currency outweighs other considerations. As China’s currency appreciates against its Asian competitors, it likely loses export share. A Fed hike will accentuate this dynamic. Maybe it will accelerate structural reforms and more domestic spending…like ramping up South Sea military island construction. The immediate concern though, is that I hope Farrakhan doesn’t have the same instant influence on his constituents as Lockhart has on his.
August 4. New lows curve and industrial materials/ oil
–ISM was slightly weaker than expected at 52.7. New export orders fell 1.5 points to 48.0 for the 5th sub-50 contractionary reading of the last 7 months. However, the larger story continues to be the plunge to new lows in oil (late CLU -1.80 at 45.32) and metals, and the strength in the dollar especially against EM. Though AAPL fell below its 200 day moving average, the large stock indexes are still holding amazingly well. In other economic news, auto sales printed at a strong 17.46 million unit annual rate, the result of cheap gas and extended financing terms. In 2011 (according to Fed’s Consumer Credit report), cars were financed at 4.4% for 61 months, with an avg $25121 balance. Since then all figures have risen: 5.2% for 65 months, $27272. The net effect of lengthening the terms is that monthly payments are nearly identical: $460/mo to $482.
–In terms of yesterday’s interest rate market action, the ten year yield fell another 5.7 bps to 214.8. The curve flattened to new lows. Red/gold eurodollar pack spread fell 4.75 bps to 129. 2/10 treasury spread down a similar 4.6 bps to 148.7. Some of the specific deferred spreads like EDZ6/EDZ7 that had been heavily accumulated (in the low 60’s) closed at new lows. EDZ6/7 settled 59.5, having been as high as 70 recently. Red/blue euro$ pack spread settled just under 97 bps…very low for 2 year spreads given even moderate growth.
–Factory Orders today expected +1.7.
Aug 3. New lows oil, copper and CAD
–As of 6:00 NY time, Crude Oil is making a new low, down 70 cents to 46.40, and Canada $ also posting a new low, as is copper. The Caixin/Markit Manufacturing PMI for China fell to 47.8 in July from 49.4 in June, lowest since July 2013.
–On Friday, US yields fell as ECI was only +0.2, the lowest on record. Ten year note eased 6 bps to 220.5, but the five year was a star performer, falling 7.5 bps to 154.7. The green eurodollar pack (3rd year) was up 7.75 bps, with heavy put liquidation, most notably a seller of 100k 2EU 9800/9750/9700p butterflies. (Green Sept EDU7, settled 9826.5, put fly settled 3.25). Red/green eurodollar one-year spreads fell to new lows, with the pack spread closing at just 58.75 bps. January 2016 Fed funds closed +3 at 9964, only 23 bps higher in yield than the just expired July contract.
–Both the punishing losses in commodity prices and the ECI data are causing a re-evaluation of the odds of a September lift off. There’s a good deal of news out this week, capped by Friday’s employment report. Today brings Personal Income and Spending, expected +0.3 and +0.2, with Core PCE prices +0.1. ISM 53.7 vs 53.5 last. Additionally Construction Spending and auto sales are out today. Construction of multi-unit housing has been particularly strong, as a firm rental market spurs a reach for better yields.
Aug 2. Weekly review, Low wages, high (junk) yields
THEMES:
- FOMC in play and out of play within the space of two days
- Hi-yield funds and discounts… an overhang of debt
- Hi-tech and creative destruction
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Review of the week: Concerns about China’s stock market and economic growth pushed US stocks lower and caused a bid in fixed income at the start of the week. On Thursday, Q2 GDP was stronger than expected with positive revisions to Q1, and the FOMC announcement enhanced perceptions that a hike was still in the cards for this year, most likely in September. But then Friday’s extraordinarily weak Employment Cost Index of just 0.2% (lowest on record) put the entire picture into a tailspin. On top of that, pressure on emerging market currencies is intensifying, and crude oil closed at a new low. I have to think the ECI data is an outlier, which could easily be contradicted in the employment data coming out this week. In any case, for the week, fixed income futures closed at the highs, with the cash 5 yr treasury yield having dropped 7.3 bps on the week; the strongest part of the curve.
There was an interesting Bloomberg article on Friday, ‘Exit From Leveraged-Credit Funds Seen as Sign of Things to Come’ http://www.bloomberg.com/news/articles/2015-07-31/exit-from-leveraged-credit-funds-seen-as-sign-of-things-to-come
The article quotes a report by Credit Suisse, ‘The steep decline in credit closed-end fund shares is “a signal both of underlying credit market illiquidity and also of end investor risk aversion.”’
I often mention the high yield ETF’s HYG and JNK, which have been under pressure but had bounces this week. Both have thus far held the lows from last December. However, some of the closed ends funds are WELL below their December levels, for example HYT*, HPF**, HYI. The latter is Western Asset Hi Yield Defined Opportunities Fund, with a yield of 8.80% according to bigcharts.com.
The point is that one man’s debt is another man’s asset, and the latter counts it as a part of his ‘wealth’.
It’s all coming down to debt. Here are some of the Financial Times headlines from Sunday: –Brazilian Households Struggling with Debt –US Equity Margin Debt Flags Top –Outflows from EM Funds Accelerate. And from the Telegraph: –Dubai Debt Crunch Looms as Oil Slump Hits Gulf
Here’s a quote from an article by Ambrose Evans Pritchard last week: “David Cui, from Bank of America, said $1.2 trillion of stock holdings are being carried on margin debt. This is 34pc of the free float of the Shanghai and Shenzhen stock markets.”
And an article on Reuters cites a Chinese central bank official: “Sheng warned about the risks of local government debt, saying that 2 trillion yuan ($322.08 billion) in bond swaps may not be able to fully cover maturing debt, according to the report.” http://www.reuters.com/article/2015/08/02/us-china-economy-idUSKCN0Q702Y20150802
Puerto Rico apparently missed a bond payment over the weekend. But nearer and dearer to my heart is Chicago, which is considering issuing debt that Puerto Rico considers “TOO RISKY” hahahahahah. Capital Appreciation Bonds, or CABs, (as in taxicabs). As we used to say on the floor, “Sell a cab, drive a cab…” Anyway, quoting form the article: “Chicago may allow the use of a type of debt that’s fallen out of favor in other municipalities because it saddles taxpayers with higher costs by delaying payments. Mayor Rahm Emanuel proposed issuing $500m of bonds this week in an ordinance that would permit the use of capital appreciation bonds, where borrowers postpone interest and principal payments into one sum at the end of the term.” http://www.bloomberg.com/news/articles/2015-07-31/chicago-mulls-borrowing-that-puerto-rico-rejected-as-too-risky
Just to bring it to full circle, (in a roundabout way), a few years ago, perhaps about five, I went into Chicago’s City Hall to appeal a traffic violation and request a hearing. I got off the elevator, entered a room with a big metal fan sitting atop the filing cabinets (hi-tech fan, the oscillating kind). The woman at the counter handed me four duplicate forms with CARBON PAPER and told me to press down hard when I wrote so that the last form would be legible. Want to lend these guys your money? Well maybe you do, because the final outcome was a $500 fine that I paid.
Contrast that to UBER, the biggest CAB company in the world. Flexible pricing. Flexible workforce. Knows where the cars are and where the customer is. The ultimate “just in time” model which fully harnesses new technology. In fact between UBER, FB, and debit/credit cards there is more information on the current crop of consumers than ever before. A complete picture of location, finances and consumer tastes at all times. But policy makers can’t quite figure out why the consumer isn’t spending as much as is necessary to ultimately service the amount of debt in the system.
So, is there going to be a Fed hike in September? Maybe. Depends on the next couple of employment reports.
But take a clue from the back end of the dollar curve. It is getting a bit flatter, not steeper. Given the positive slope of the curve there should be a natural roll carry. However, a spread like EDZ6/EDZ7 actually declined 3 bps on the week to just 61 bps. I continue to think there’s a risk that long curve trades are squeezed out, thus leading to a further painful rally in green and blue Eurodollars (3rd and 4th years). However, implied vol is still low enough that it’s relatively inexpensive to put on downside for protection.
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*HYT is Blackrock Corp High Yield
**HPF is Hancock Preferred Income Fund II
July 31. Flatlining
–Hard flattener yesterday as 5/30 ended at 133, down 4.6 bps, its lowest level since early May. Out of the blue, three clients mentioned curve inversion. How does the curve invert with 2’s under 100 bps? To this day I remember coming on to the CME floor one morning in the 1990’s and having to cover a curve trade error in eurodollars. The contract I had to sell just kept going down and the one I had to buy was going up. I remember thinking I just hadn’t seen anything like it, and was going to have a hard time explaining it to the boss, who had at best a nodding acquaintance familiarity with the curve. The point is, people are starting to get unsettled about how the curve is trading and yesterday was a good example with reds -3.5 and golds +1.875. Red to blue pack spread settled at exactly 100 bps, pretty low for a two year spread, and a new recent low, as were reds to all contracts behind.
–GDP and revisions were better than expected yesterday, lending additional cover for a rate hike. However, inflation signals just aren’t all that robust. For example, the 5y5y inflation swap averaged around 280 in the first half of 2014. For the first 7 months of 2015 the range is 211 to 248. The midpoint is 229.5. Yesterday late? 229.3. Similar exercise with 10 yr breakeven using the inflation index note. Range this year 154 to 194. Midpoint 174. Yesterday 177.5. Go ahead and tighten. And encourage further speculative flows as a result of lower rates at the long end.
–ECI is expected +0.6, Chgo PMI 50.8 from 49.4. In Q1 of 2014, Chicago PMI was around 60. In Feb this year, it hit the low 45.8. There hasn’t really been much of a bounce from Q1 weakness.
–Crude oil again lower this morning after a midweek bounce. AUD at new low.
