July 3. Could banking issues in Europe and China pressure short term dollar rates?
–Not much in the way of good news this morning as S&P downgraded Barclays, Deutsche and Credit Suisse. Tensions in Egypt, Portugal, Greece, etc are sending equities lower. August Crude traded over 102/bbl. August’13 crude is trading with a premium of about $8.50 to August’14…this spread was about $4 at the beginning of June, so supply concerns are at the forefront. While the Fed’s Dudley expressed confidence that growth would be much stronger in 2014, it’s not looking so great for the rest of this year. In response(?) the Obama team delayed rules forcing employers to pay for healthcare until 2015. New low for Aussie this morning. Hong Kong stocks down 2.5% as banks weigh down that index.
–The curve edged flatter yesterday and more so this morning. Tens closed down 2 bps at 2.47. This morning around 2.44. Now that the Fed has chiseled away at the idea of guaranteed low funding rates for the carry trade, economic data becomes more important. Today brings ADP expected 165k, Jobless Claims 345k, Trade balance -$40b, and non-mfg ISM 54.5.
–The highest one year calendar EDU15/EDU16 settled 102 yesterday. The fever appears to be breaking as it trades 100.5 this morning (high has been 106).
–Shortened floor trade today. US will have abbreviated electronic schedule Thursday as BoE and ECB meet.
July 2. Could China’s banking problems spill over?
–Not much to say about Monday’s session. However EDM15/EDM16 rose 1.5 bps to a new high at 102.5. The peak of the one year spreads remains EDU15/U16 which pegged its high at 106. New high as well in red/gold pack spread at 259.6 up 4.5 on the day. Continuing adjustments to the idea that actual tightening may occur in a few years, and there’s now a bit more premium demanded for the longer dated carry trade.
–While the Fed has had a hard time wrestling with communication, not so in China, where the state has instructed media to stop hyping news about a credit crunch and instead report that there is plenty of liquidity. Problem solved. Except that last Friday (from Forbes) ATM’s of Industrial and Commercial Bank of China wouldn’t dispense cash and several banks had problems with money transfer systems. http://www.forbes.com/sites/gordonchang/2013/06/30/citibank-caught-in-china-cash-crunch-not-making-money-transfers/
Bloomberg also has a couple of China banking stories, noting that the largest banks’ shares fell an average of 12% last month in Hong Kong trade. “Policy makers are concerned that large borrowers who have been living off “cheap credit” in China will begin defaulting as the economy slows down, Eswar Prasad… said in an interview with Bloomberg Television. That in turn could have a “cascading effect” within the financial system.”
http://www.bloomberg.com/news/2013-07-02/golden-era-fades-for-china-s-banks-as-crunch-raises-default-risk.html
But it’s not a default if you aren’t required to pay: (BBG) Chinese Malls Waive Rents as Vacancies Loom: Real Estate… http://www.bloomberg.com/news/2013-07-01/chinese-malls-waive-rents-as-vacancies-loom-real-estate.html “Half of the 32 million square meters (344 million square feet) of shopping centers under construction around the world are in China”
–News in the US today includes Factory Orders expected +2.0 and NY Fed’s Dudley speaks at 12:30 NY Time.
June 27. Fed’s going to have to keep revising growth forecasts lower
–Interest rate futures bounced Wednesday in spite of a mediocre five year auction. Q1 GDP was revised down to 1.8. It’s interesting to look at the last few FOMC growth projections. Last December, the “central tendency” projection for 2013 GDP was 2.3 to 3.0. In March it was 2.3 to 2.8. In June it was 2.3 to 2.6. The lower bound is going to have to give way by September. Maybe they will make it 2.3 to 2.0. We would now need 2.5 for the rest of the year to hit 2.3, the lower bound. Not going to happen. The sequester just kicked in for Q2. The emerging market collapse just occurred. It’s likely that rates overshot to the upside.
–Eurodollar calendar spreads are a clear reflection of where the pain was felt. EDU14/EDU15 one year spread went from 24 to 71 on this sell off (to Tuesday close), a gain of 47 bps. EDU15/16 went from 49.5 to 105, a gain of 55.5 bps, but EDU16/17 only went up 19.5 bps from 62.5 to 82 and EDU17/18 actually declined from 59 to 53. It’s quite probable that green/blue calendars will react lower from here, not to levels from the beginning of May but certainly well below 100 bps. Makes sense to look at buying blue euro$ call spreads. Today’s Core PCE price data may provide further support for treasuries if it prints zero again, but if not then Fed speakers will likely continue to try to calm the market.
–The five year auction was at 1.484. The previous 5 months’ auctions averaged just over 83.5 bps. Very nearly doubled the five year yield, and indeed April was only 71 bps, so more than double in two months. Jobless claims may also be important as we approach employment data next week. Claims expected 345k.
June 26. Quarter end capitulation?
–New lows in gold and silver this morning with GCQ down 50 (around 1225) and SIN down over a dollar below 18.40. Interest rate futures were lower last evening but have rebounded and now show modest gains.
–Yesterday tens rose a bit over 4 bps to 258.6. The curve made new highs with 2/10 to 218.5 and red/gold pack spread up nearly 3 bps to just over 258. The peak one year spread, EDU15/EDU16, rose 2.5 bps to a new high of 106. Treasury auctions 5 yr notes today, followed by 7’s tomorrow.
–Nikkei is down 1% this morning. From the high in May to the low in June, the Nikkei lost 22%. It’s worth looking at some other equity markets as well. Brazil has done nothing but decline since the beginning of the year, down over 28%! The real and sudden damage has been done in Asia over the past month due to a shift in the Fed’s liquidity stance and a surge in China’s funding costs. From highs in May to yesterday’s lows: Korea (KOSPI) -12%. India (SENSEX) -9.7%. Hong Kong (HSI) -17.4%. China (SHCOMP) -20.7, but only -16% to yesterday’s close because of a huge bounce off the low. It’s evaporation of capital in parts of the world that had been economic drivers. Using the term “transitory” to describe falling US inflation against this sort of backdrop is dubious at best.
–The real interest rate as expressed by the ten year inflation-indexed (TIP) note yield has soared this quarter, from around -80 in March to +60 now. Massive move of nearly 1.5%. The start of the 3rd quarter end will likely coincide with a reaction back (or at the very least consolidation) of some of the extreme moves we’ve just witnessed.
June 24. All aboard the pain train.
–Real rates continue to explode higher, as ten year inflation index note hit a yield of 52 bps. Ten yr treasury minus tip spread fell under 2% (for the first time since late 2011). The ten year treasury yield was up 9 bps to 251 and went higher yet after the floor close.
–There was quite a bit of weakness in the front end of the eurodollar curve as reds settled -7.5. Some suggested that the CME margin increase was to blame, but I think that’s a minor factor, part of a much larger picture. But before I get to that, note that total eurodollar open interest fell 174k and in the reds it was -128k, a significant drop. Red midcurve straddles soared, with 0EZ 9925 around 32 in the beginning of day, traded as high as 37 and settled 36. (capitulation signal?)
–OK back to the larger theme. Which is that private capital is fickle, subject to rapid retrenchment, especially given last week’s signals that both the Fed and PBoC might not provide the liquidity backstop that everyone has taken for granted. There are many examples. I noted ETF problems Friday (reported in FT and ZH), a decline in eurozone interbank lending, Detroit and the muni bond scare, emerging market problems, the rise in CME margins. There has been naive trust that central banks can always provide the liquidity for a functioning financial system. And thru the crisis. one might conclude that the point was proven, but the liquidity was never really pared back. Now there are signs that Japan’s ‘all-in’ QE could backfire. I’m not so sure that the credibility of central banks is perceived in the same prism these days. And THAT’S why short term rates go up. Because now what’s left of ‘private’ capital is forced to seek a margin of error, a cushion. Because the implicit model of shifting losses onto the Fed/govt is looking like a more and more slender reed. “We’ve relied on the Fed and China so much over the last few years so any signs that either might be less supportive is taken negatively — and we got both of those over the past week,” said Oliver at AMP. http://www.bloomberg.com/news/2013-06-21/china-poses-global-growth-risk-as-li-squeezes-credit-binge.html
–One more thing, I noted that the ten yr treasury/tip spread is below 200 and in a downward trend, lowest since late 2011. In late 2011, the spread was in an uptrend and continued to strengthen as 2012 began. Equity markets, and especially emerging markets, had strong rallies into the first quarter of 2012. That’s when treasuries rose in yield, to 2.42 in tens in March, the level that was just surpassed this week. It looked like a case of “escape velocity” in 2012 but then it all turned sour. The global environment couldn’t be more different currently. As Bullard notes, inflation is FALLING, BBG “Federal Reserve Bank of St. Louis President James Bullard said the Fed “inappropriately timed” a plan to trim $85 billion in monthly bond purchases amid slowing inflation.” Emerging markets appear vulnerable. But the Fed has grown to control so much that the market must heed its overlord.
–Auctions of 2’s, 5’s and 7’s this week so the pressure might continue in the first part of the week. But I wouldn’t be surprised to see a sharp upside move into the end of the week, especially if Core PCE price index is weak on Thursday.
–As Izzy Mandelbaum (Played by Lloyd Bridges) says… “All aboard the pain train.” https://www.youtube.com/watch?v=pcFSOnumgZA
June 20. Nearing the summer solstice, the longest day of the year (for bond longs)
–After a long period of complacency, volatility has come back with a vengeance. Massive sell off in fixed income after Bernanke suggested tapering could begin, depending on data. The huge convexity vortex that Bruce Krasting had mentioned would kick in around 2.20 yield was right on target, as tens jumped over 12 bps to 2.30 by yesterday’s close, and are now 2.38, essentially at the high yield mark set in March 2012. 30 year bond yield at 3.45 is above the level seen in March 2012 (3.42). All eurodollar calendars exploded to new highs, with red/gold pack spread up a whopping 23 bps to 241.
–Though global stock markets are getting rocked, it’s not providing much in the way of support for fixed income. Gold is down over $60 to 1308 and has taken out the spike lows of April and May.
–HSBC China PMI was down to 48.3. Stories on zerohedge this morning note that overnight repo rate surged to 25%. Concerns about China appear to have been well founded; in the interconnected world of global finance I would suspect that funding issues will soon spill over into the front end of the US eurodollar curve. And yes, I mean EDU3, which is currently sitting like a duck at 99.695. Copper, an important asset and financing vehicle in China, is down 7 cents this morning and nearing critical support around $3.
–A bunch of US data this morning, though I’m not sure it will mean anything. Jobless Claims expected 340k, PMI 52.7, Existing Home Sales 5.0m, Leading Indicators +0.2 and Philly Fed expected -1.0 from -5.2.
As US real yields rise, emerging markets get hit? 18-june 2013
The chart below is the US ten year note yield – US ten year inflation index note yield (the red line, often cited as a proxy for long term inflation expectations) AND the Brazil stock market (IBOVESPA). The red chart shows that US inflation expectations have fallen this year from 260 bps to around 210 bps currently. The idea is that as real yields go higher in the US, money is siphoned out of emerging markets. In the chart below, it looks to be opposite…that Brazil has led the way lower. The point is that as inflation expectations decline, emerging equity markets take notice. May just be that declining inflation expectations are the result of less central bank accommodation.
June 18. Curve steepens to new high in front of FOMC tomorrow
–Curve steepened to new highs yesterday with 2/10 treasury spread up 5 bps to 191.4 and (new) red/gold euro$ pack spread up over 7.5 to nearly 213. A piece by FT late in the day suggesting the onset of tapering accelerated the bond slide, but as the author pointed out, the Fed doesn’t leak stuff during the blackout period. I think there’s risk of a decline in growth forecasts, and that low inflation will be cited as a concern.
–Several news reports are renewing speculation about a new Fed chief as Obama said that Bernanke has stayed at the Fed longer than he (BB) wanted. The announcement will likely come in August, as Bernanke has already said that he won’t be going to the Jackson Hole conference. The new appointee (Yellen, Geithner, Summers) will probably be inclined to continue (or even expand) QE, but if BB has had trouble communicating the Fed’s message after his lengthy experience, imagine the difficulty a new FOMC will face next year (in the wake of an emerging market blow-up).
–News today includes CPI expected +0.2 both headline and core. Housing Starts 955k. FOMC announcement with press conference tomorrow.
–From Bloomberg: “Abe-Bernanke 1-2 Punch Pummeling World’s Top Carry Trade” Investors who borrowed funds in Japan and then bought the peso to take advantage of Mexican interest rates that are about 40 times higher have lost 11 percent in the past month as the Latin American currency sank. That’s a reversal from the 20 percent return in the first four months of 2013, the biggest in emerging markets…” http://www.bloomberg.com/news/2013-06-17/abe-bernanke-one-two-punch-crushes-carry-trade-mexico-credit.html This story is emblematic of problems emerging markets have encountered as real rates have gone up in the US. For example, Brazil’s stocks are making new lows for the year, down over 20%. Not surprisingly, social unrest in the form of rioting is becoming a problem.
June 17. Inflation and helicoptors
–Sharply lower interest rates Friday as the market continued to digest Thursday’s Hilsenrath blog, which said that the Fed was going to ‘push back’ market expectations of rate tightening. The green euro$ pack, (third year out) saw the strongest rally, closing +10.375 bps. The five year note fell over 7 bps in yield. Red/gold pack spread actually steepened by 2 bps.
–The big event this week is the FOMC announcement and press conference on Wednesday. But given the strong bounce in bonds, it’s worth spending a bit of extra time considering inflation in general, with CPI for May released Tuesday. Inflation is falling. Core Personal Consumption Expenditure Price Index was only 1.29% month/month in April, near the lowest m/m reading ever. In March 2012 (by the way, spring of 2012 tens hit their high yield of 2.4%), it was 2.00% which was the highest since the end of 2008. The year over year change in April Core PCE Prices at 1.05% is the lowest on record, back to 1960. Let that set in for a second. THE LOWEST ON RECORD. Sure, the Fed may begin to taper at some point, but the fear of a deflationary asset spiral is still palpable, especially as other Asian export nations respond to Japanese market share gains due to a weaker yen. The Fed’s thresholds are inflation and employment, and recent data suggests that housing will be negatively impacted by the modest rate rise just experienced (for example, refi applications plunged). Last employment data was ok, but month over month wage gains were zero. While tapering may well occur by autumn, it’s likely to be modest.
http://www.advisorperspectives.com/dshort/updates/PCE-Price-Index.php
http://fabiusmaximus.com/2013/06/14/inflation-interest-rates-51376/#more-51376
June 14. Fed fine-tuning; a world of central control
–Just after the close of the pit, WSJ’s Hilsenrath released a blog saying the Fed was likely to push back market expectations of rate increases. http://blogs.wsj.com/economics/2013/06/13/fed-likely-to-push-back-on-market-expectations-of-rate-increase/ Interest rate futures immediately exploded higher, with greens jumping nearly 10 bps. Ten year note rose almost half a point from 129-005 settlement to 129-145. June euro$ midcurve options expire today, leaving short calls scrambling to cover as the market gapped higher.
–Having successfully communicated a change in sentiment regarding a pullback in QE, the idea that the Fed should attempt to fine tune market positioning is overreaching in my opinion. After seemingly endless accommodation, a change in stance by the central bank necessarily leads to some degree of market overshoot, and tens didn’t even trade to last year’s highest yield level, so it’s hard to argue that things have gotten out of hand. Let economic circumstances determine whether rates have moved higher too quickly. Central planning has a way of backfiring, as is evident in Japan. Stocks however, were comforted by the idea that the rich uncle hasn’t abandoned support, and rebounded with a joy ride higher yesterday.
–In terms of data, clues were already apparent that inflation is falling, and market prices of precious metals provide another hint. Headwinds associated with even small rate increases have been reported: Foreclosures ticked up from a 75 month low and the WSJ ran this headline: Refinancings Plunge as Bond Yields Rise.
–News today includes PPI expected +0.2, Core +0.1. Industrial Production +0.2 from -0.5. Consumer Sentiment 84.5. In other news, BBG reports that China had a failed auction: “China’s Finance Ministry failed to sell all of the debt offered at an auction for the first time in 23 months owing to a cash squeeze that threatens to exacerbate a slowdown in the world’s second-largest economy.” Can’t control everything….
