Liquidity in high yield bonds has clearly deteriorated ... has selected two benchmark interest rate candidates: OBFR and
StreetStuff Daily June 9, 2016
BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones…
8 June 2016
US hiring slows, while openings continue to increase Wed 6/8/2016 11:02 AM
GDP Housekeeping Stephen Stanley Chief Economist
…Meanwhile, after a crazed Friday, I finally got around early this week to composing a Q2 forecast for the net exports sector on the back of the April trade report. Based on the April numbers and my updated projections for May and June, I now envision a modest improvement in the real trade balance in Q2, whereas I had penciled in a small deterioration before the April data were available. In particular, exports may be poised to bounce in real terms after dropping in Q4 and Q1. This makes sense, as the most intense period of dollar appreciation is now over a year behind us. In any case, the revision to my trade projections took my tracking estimate all the way from 2.3% to 3.0% for Q2 real GDP growth.
Both of these developments work in the direction of calming any concerns with regard to the slowdown in GDP seen in the winter. It remains to be seen whether the FOMC is willing to check the box on growth before the Q2 GDP figures are actually released (the preliminary data will be reported on July 29, two days after the July FOMC meeting). My sense is that, unlike last year, the Fed would be willing to move on the assumption of a solid rebound in growth in Q2 as long as all of their other boxes are checked. So far, the data are shaping up to give them a fair degree of confidence in a healthy Q2 GDP figure. Thus, the onus for the FOMC’s July decision will likely be on the June employment report (due out July 8) as well as the financial markets (does the Brexit vote come and go without causing a major disruption and more generally can the markets avoid the sort of risk-off spasm that occurred in the summer of 2015).
The slowdown in hiring evident in this morning’s April JOLTS report, particular within the serviceproviding sector, follows last Friday’s May employment report that shows a broad-based slowdown in net job gains (see May US employment report: Trend slowing in hiring points to increase risk of recession). Thus, this morning’s report provides further support for the negative signal from May payrolls. That said, the information gain from the JOLTS data is marginal, as these data are revised by the BLS to be consistent with the establishment survey. Next month’s payroll report, as well as weekly unemployment insurance data, will provide the next major indications on the state of US labor markets and the broader economy. 8 June 2016
June Supply Monthly The US Treasury is to take $49.3bn from the market in June and return $17.3bn in July (including SOMA).
FIGURE 1 Net cash flows by region ($ bn)
8 June 2016
Behavior Modification •
Realized bid-offer is a metric some commentators have cited as evidence that corporate bond liquidity has not worsened. We use TRACE data to estimate the round-trip transaction cost on block trades in investment grade bonds. Realized transaction costs decreased about 10% between
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2010 and 2015, in line with other research indicating that realized bid-offer has not increased through the period of supposedly declining liquidity. However, aggregate statistics combine trades in on- and off-the-run issues, as well as principal and agent trades. The bid-offer charged depends on the type of trade, and breaking down the aggregate statistics into the component parts tells a more complete story of how liquidity has evolved. The average bid/ask spread for agent and principal trades and across different vintage buckets has remained largely unchanged between 2010 and 2015. The decrease in realized transaction costs can be explained by a change in trading behavior to favor lower transaction cost trades. Trading volumes have become increasingly concentrated in recently issued bonds. The number of block trades per bond has increased for recent vintage securities, while it has declined for older vintage bonds. Agent trades have increased significantly, indicating that a much higher proportion of trading now happens on order. Block trades with an almost immediate offset (within 15 minutes) have increased almost 50% since 2010. On the other hand, the fraction of block trades without an offset in five days – one where the risk stays on dealer inventories for a longer time – has declined significantly. Trades involving highly liquid securities, as well as those done on order, carry the lowest bid/ask spread; therefore, concentration of volumes in these trades has resulted in lower realized transaction costs. While realized transaction costs are lower now, we do not believe that they imply liquidity is better. The change in trading behavior comes with other less measurable but equally important costs. The time between the desire to trade and execution is likely much higher today. Limiting trading to more newly issued securities (to minimize transaction costs) lowers portfolio flexibility and could lead to higher tracking error. Finally, our analysis captures only trades that were executed. There have likely been many instances when an investor wanted to trade but decided against it, given the prohibitively expensive bid/ask or dealers’ inability to offer liquidity. The material shift in trading behavior is itself evidence that liquidity conditions have worsened, in our view.
9 June 2016
A Panel Discussion on High Yield Liquidity Adjusting to the New Market Microstructure Liquidity in high yield bonds has clearly deteriorated, by our measures. Investors have employed various tools to help adjust to the new market microstructure, including an increased use of portfolio products such as ETFs and CDX. New liquidity regulations proposed by the SEC will require a lot of work for open-ended mutual fund managers; their eventual effect will depend to a significant degree on how funds choose to model liquidity.
How Are Managers Adjusting? Fixed income managers have taken steps to mitigate the gap in liquidity, mostly through the use of portfolio products
8 June 2016
Update: US Q1 GDP tracking 1.2% after Quarterly Services Survey After refreshing our models to account for the Census Bureau’s data error earlier this morning, we have revised our tracking estimate of Q1 real PCE growth to 2.0% (previous: 2.1%) but left our Q1 GDP tracking estimate unchanged at 1.2% after rounding. We now expect a smaller upward revision to real consumption growth from healthcare services spending. In addition, we now expect a larger upward revision to intellectual property investment, to 3.4%. On net, we still for upward revisions to PCE, business investment and net trade from the second to third estimates of Q1 GDP (see US Q1 GDP tracking 1.2% after Quarterly Services Survey).
9 June 2016
China Moderating CPI inflation due to both lower food prices and food weights …We maintain our annual inflation forecast of 2.2%, but note some downside risk. Despite the lower-than-expected inflation in May, we believe rising house prices and an improving PPI trend will pass through to consumer prices and support inflation in the very near term, while a pull factor will be the rapid declines in food prices. We expect CPI inflation to pick up again over June-July, before moderating to c.2% by year end, as we expect sequential GDP growth to moderate in H2 16 following a rebound in Q2. As a result, our monetary policy call remains for a total of 150bp of RRR cuts over the rest of 2016 and two interest rate cuts of 25bp, one each in Q3 and Q4. We see a risk to our forecast of less policy action, as financial risks and currency pressures could add to the PBoC’s reluctance to act on rate cuts.
to widen as an estimated $350bn shifts out of prime funds ahead of October’s reform deadline. Separately, we examine the Presidential candidates’ policy platforms. Several themes with respect to shortterm interest rate markets are emerging. Donald Trump has indicated that he is in favor of “auditing’ the Fed and repealing Dodd-Frank as he says the latter is restraining real activity. Hillary Clinton’s platform has detailed recommendations for regulating “shadow banking” and repo.
One hike in 2016
9 June 2016
Money Markets Monthly Update This month we discuss the Alternative Reference Rate Committee (ARRC) plans to replace Libor. The ARRC has selected two benchmark interest rate candidates: OBFR and a to-be-determined overnight Treasury GC rate. The ARRC is focused on a “paced” transition that is expected to build initial liquidity in derivatives and futures tied to the new rate. Separately, ICAP has pushed back the date when it will cease publishing the fed funds open from July to October in order to give the market more time to adjust to a new benchmark rate. The fed funds open is not IOSCO-compliant as a reference rate and OBFR is the recommended replacement. We also review some potential near-term implications of the EU referendum on US short-term dollar funding markets. While the polling data are confusing and there is some potential for rate volatility ahead of the June 23 vote, we judge a sustained bank funding shock is unlikely. Instead we think money fund reform flows out of prime funds will have a much bigger and longer lasting effect on European bank unsecured dollar financing rates. That said, we still look for LOIS
8 June 2016
BMO Closing Comment | A Lonely Long Figure 1: A Worrisome Flattening
Breakevens were also higher through most of the day though the main impulse for this wasn’t optimism in TIPS as much as it was a surge in crude to 2016 highs. Unlike the last few sessions, RBOB was more than along for the ride despite an API report that showed gasoline building. Nonetheless, the breakevens curve was flatter with 5s10s now reaching lows not seen since 2008. Figure 2: The Lonely Long
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The long-end is essentially the only part of the curve where we see significant longs. We look at such positioning on two metrics. The first is versus recent history (such as for the WN) while the second is on an outright basis (like for the US contract). Though the relationship of the WN to subsequent 30yr performance is tenuous, we still believe that the move towards a less short position for the WN and a bigger long for the US continue to emphasize potential weakness ahead.
June 8, 2016
FLASH | Auction Preview: 30yr UST The Setup from the Floor • For the $12 bn 30yr reopening, we believe that RV will be a bigger consideration and expect the rich levels to elicit some sticker shock from investors. Though the 3yr and 10yr have been good overall, the 30yr may face more headwinds as real money buyers are likely to wait for better yield levels and we are expecting a small tail at the auction. Liquidity will be a strong draw again, as will global yields, but falling investment manager demand suggest potential weakness.
Positioning in futures (see chart) is also somewhat skewed to longs already.
• Desk View: The 30yr will be ok at auction as the recent steepening has brought in buyers. What we have seen since, with the bond catching a strong bid is also indicative of momentum that favors the long-end of the curve.
G10 Rate Strategy Trade update : Hold UST 10y Treasury One month ago, we recommended a long position in the UST 10y Treasury. Our entry was 1.90% with a target of 1.60% and a stop at 2.05%. We have since lowered the stop to 1.90%, ensuring a profit to the carry at a minimum. At this point, the market may be a little overbought and due for a pullback. Therefore, 1.70% may not be the best entry point. With this in mind, we feel it prudent to amend our target and stop level: Hold UST 10y Treasury: Move target to 1.50% and stop to 1.80%. Re-enter long position at 1.90%.
Global Daily Macro Monitor | 9 June 2016 •
Japan: We now see less than a 50% chance of further policy easing when the BoJ meets next week,
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as conditions have not worsened enough to justify additional action at this stage. ECB: President Mario Draghi is due to speak at the Brussels Economic Forum on Thursday. His comments are unlikely to strike a different tone to those at the June press conference. Greece: The government is tying up loose ends to finalise the first review of the third bailout programme. This should unlock the disbursement of EUR 7.5bn of ESM funds in June. Latam: We expect Mexican CPI inflation to have remained subdued in May. The central bank of Peru is likely to keep its policy rate unchanged.
US Rates at the Bell June 8th, 2016 Ed Acton & Bill O’Donnell
Recap & Discussion:
…In the process of taking a look into the internals of today’s JOLTS report, we happened upon a very interesting data set from the Conference Board that corroborates the recent deceleration in employment growth. The link to the (exportable) data is here:http://tinyurl.com/ztrzlnr . The index is the “Help Wanted Online Index”, which tracks web-based advertised vacancies. The most recent release, as of June 1st, shows that online advertised vacancies decreased 285,800 to 4,884,200 in May (49 states fell, 1 rose), effectively showing that the demand side weakened considerably. The chief economist of the Conf. Board goes on to state that the “large May loss continues a pattern of weak employer demand in 2016…and following relatively slow growth in 2014 and 2015, we are now seeing some clear signs of softness in labor demand in recent months.” We share the finding in today’s first chart. Next up, with little changed from a technical perspective in macro-assets after yesterday’s broad scan (though TYs near ~131 and 30y flirting with 10% wage rise stretched over four years support the NAIRU case. However, falling corporate profitability and falling investment cannot stand against labour market strength for too long unless productivity falls through the floor, suggesting a long-term decline of the US growth potential. NAIRU versus cyclical labour market slowdown: Should recent labour market weakness be the harbinger of a cyclical slowdown of the US economy, then the Fed will have to stay absent for some time, suggesting USD to decline another 5% from current levels. On the contrary, labour market weakness due to supply constraints suggests the current USD weakness turning back into USD strength in the coming months. US wage data should determine the medium-term outlook for USD.
JUNE 9, 2016 S. Korea Economics A Surprise 25bps Cut; And Still Not The End of the Easing Cycle We expect another 25bps cut in 1Q17 amid expectations of core inflation edging lower. Rising risks of lower growth and lowflation for longer, coupled with a subtle change in forward guidance, suggest that risks are skewed towards more and earlier policy rate cuts.
JUNE 8, 2016
Sustainable Economics
Worth Sharing? The sharing economy is expanding rapidly: this note provides a framework to analyse how it is impacting sectors, how it is changing consumer decisions and how future challenges might reshape it. The sharing economy could redesign the competitive landscape, judging from the sectors where it has taken hold, with important implications for labor markets, price formation, consumption trends and investment incentives. The pool of assets 'shared' through on-line platforms is growing beyond free file exchange, transport, tourism and financial services, where impact is already material. Affordability and convenience drive the popularity of on-line exchanges. Moreover, an increasing shift in preference towards asset 'access' rather than asset 'ownership', partly fostered by demographic trends but also urbanisation, help to create the critical mass that sharing platforms need to become viable business propositions.
At the macro level, there are multiple benefits of the sharing economy for economic growth. A better utilisation of resources increases supply. By lowering prices, it adds to real disposable income, eventually stimulating demand, also by creating new markets. At the same time, online platforms enable
more efficient pricing and a better supply-demand matching. At the micro level, there are more grey areas. Consumers will probably increasingly become 'partial' asset owners - as it is now easier to rent instead of buying - and micro-entrepreneurs. However, the increasingly blurred line between the personal and professional sphere in commercial transactions raises concerns about the labour market and health and safety, posing new challenges for the measurement of economic output, tax-revenue capturing and policymakers' regulation. Our analysts see the impact by industry as mixed: In Autos, the long term impact is likely to be negative, but there could be some shorter term opportunities, in particular Toyota (due to strategic tie-up with Uber) and Tesla (investment thesis is substantially driven by our view of the company entering the on-demand mobility business where we see it as well positioned), whilst BMW has the most significant in-house development of car sharing services. Elsewhere, we see a negative impact on OTAs (Expedia, Priceline) and Parcel carriers (UPS, Fedex) and watch developments in the Hotel Industry after some recent cautious comments.
slight increase in the underutilization of labor market resources. Indeed, most components of this dashboard deteriorated in the latest month, point to a slight uptick in the amount of labor market slack versus the prior period.
JUNE 9, 2016
FIXED INCOME DAILY HUNKY-DORY TRADING …Strategy …Treasury supply. The 10y auction went rather well on Thursday, stopping through by 0.5bp, with bid/cover slightly above the recent average at 2.7. The indirect bid was at historically high levels, and in line with the strength seen also in the May supply. This, coupled with the soft 3y auction on Thursday, paints a picture of some consensus for anchoring of the backend of the curve in the near-term, with risks slightly skewed towards the bearish side at the front of the curve.
The sharing economy will probably evolve compared to how we know it today. Its future depends on the pace at which regulators and incumbents will react as well as how new technology reduces the need for intermediation on which the sharing economy is still relying at present. Next on the calendar is the auction of $12bn in 30Y bonds on 9 June. The 30y is trading roughly 11bp richer than the May stop-out rate, and primary dealers increased their holdings in the >11y bucket since the last auction. We therefore may need to see some concession going into the auction for the underwriting to go smoothly. 8 June 2016
Kit Juckes
Yellen's Web: Monthly Update
JUNE 8, 2016
Bottom line: Based on the latest data available (the employment report for May and JOLTS for April), the average normalized deviation across all nine labor market indicators included in “Yellen’s Web” (versus their pre-crisis trend) showed a
FX DAILY CLUTCHING AT STRAWS …The Fed's on hold, bond yields are tumbling everywhere, the S&P is flirting with all-time highs and high-beta FX is on a flyer. If you don't like the idea that Easy Money is a panacea for asset markets, and think the Bank of Korea
rate cut reflects the woes of an economy with excess savings, importing disinflation from both Japan and China and heading for economic stagnation, this might be a good time to find a rock to hide under for a while. …Otherwise today's key theme will continue to be dollar softness, driven by collapsing US real yields. 10year TIIPS yield are down to 7bp, lowest levels since April 2015 and dragging the dollar lower on a trade-weighted basis. With only jobless claims due today, the only thing standing in the way of even lower yields is the equity market rally but that won't matter unless/until US data improve. For today, the only currency we'll see against the dollar is the pound as we enter the last two weeks of referendum campaigning. And we'd sell sterling vs. CAD, NOK, or SEK too...
MON 6/6/2016 12:40 PM JUNE 6, 2016
FI SPECIAL TREASURY AUCTION PREVIEW (6P)
Key points …The 30Y sector does not seem to have set up for the upcoming auction. The 5s30s curve has flattened sharply over the last month, primary dealers have slightly increased their holdings in Treasuries with more than 11 years to maturity since the last auction and the current 30s yield is trading below the last auction's stopout rate.
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contrast, Lifers and Investment Trust buying remains elevated and well above averages. Foreign buying of JGBs was 3x the monthly averages in April. With basis moving further to the left and historicals suggesting foreign buying of JGBs picks up in Q2 over Q1, we anticipate foreign interest in JGBs will remain strong
6 June 2016
US Treasury Auction Preview Treasury will auction a total of $56bn this week, selling $24bn in 3s on Tuesday, $20bn in reopened 10s on Wednesday, and $12bn in reopened 30s on Thursday. With $32bn of holdings maturing at mid-month settlement, net cash raised at the sale will total $24bn. With no SOMA holdings maturing, there will be no Fed add-ons this week (for more on add-ons see here). Given the ongoing grind lower in global interest rates and the sharp decline in the pricing for June and July rate hikes, we expect this week’s auctions to see strong demand. The 2yr, 5yr, and 7yr auctions two weeks ago saw extremely strong end-user demand, with all three auctions stopping through the screens for the first time since November 2015 and dealers seeing record low takedowns.
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…30s: Long bond auctions have seen mixed results in recent months, tailing 1.1bp in May. Averages hint at another 0.5bp tail this month, with 71% awarded to the buy side (61% to indirects and 10% to directs). Steepening in the curve following the weak May payroll report may nevertheless provide some concessions, ensuring decent auction demand, particularly as 30yr reopenings tend to fare better than new issues.
8 June 2016
Market Musing FOREIGN JGB BUYING SPIKED IN APRIL - YIELD GRAB IN PLAY •
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The monthly Japanese Ministry of Finance (MoF) data released this morning showed buying of foreign sovereign bonds slowed in April, but exceeded average monthly purchases based on data back to 2005. Italy, France, Sweden and Canada received the most interest from Japanese investors, with buying of Canadian sovereigns the standout since the start of this year to April. Looking at foreign bond buying by investor type showed buying in May was below average, but this was due to large selling by Japanese Banks. In
8 June 2016
US Economic Comment Has the well run dry? Openings up and hiring down April JOLTs data mostly corroborate labor market softening The hiring and quits rates fell 0.2 pts and 0.1 pt to 3.5% and 2.0% in April, respectively. The declines point to labor market sluggishness, corroborating the slowdown in payrolls in Q2 (123k in April after Q1 average of
196k). In addition, the net job creation reflected in those hiring and separations figures slowed to 104k in April from 231k per month on average in Q1 and a weatheraided 289k per month in Q4. The continuing rise in the job openings rate (up 0.1 pt to 3.9%) amid slower hiring suggests that firms may be having difficulty in finding qualified employees in a tightening job market. However, there is some reason to question that rise in job openings: the job openings rate has diverged from the number of new help wanted online advertisements, which has fallen steadily after peaking in Q2 2015 (see chart). Q1 GDP now tracking at 1.2% on new services spending data The healthcare elements of the Quarterly Services Survey (QSS) adds an estimated 0.2 pct pt to Q1 real GDP growth, which is now tracking at an estimated 1.2% annual rate (also including small boosts from upward revision to construction spending and exports). Healthcare spending rose 4.4% q/q (at an annual rate in) Q2—twice the pace assumed by the BEA in its latest estimate of Q1 GDP (see chart).
Treasury Holdings: Beginning to Level Off? Bank holdings of U.S. Treasuries surged over the past few years, led higher by increased capital requirements, new regulations and an increase in demand for safe and liquid assets. As we have reiterated in previous Interest Rate Weekly reports, this has been one factor, among others, that has helped hold down long-term Treasury yields. This upward trend, however, appears to have leveled off in recent quarters in both nominal dollars and as a share of total assets (bottom chart). Although we believe rates at the end of the yield curve will rise in the quarters ahead, we expect the increases to be modest. Our most recent forecast has the 10-year finishing the year around two percent, up from its current level of about 1.7 percent.
June 08, 2016
Economics Group
June 08, 2016
Economics Group Interest Rate Weekly FDIC Quarterly: Loan Delinquencies Creep Up The most recent FDIC Quarterly Banking Profile showed noncurrent loan rates rising, but with significant variation between sectors. Unsurprisingly, energy loans were the prime culprit. Noncurrent Loans on the Rise, but Vary Sharply by Sector Bank Lending Maintains Upward Momentum
Where's the Rebound in Inflation Expectations? Despite oil’s rebound and pickup in core inflation, inflation expectations have changed little in recent months. History and demographics suggest that the Fed appears correct in remaining cautious about a full recovery. Inflation Expectations and the Fed: Victim of Its Own Success? Since oil prices began to tumble in mid-2014, inflation expectations have followed suit. While a decline in shortterm inflation expectations was to be expected, longerterm expectations sank right alongside oil. Yet, with oil prices recovering roughly 80 percent since earlier this year and inflation picking up, long-term inflation expectations have not changed much. The lack of a rebound has caught the Fed’s attention. As Chair Yellen noted in a speech this week, a sustained decline in expectations would raise doubts about how quickly inflation would return to the FOMC’s target. …However, in other episodes in which oil prices collapsed outside of an economic expansion (1985-86, 1993-94, 1997-98) long-term inflation expectations never fully recovered until oil hit a new record high
(bottom chart). With the double-digit inflation rates of the 1970s and early 1980s fading further from memory and core inflation only briefly reaching the Fed’s target since the Great Recession, it may be difficult for longterm inflation expectations to fully recover back to early 2014 levels. Demographics provide no help. Since the first of the Millennials became of working age in the mid-1990s, core PCE inflation has averaged only 1.7 percent and not exceeded 2.5 percent. As such, it is not surprising that in the New York Federal Reserve’s Survey of Consumer Expectations, respondents under the age of 40 have consistently reported lower inflation expectations than their older counterparts. Fed officials may therefore be right in not taking an eventual rebound in inflation expectations as a given.
