2017 given the government's efforts to stabilize .... year, $56bn bills were paid down and bills/coups ... UK government
StreetStuff Daily February 1, 2017
BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… Just to put the overall consumer confidence picture into perspective, the January Conference Board reading is the second-best of the cycle and the third-best since 2001, while the University of Michigan sentiment gauge established its highest level since 2004 in January. Consumers are feeling pretty positive, hopeful that President Trump can deliver the goods on the economy.
Tue 1/31/2017 2:25 PM
January FOMC Preview Stephen Stanley Chief Economist
…This is the third year in a row that the FOMC enters the year projecting multiple rate hikes (and we all know what happened in 2015 and 2016), but Fed officials sound like they really mean it this time …
1 February 2017
Global Macro Daily
Second the best …Barclays Charts
Cross-market positioning is fairly stretched: Futures and options net spec positioning
Tue 1/31/2017 10:18 AM
January Conference Board Consumer Confidence Stephen Stanley Chief Economist
The Conference Board measure of consumer confidence slipped modestly in January to 111.8 from a revised 113.3. In the last two months of the year, i.e. after the election, this gauge surged by almost 13 points to a 15-year high, so a small pullback in January is certainly not a cause for concern. The composition of the January results are encouraging at the margin. In December, the present situation component sank by 9 points while expectations soared by 12 points. In contrast, this month, assessments of the current situation rebounded by 6 points while expectations were tempered. In my view, this is a healthier mix, as a jump in confidence driven solely by expectations is of course subject to disappointment. The fact that households viewed the actual economic landscape as better in January provides a more robust basis on which to pin hopes of a continued strong consumer performance in 2017.
31 January 2017
US ECI: Wage growth remains modest …On balance, the Q4 data suggest a continued solid pace of compensation growth. We continue to expect acceleration in wage growth this year, as we see the unemployment rate continuing to fall and labor markets continuing to tighten. In addition, we expect a substantial fiscal stimulus package in late 2017 that would also put upward pressure on wages.
1 February 2017
1 February 2017
China
Investor Intel
January PMI stays robust; policy bias remains tight
Markets meet the new boss
…Our 2017 GDP growth forecast is 6.4% (likely government target of ~6.5%, in our view), with downside risks to trade given likely protectionist policies from the Trump administration. The announced members of Mr Trump’s trade team suggest the new administration could be aggressive in implementing restrictive trade policies toward China. In our view, some of their recent statements add to risks of a trade war. For instance, according to Reuters, on 19 January, Commerce Secretarydesignate Wilbur Ross said he would pay particular attention to sectors in need of anti-dumping tariffs, including steel and aluminum. We forecast a 6.4% contraction in Chinese exports in 2017 (2016: -7.7%). Domestically, we think developments in the housing market will remain key to watch for growth risks in 2017 given the government’s efforts to stabilize the property market. Overall, we think the government’s priorities in 2017 are to maintain stability and control risks. Stability is the overarching goal given that the Communist Party’s 19th Party Congress (the Party Congress is held every five years), at which the party prepares for the next leadership transition, will be held in November. The macro policy priorities in 2017 involve controlling financial risks, stabilising house prices (see China: Annual conference sends tightening monetary bias signals, 16 December 2016), and managing the exchange rate with tightening capital controls. Near-term stabilization, as seen in recent activity data and PMIs, together with rising inflation pressures, reinforce our view of a continued tightening bias in monetary policy in 2017, particularly in H1. On 24 January, the PBoC raised the interest rate on loans through its medium-term lending facility (MLF) by 10bp, pushing the rate for one-year loans to 3.1% and the rate for six-month loans to 2.95%. The move confirms our reading of the central bank’s maintaining a tight liquidity bias, guiding interbank interest rates higher and tolerating higher volatility in rates. Our base case is for benchmark interest rates to remain unchanged through 2017, given our forecast of 2.2% CPI inflation, downward pressures to growth, and CNY depreciation pressures. We forecast CPI inflation will peak at 2.6% in August 2017. Inflation exceeding 3% in 2017 and growth above 6.5% would add risks of an interest rate hike, in our view.
The start of President Trump's administration has been unparalleled. From "America first" to dialing back regulations, the pace of potential change has investors reading "The Art of the Deal" and watching "The Apprentice" to try and better understand the new man in the White House. In the meantime, investors are showing signs of shifting positions amid the political uncertainty, with positioning stretched in many instances after the post-election rotations. The big election-driven moves have largely stopped, but not reversed. Reflation is still the theme, but market moves have been smaller. Copper, emerging market equities, and inflation breakevens were the standout January performers. The dip in the USD helped boost EM and select commodities as rates consolidated and real rates moved lower to start the year. S&P 500 performance has most closely tracked credit and copper, suggesting that equities have benefited from the continued demand for relative value and the reflation theme. The reflation theme is most clearly seen in the performance of 5yr TIPS breakeven rates, which are up 45bp since election day. Equities have been positively correlated with rates and the USD since the election, though the S&P has not followed the dollar lower. Positioning in the long equity/commodity and short bonds trade appears stretched. Futures positioning in the Russell 2000, copper, and oil is roughly 2std above the post-crisis average while the short in 5y and 10y bonds is nearly 2std below. Our global composite equity positioning measure is moderately above average (0.5std), with macro HFs and US equity mutual funds most overweight.
Bond funds have had $27bn of inflows to start 2017. After bond allocations fell so much in Q4, fears of massive bond fund redemptions have not materialized, suggesting that uncertainty may be keeping risk sentiment in check. A closer look, though, shows that flows are going to TIPs and floating-rate loan funds. Investors may be looking for more safety, but they are still concerned about an upward move in rates. Equity inflows have stalled recently, with US outflows and non US/EM inflows. Outflows from US equities the last two weeks may reflect growing concerns around Trump's agenda, particularly after US outperformance. Global and Japan funds have had sizeable inflows while Europe continues to lag. EM equities have had small positive inflows the last three weeks, potentially as a catch-up. We note that the
MSCI EM index has outperformed the S&P 500 by 4% this year to date. By our measures, EM equity MFs are underweight Mexico and Turkey and overweight Asia. Equity fund positioning is overweight cyclicals and underweight defensives. The fund flow rotation into cyclical sector funds (vs. defensives) has reached $53bn since the election. Our positioning measures show that both MFs and HFs are most overweight financials and industrials, and underweight the defensive sectors and energy. From a style perspective, inflows to small cap funds have continued, albeit at a slower pace the last two weeks.
Bond fund inflows have resumed FiGUre 5 FLOWS TO Us AND NON-Us BOND FUNDS
year, it’s likely that they won’t inspire the same risk selloff that their past moves did. This gives them elbow room and even some of the more dovish members of the FOMC, from Evans to Yellen have demonstrated recently, there is a newfound willingness to increase the number of hikes that the Fed is choreographing for the year. One other factor that has been tremendously cooperative, until recently at least, was the data. The extent to which data was outperforming expectations as seen in surprise indicators was at a record high -- partly for seasonal factors and partly because economists had lowered their expectations after the weaker-than-expected data of Q2 and Q3. Since surprising to the upside for most of Q4, we’ve seen data begin to disappoint (at least marginally) as expectations have caught up with reality. To us, this emphasizes one more dimension that could leave a hawkish Fed in the cards as the FOMC may use the upside surprises as cover to tighten conditions somewhat – i.e. ‘verbal intervention’ via the statement.
Tactical Bias mONEY FLOWS TO Us BOND FUNDS HAVE PICKED UP, PARTICULARLY Us BONDS, POSSIBLY INDICATING A PREFERENCE FOR SAFETY UNTIL THE new president’s POLICIES ARE CLARIFIED.
Lyngen/Kohli BMO Closing Call, January 31, 2017 …While we’re certainly sympathetic to that view, the risk for us remains a more hawkish Fed if for no other reason than the fact that this is one of the few times that the Fed has had the ability to sound more aggressive than it has in the past without catalyzing a major risk-off move. In the past, it was the feedback effect of such moves that often forced the Fed to back down and with the market focused on the potential for fiscal stimulus and distracted by the political headlines, it gives the Fed room to sound more hawkish now and dial that back later if the facts don’t support it. This wouldn’t be the only year when the fed started sounding hawkish early only to back off later on as data come in. Away from whether they will or won’t sound hawkish, risk is still fairly strong and our view for a 5s/30s steepening remains our default. Even if the Fed does attempt to take a more aggressive tack on rate hikes this
… From a technical perspective, the 10-year chart shows a rare outside-day in yields that projects toward lower rates. The move was accompanied by a stochastics-cross from bearish to bullish – a shift that offers plenty of room to extend in favor of a further rally. The 21-day moving-average is an obvious resistance level and comes in at 2.426% before the yield-close at 2.40% -- a break of which point to the twice-held range-bottom at 2.305%. In the longbond, we’re watching a similar set of resistance levels with the 21-day MA at 3.02% before the rangebottom at 2.901%
Global Daily Macro Monitor
1 February 2017 US: The FOMC is likely to keep rates on hold at its January meeting. We expect the ISM manufacturing index to continue its recent rise and ADP payrolls to tick down.
Eurozone: Higher headline inflation and abovetrend growth suggest the ECB could open the debate on exiting QE as early as June this year. UK: Theresa May is reportedly targeting the EU summit on 9 March to trigger Article 50. The manufacturing PMI for December is likely to edge up slightly. Mexico: While the economy grew by 2.2% in 2016, slightly above consensus, domestic factors reinforce our high-confidence, below-consensus call of 0% growth in 2017.
US Rates at the Bell January 31st, 2017
Trader’s Tab …We’re still somewhat skeptical of the future reliability of the DXY/5yr Rate relationship…especially as the 5s30s curve looks like it may be re-establishing its once long-held correlation to EURUSD(chart 5). Recap & Discussion:
…Equally puzzling given the lack of movement in market pricing for the Fed’s trajectory is the 50% retrace in 5y real yields since the beginning of January (chart 4). Maybe I am being too myopic in my assessment, but the FOMC has become incrementally more hawkish if anything. The last
four Fed governors to speak before the black-out period (Harker, Rosengren, Bullard, and “even” Brainard) have brought up the subject of when and how the Fed should reinvest/trim their QE holdings. And most surprising of all, Janet Yellen warned twice in her last two addresses that a delay in tightening monetary policy could drive up inflation and force the Fed to move up rates at an accelerated pace in response. That of course leads us into tomorrow’s release of the FOMC Statement. There would seem to be little sense of urgency with Yellen having the opportunity to outline the big-picture argument at her semi-annual monetary report hearings on February 14/15th, but we still think the risks line up for a slightly hawkish read-through. Our base case is that the FOMC will humbly upgrade its assessment of economic activity in the first paragraph. This is likely due to a necessity to upgrade the inflation characterization from December: “Market-based measures of inflation compensation have moved up considerably but still are low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.” This change is seemingly necessary as 5y, 10y, 30y and 5y5y inflation breakevens are all above 2% for the first time since Q3 2014. Survey based inflation expectations have also edged back up. Similarly, with many formerly-dovish FOMC members remaining quite comfortable verbally forecasting three moves this year, we can’t rule out another subtle nudge in the hawkish direction, such as the elimination of the necessity for the committee to “closely monitor inflation”.
31 Jan 2017
North America Rates Trade Idea Alert: Foxy Five Update: Taking profits on 1y UST vs OIS As one of our trades for 2017, we recommended going long 1y Treasuries vs a matched-maturity OIS swap to position for the debt ceiling deadline on March 16 (North America Rates Strategy Focus: The Foxy Five – 2017 edition). The main idea was that bill paydowns by the Treasury ahead of the debt ceiling deadline would result in a richening of bills, and this richness would also benefit short dated coupon securities. Since the beginning of this year, $56bn bills were paid down and bills/coups have richened quite substantially against OIS. As we noted last week (Short-End Notes: Race to the bottom) our base case scenario is further richening in bills as it gets paid down going into March, but we also see some risk of a stall in the richening, especially given the current level– since the beginning of Jan, the Oct 17 UST has richened by 12 bp (Figure 2). Now that 6M/12M bill-OIS trading near the lowest point since the crisis, we think it is prudent to close this trade.
31 Jan 2017 08:31:32 ET
RPM Daily Lightening Up on Positioning* In US, the market continues to reduce the current short duration bias. Yesterday, over 5mln DV01 of new longs were added across the curve as investors square up positions into upcoming risk events (FOMC and NFP) and on rising geopolitical uncertainty. The theme of reducing short (which has occurred over the last few trading sessions) has driven RPM positioning metric to move to -1 (out of max of -5) which means short positioning is light. 31 Jan 2017
Energy Weekly It’s Parity Time in Oil; Brent Spreads and Deferred Arbs Flatten
Financing estimates from the Treasury yesterday imply that they are expecting larger deficits for Q1 (possibly due to higher tax refunds), which would reduce the need for bill paydowns going into March 16, if realized. Additionally, a possible CMB issuance that matures the day before the deadline would offset the paydown in bills. The Treasury’s propensity to utilize CMBs is uncertain given that it tends to be a more expensive funding vehicle compared to bills, but it is possible that the Treasury may override their discomfort with CMBs to better manage liquidity conditions. We might get better color on this from tomorrow’s refunding announcement.
Oil prices have settled into a remarkably narrow range this year, with spot Brent fluctuating less than $5/bbl YTD, bottoming at $53.58/bbl and peaking at $58.37/bbl. Implied volatility has come off hard as a result, but a multitude of factors could see oil price volatility return, especially with investor length at an all-time high. As flat price has stabilized, crude spreads have been rallying around the globe however, indicating that near-term physical markets are tightening in response to the OPEC and non-OPEC output restriction agreement. Prompt Brent futures priced flat to 2nd month Brent futures earlier today i.e. almost backwardation and a signal that the prompt s/d is firming (some caution should be noted given it is expiry day but the prompt spread has rallied ~$0.60/bbl this past month).
Figure 1. 1y bill-OIS richened significantly and is now trading near post-crisis lows
CitiFX | 31 Jan 2017 February Fun or Fear? Global events that matter As 2017 gets under way, we have a busy month ahead. Here are all the key events for G10 and EM markets in February.
Politics remain a key driver of markets. Policies, executive orders and administrative decisions by new US President Donald Trump will be closely watched. We’re keeping an eye out for tax reform, trade policies and foreign relations with meetings with Japan’s Abe and Israel’s Netanyahu scheduled. Trump will end the month with his Congress address. Follow our regular Cheatsheet series on Trump for all the latest developments. On the other side of the world, European politics and Brexit will also be in focus. The legislation to allow the UK government to trigger Article 50 will make its way through the two Houses of Parliament and is expected to pass. Of course, don’t forget about central banks. The FOMC kicks of the month on Wednesday but hawkish risks cannot be excluded. FOMC Chair Yellen will be delivering her semi-annual congressional testimony on February 15. In terms of central bank decisions, we also have the BoE, RBA, RBNZ, Riksbank, Banxico and more. Currencies in dark blue denote a G10 currency; EM currencies in light blue. 01 Feb 2017
Energy 2022: Return of the Unconventionals Oil looking for $40-65 range, with downside potential—don’t underestimate shale, don’t overestimate decline rates Market Forces Awaken… The 2014-15 oil price crash led to sharp pullbacks in upstream capex, leading to the “conventional wisdom” (as held by the IEA, EIA, and OPEC Secretariat) that a supply gap will open up by the end of the decade due to limited greenfield projects and accelerating decline rates… but we disagree with this consensus. To be sure, oil markets are tightening over 2017-18 as non-OPEC declines set in, and petrostates adhere to a production cut for now, reflected in recent sharper global inventory drawdowns, but…
A New Hope? A revolution in unconventional supply upturned the oil market, bringing $100+
prices back down to earth, and may now cap prices at $70 or lower out to 2022. Shale brought an unprecedented amount of “shortcycle” supply to the market. Looking at various indices of costs as well as medium-term supply-demand balances helps zero-in on a base case $40-65 crude oil price range out to 2022. The Petrostates Strike Back: Saudi Arabia and OPEC as regulator of prices? The Return of Shale—and other unconventional Rogue Factors: To what degree can Saudi Arabia and OPEC continue to act as regulator of prices? Citi believes that, despite recent agreements, OPEC market power has been severely limited by the rise of short-cycle oil,
Executive Summary Shale and unconventional oil keep prices capped at $65, but with wild swings Global oil balances are tightening in the short term, but in the medium term, shale and other unconventional oil sources impose a $65 soft ceiling, while rounds of OPEC versus shale market-share battles could mean $40 or below at times, pre2020. Shale, deepwater, and oil sands supply have combined in an unconventional revolution that has utterly changed the structure of oil markets, presenting a critical challenge to OPEC and petrostates’ ability to regulate oil prices. 01 Feb 2017
UK Economics Flash Alert: Long-term Inflation Expectations Stay at 3% UK inflation expectations maintain moderate uptrend in January
The New Year did not bring major upheaval to the Citi/YouGov Inflation Tracker. In the short-term, inflation expectations rose a bit,
in the longer-term, they were unchanged at 3%. With the former below Bank of England forecasts and the latter below the long-run average, the MPC is unlikely to be worried about unanchored expectations. Short-term inflation expectations rise to 2.6% YY
momentum in US real rates since the start of the year (chart 2). Our assumption is that Fed appointments lean hawkish (as most of Team Trump has suggested), and combined with a US stimulus and/or border tax at full employment real yields move higher over the course of the year. It is not Twitter but the Fed and US tax reform/stimulus that will ultimately determine the direction of the dollar this year.
Long-term inflation expectations unchanged
Deutsche Bank 01 February 2017
FX Daily - Imagine a Trump Fed For all the focus on tonight's FOMC the stakes for the Fed are much higher this year. Two (out of seven) governor posts are vacant, potentially three more vacancies are coming and most importantly Yellen's chairmanship is soon ending. President Trump is responsible for the appointments and has the capacity to completely re-shape the Fed and the outlook for US monetary policy well into the next decade. We would make a number of observations. First, Trump's Fed appointments will ultimately determine the fate of "dollar policy" this year. For all the attention on recent comments on exchange rates, a Trump Fed's hawkish or dovish leanings will matter much more. Second, news on Fed appointments could come quicker than the market assumes. Now that the Supreme Court nomination is out of the way the Fed may be next. The next Fed Chair could easily be placed in one of the two vacant seats even if a chairmanship appointment is left for later. Third, a dovish Fed does not mean lower UST yields. If under Trump the Fed turns extremely dovish, credibility is lost, inflation expectations spike, UST yields rise and the dollar weakens. If Trump wants a soft dollar he needs to make dovish appointments; but that will not necessarily guarantee low rates. Our bullish dollar view has been suffering on the back of positioning adjustment and a number of US officials, including Trump, commenting on exchange rates in recent weeks. More important for us is the lack of
01 February 2017
The Outlook MBS and Securitized Products Commercial MBS : CMBS 2017: What a difference a year makes First conduit of 2017 was also the first L shaped risk retention compliant deal. We take a closer look at the L shape sizing and dynamics.
CLOs : Market update The second new issue CLO of the year prices and refinancings continue, with spreads grinding tighter. Consumer and Esoteric ABS : An early look at risk retention in ABS We look at how ABS issuers satisfy credit risk retention requirements to date. Transportation Debt : Prices higher, spreads tighter, new issues continue Prices higher, spreads tighter, new issues continue. Non-Agency Residential MBS : Home prices hit new highs in more regional markets More regional housing markets are on track to fully recover from downturns during the Great Recession.
Agency Residential MBS : Hindsight is 20-30 20-year pools, particularly discounts, have ramped up recently. We speculate 20 to 30 year cash out refi to be one cause. The good news: their may be opportunities in discount coupons and structure. …In this article, we propose that increased cash-out refinancings from 20-year into 30-year loans could be behind the spike in 20-year lower coupons. As the bulk of the increase is concentrated in the 2014 vintage, borrowers would have had ample time to build equity and could even extend in term AND still lower payment. We take a closer look at some of the fast paying pools and see they have some similarities, including: low LTV, strong borrower credit, a sizeable TPO percentage, a small servicer or fast servier presence, and a nonnegligible amount of loans at the previous $417,000 threshold. The rise in speeds may actually be advantageous. With FNCL 3.0% at 99-02 (as of 1/31/2017), 20-year 3.0% are trading par handle. Therefore, a further sell off could provide an opportunity to buy these faster paying bonds (or create structures off of them) at a discount. Additionally, 20-year pools are often desired for their extension protection; the pick-up in speeds only enhances this… Economics : POTUS and unemployment rate With a new Administration in place, we construct a longterm history of the unemployment rate going back to 1901 to see where each new US Presidency started with respect to the state of the economy. Rates : Beginnings of a Regime Change? We expect the Fed to air on the cautious side through the year but they are unlikely prematurely to remove optionality.
01 February 2017
Early Morning Reid Macro Strategy …January performance review A slow start to the year aside, the month of January will be best remembered for the official inauguration of President Trump and with it, the first clues of what to expect in his presidency ahead. While still an overall positive month for risk assets, another theme has been the continuation of rising bond yields, partly reflecting the Trumpflation trade and also better growth prospects in Europe following a decent slug of economic data during the month. Indeed in local currency terms BTP’s (-3%), Gilts (-2%), Bunds (-1%) and Spanish Bonds (-1%) all ended the month with negative total returns although it’s worth noting that the weak month for the US Dollar does help to pare some of those losses somewhat when you look at US Dollar returns. In fact returns are more in the range of 0% to +1% in Dollar terms. It also wasn't a great month for peripheral risk as Greek equities (-5%), Italian equities (-3%), BTPs and Portuguese equities (3%) were 4 of the 5 worst performers in local currency terms as political risk mounted. Treasuries finished the month broadly unchanged although that doesn’t hide the fact that the range on the 10y was a relatively lofty 25bps. Interestingly EM bonds (+2%) had a much better month, while the same can also be said for EM equities (+6%). …Meanwhile
it was a fairly unspectacular month for credit markets, not helped by the underlying weakness in rates. In US Dollar terms though it was European credit indices which outperformed with Eur HY (+3%), Eur Fin Sub (+3%), Eur Fin Sen (+2%) and Eur IG Non-Fin (+2%) indices all in positive territory although again with local currency returns anywhere from -1% to +1%. Meanwhile US credit returned 0% to +1% with higher beta HY and Fin Sub outperforming Fin Sen and IG Corp. Finally it was a fairly mixed month for commodity markets. At the top end of the scale was Silver (+10%), Copper (+9%) and Gold (+5%) while at the other end of the scale it was Brent (-3%) and WTI (-2%) which underperformed as concerns about the prospect of further US supply in the wake of OPEC agreement came to the forefront.
All in all then, excluding currencies, 34 out of our 39 assets within our sample had a positive total return during January in US Dollar terms while 21 assets had a positive total return in local currency terms.
31 January 2017
Asset Allocation - Q4 S&P 500 Earnings: Most of The Way Through V-shaped Recovery
A V-shaped recovery in S&P 500 earnings growth has been unfolding since Q1 2016 as the dollar and oil shocks have faded. Four takes from Q4 earnings: a relatively typical 3.2% beat is stronger than it looks as it comes off of an un-lowered bar in contrast to previous earnings seasons which saw cuts in the lead up by 5%; likely growth of 7.4% in Q4 would take it most of the way back up to rates prevailing before the dollar shock; the level of S&P 500 EPS is up to a new high, driven by both sales and margins; underlying (constant currency) earnings growth is running at a strong 10.1%. In 2017 we see S&P 500 EPS growing 13% to $133, boosted by better US and global economic growth, stronger Financials earnings and a turnaround in Energy earnings, partly offset by a continued drag from the dollar. With plenty of uncertainty about the form and timing our current forecasts do not factor in potential tax policy changes. Bottom up consensus for 2017 EPS is at $130 and so we expect modest upgrades over the year which would mark the first such instance since 2010.
31 January 2017
US Daily Economic Notes FOMC Preview: More positive on business spending …As we learned last week, nondefense capital goods orders excluding aircraft (core orders), which are an excellent proxy for capital spending (capex), have risen for three consecutive months. As we illustrate in Figure 1, the underlying trend in core orders has
meaningfully improved. For example, over the last six months, core orders have increased nearly 7% annualized, their best showing in over two years (September 2014). With corporate tax reform on its way and with other investment incentives for businesses likely to be implemented, such as full expensing of capital outlays, the overall trend in investment spending is poised to strengthen significantly further in the quarters ahead.
Figure 1: The rebound in capital spending is already underway
01 February 2017
Japan FX Insights - JPY: Good Trump, Bad Trump USD/JPY firmer-than-expected for now, despite bearish pressure from Bad Trump US President Donald Trump has finally turned his criticism toward the weak yen. He has accused other countries of giving themselves an advantage through money supply policies and weak currency guidance, and said of Japan and China, "They play the money market, they play the devaluation market and we sit there like a bunch of dummies." Additionally, Peter Navarro, head of the White House National Trade Council, told the Financial Times that Germany "continues to exploit other countries in the EU as well as the US with an 'implicit Deutsche Mark' that is grossly undervalued". …If China were to stop its currency intervention, the CNY could very well weaken. The euro is expensive for southern Europe but cheap for Germany, and the latter will continue to have an advantage as long as they live with this unified currency. Japan has not engaged in currency intervention. Its ultra accommodative monetary policy, aimed at crushing deflation, is one factor behind the yen's decline, but any retreat in its easing stance at America's insistence would destroy its credibility as a central bank. The dollar's strength in recent years reflects the robustness of the US economy compared to other nations. The US itself had an ultra-easing monetary policy in 2009-11 that pressured the dollar downward. …Still, any correction in the rate in 1Q 2017 would be as anticipated. To the contrary, we note the surprising resilience of the rate, which even now remains above
¥112 despite the heavy US criticism of the weak yen. We maintain our belief that the USD/JPY will move in fits and starts in a ¥110-115 range for now. Over the medium term, we believe that fiscal stimulus will spur 34% growth in the US economy and multiple rate hikes by the Fed, sending the currency to the ¥120 level. We feel the sustainability of the USD/JPY correction phase will depend on expectations on the next rate hike by the Fed could come earlier from June. 31 January 2017
Special Report - UK pension indexation: changes ahead? At the end of last year the Work and Pension's Committee published the results of their inquiry into UK defined benefit pension schemes, with the Committee calling in their recommendations for greater flexibility for scheme indexation, and in particular for the government to "consult on means of permitting trustees to propose changes to scheme indexation rules in the interests of members." The debate over potential changes to the link of defined benefit pension schemes to inflation will represent an ongoing theme for UK inflation over the coming year and beyond. The next key event in the process will be the upcoming publication of the government's Green Paper on pensions, expected early this year, which should make the government's propositions on potential indexation changes more explicit. In our view, the likelihood of a complete move away from pension indexation is limited. However, with DB schemes' deficits remaining in the spotlight, a move to introduce greater flexibility in terms of inflation uprating of pensions and deferred rights would represent a powerful tool with which to reduce PF liabilities. In this regard, measures could include legislation which would allow schemes to switch indexation from RPI towards CPI (or CPIH) or the potential for schemes to temporarily suspend or reduce inflation indexation during periods of financial difficulty. The Green Paper will mark the start of a longer process that could open a period of heightened uncertainty over indexation rules for pension schemes. Given the importance of PF demand for inflation markets, increased uncertainty about future indexation rules represent a significant risk for RPI-linked instruments.
01 February 2017
Special Report - Japan: Closed-economy regime goes on: Smoot-Hawley and protectionism The Smoot-Hawley Tariff was proposed in 1928 and passed in June 1930 in the US Congress. We believe it contributed to the overseas contagion and amplification of the US-originated Great Depression. The following list describes the implications of protectionism – no country benefits from it. 1) Higher tariffs have a larger negative effect on small countries, trigger retaliation by other countries, and contribute to the cumulative contraction in international trade. 2) Higher tariffs deliver a strong negative announcement effect on other countries as a symbol of impasse in economic policy (i.e. rise in uncertainty). 3) The global economy has already suffered a structural contraction in international trade as a result of the ‘disappearance of growth frontiers’ and shifted to a ‘closed-economy regime’ after the GFC, well before Brexit and the Trump victory. Protectionism just reinforces this trend. 4) Higher tariffs and local content requirements necessitate the reallocation of factor inputs (capital and labor) in both the US and its trading partners. New allocations of factor inputs are inevitably not Paretooptimal (i.e. less efficient than the existing one), and this lowers total factor productivity growth and potential growth. It also accompanies irreversible costs (hysteresis effect) such as the relocation of supply chains. 5) Higher tariffs lower the purchasing power of domestic producers and consumers (i.e. lower domestic demand) in the US. Both actual economic growth and potential growth should fall. Lower potential growth leads to lower terminal inflation. 6) All major developed countries have seen their manufacturing employment weight to secularly fall. 7) The main cause of the US trade deficit is excessive spending beyond income. The first Reagan administration held tough negotiations to open the Japanese market and narrow their trade deficit. It was only after the Plaza Accord of September 1985 in which the USD was devalued against the JPY that US exports grew steadily and the deficit narrowed. 8) Political intervention in the economic activity of individual companies leads to crony capitalism, often prevalent in EM economies, which impedes marketbased resource allocations.
31 January 2017
Weekly Fund Flows - Executive orders make for volatile flows Last week’s (Wed-Wed) review of funds’ in/outflows as % of funds’ AuM. Global equities rose last week with US indices breaking record new highs. But leading up to these events, fund flows told a slightly different tale with US equity funds under our universe posting highest weekly outflows since Oct’16, with the brunt coming from healthcare sector funds. The latter coincided with US President Trump’s executive order to delay further implantation of the 'Obamacare' reforms, and daily data showed a strong surge back into US equity funds on the closing Wednesday of last week’s data set, in the aftermath of Trump’s executive orders and memorandums on deregulation, infrastructure projects and the stalled Dakota and Keystone XL pipeline projects. Uncertainty around the US President’s policy platform is high and we expect DM flows to remain sensitive to US news flow. Doubts regarding substantial fiscal spending and the oil price establishing a trading range, have both arguably contributed to a slowing pace in US inflation expectations, causing the strong inflation momentum to normalize somewhat, and along the way, allowing US sovereign bond funds to stop 5months of bleeding (see top right chart). But we think this will not persist, and note that although the US 10-year bond yield has rebounded in line with global PMIs, it has recently lagged behind the fairvalue of 2.8%, implying further downside for US (and hence DM) sovereign bond flows.
31 Jan 2017
US Daily: January GSAI: Business Activity Remains Firm (Thakkar)
The GSAI edged down to 58.8 in January, but remains close to its two-year high. The trend in the index remains encouraging with the three-monthmoving average moving up to 56.0. The underlying composition also remains strong with four of the five indexes still firmly in expansionary territory. On balance, manufacturing and non-manufacturing surveys in January continued to show improvements in business activity. We expect the ISM manufacturing index to increase to 55.3 in tomorrow’s report for January. In Friday’s ISM nonmanufacturing report, we expect the index to hold steady at 56.6. This month, we asked respondents to assess the impact of current corporate tax reform proposals on companies in their respective sectors. Most analysts viewed statutory rate cuts as a significant positive, full capex expensing and profit repatriation as small positives, and repeal of net interest deductibility as a small negative. Views on the border-adjusted tax proposal were split, but a majority of respondents viewed it as a negative.
Exhibit 1: GSAI Edges Down, But Remains Firmly In Expansionary Territory
31 Jan 2017
USA: Employment Costs Rise Less Than Expected, Details More Encouraging; S&P/CaseShiller Home Prices Rise BOTTOM LINE: The Employment Cost Index (ECI) rose 0.5% in the fourth quarter (not
annualized), modestly below consensus estimates. The S&P/Case-Shiller home price index rose more than expected in November. MAIN POINTS: 1. The Employment Cost Index (ECI) increased by 0.5% (qoq, not annualized) in the fourth quarter, below consensus expectations for a 0.6% rise. On a year-overyear basis, total compensation increased by 2.2%, down slightly from 2.3% in Q3. Underlying details were more encouraging, as wages and salaries excluding incentivepaid occupations firmed, rising 2.5% year-over-year vs. 2.4% in Q3. The 30 basis point (bp) wedge between these two measures is explained by relative softness in incentive pay and in benefits, which restrained yearover-year growth in overall employment costs by roughly 20bp and 10bp, respectively. Benefits increased 0.4% (qoq), softening on a year-over-year basis to 2.0% from 2.3%.
01 Feb 2017
China: Official manufacturing PMI edged down in January …Judging from the NBS manufacturing PMI, January industrial activity growth appears to have moderated in January, partially reflecting the Chinese New Year holiday effect. We expect sequential activity growth to slow down in the first quarter of the year, compared with Q4 last year. The Caixin manufacturing PMI will be released on February 3rd, but there will be no separate release of January industrial production. Instead, a combined reading for January and February industrial production will be released in March.
Exhibit 1: NBS manufacturing PMI fell in January
2. Despite some underlying improvement, we view the report as modestly disappointing in the context of firming labor markets and accelerating average hourly earnings (+2.9% yoy in December vs. 2.7% in September). Incorporating today’s ECI report, our wage tracker for Q4 declined one tenth to 2.7% (yoy).
31 Jan 2017
USA: Consumer Confidence Softens on Reduced Optimism about the Outlook BOTTOM LINE: The index of consumer confidence fell in January after reaching a 15year high last month, though perceptions of the labor market improved. 1. The index of consumer confidence fell 1.5pt to 111.8, a somewhat larger drop than expected by consensus forecasts. The decrease was driven by the expectations sub-index, which fell 6.6pt to 99.8. Other details were more encouraging, with the index measuring households’ perceptions of present economic conditions rising 6.2pt to 129.7, and the labor differential—the difference between the percent of respondents saying jobs are plentiful and those saying jobs are hard to get— rising 2.6pt to 5.9, close to cycle highs. 2. According to the Conference Board, the sequential weakness in the report reflected reduced optimism regarding business conditions, jobs, and income. The Conference Board survey period concluded on January th 19 .
31 Jan 2017
US Daily: Can Border Adjustment Really Pay for Permanent Statutory Corporate Tax Rate Cuts? (Struyven/Mericle)
The House Republic corporate tax plan includes a shift to destination based taxation with border adjustment that finances a large share of its proposed statutory rate cuts. The revenue impact of border adjustment, which is proportional to the trade deficit, will be especially important if Republicans seek to pass tax reform through reconciliation. But how confident can we be that the US will run a substantial trade deficit well into the future? A country can run a persistent trade deficit as long as it earns a higher return on its foreign assets than it pays in its foreign liabilities. The
US has earned a substantial positive return differential historically, and it is plausible that it will continue to do so. But the US already has a net international investment position (NIIP) of 42% of GDP, and under reasonable assumptions about the future path of the NIIP, the return differential, and remittances, the US appears unlikely to maintain its current trade deficit in the long run.
As a result, it seems unlikely that the border adjusted tax will raise as much revenue in the long run as it would have in recent years. At a minimum, in the long run one can have more confidence in the revenue-reducing effects of a statutory rate cut than in the revenueincreasing effects of border adjustment due to a persistent trade deficit.
Exhibit 1: The US Trade Deficit Is Roughly 2.7% of GDP
The realities of the US legislative process and the strong dollar will delay stimulus measures and crimp export earnings, according to Informa’s Chief Macro Strategist David Ader, who sees any fiscal boost to the US economy coming in 1H18. That strengthens the case for two – or less – rate hikes this year and puts talk of the Fed reducing its balance sheet this year in the category of ‘a distant risk.’ [Pages 2-4, 6, 16] With the UK’s Supreme Court throwing another spanner in the workings of the government’s Brexit strategy, IGM Analyst Alvin Baker expects the Bank of England to keep its key interest rate unchanged into 2018. January’s outlook forecast a 0.25% hike by year’s end. [Pages 6, 9, 19] Our forecast for Brazil has changed. Christopher Shiells believes Brazil’s central bank “has established a 'new rhythm of easing', given the anchoring of inflation expectations, widespread disinflation and GDP growth still weaker than expected…it could be the case that the loosening cycle will be more intense and shorter.” [Pages 7, 16]
No Fed Move in March is Old News, Balance Sheet Considerations Are Not By David Ader, Informa Financial Intelligence Chief Macro Strategist
27 JANUARY 2017
FEBRUARY MONTHLY INTEREST RATE OUTLOOK If you believe the forecasts, this is the year when fiscal policy does the heavy lifting and central bankers have more scope to normalize monetary policy. But inaction or further easing still dominate IGM’s countryby-country outlook for 2017. Among the highlights of this month’s report:
To wit, the market is giving very low odds for a hike at the March meeting (roughly a one in three chance) which seems about right though I’d probably take that even lower. The odds shoot up down the road with December Fed Fund futures at 1.15% implying two hikes left for this year. This is somewhat at odds with the Fed’s own sense of the dot plot and Fedspeak to the effect that three hikes should be in the cards. However, the Fed has been habitually over-optimistic about growth and removal of accommodation throughout this crisis; it’s appropriate for the market to take the more cautious view.
And the Fed has told us to. Yellen (who it must be reminded remains in charge this year) has just opined that the next hike depends on the economy “over coming months.” March seems a wee bit too close to make a strong judgement for a hike. It is interesting and notable to see what the Fed is curious (‘concerned’ might be the better term) about as the Trump presidency and all its oddities unfold. One thing they referenced several times with increased frequency is the dollar and slow global demand. This clearly has disinflationary implications putting a move as early March in reliable doubt. A second thing is the unknown of fiscal policy. Even in the most optimistic scenario from a stimulative standpoint, fiscal measures take a while to have an impact. It’s probably not reasonable to expect much stimulus until later in the year at the earliest, especially on any spending plans. Look for CPI to bounce further in coming months due to at the very least base effects and the contribution from higher oil prices. (This dovetails with bearish seasonal tendencies for interest rates, by the way). That, along with the low level of unemployment, gives the Fed ample cover to hike later in Q2 and beyond per their own expectations and, it seems, predilection. The very nature of base effects means they are limited; the question is whether gains in inflation will come from non-energy areas. Consider that the latest read on core PCE prices (the Fed’s preferred measure of inflation) dipped a bit to 1.4% in November, well below their target. But with two hikes priced in it will take more data and understanding of fiscal policies to price in, say, three or more. Base effects will subside and the dollar’s strength should serve as some inhibition to a continued rise in inflation which leaves it to the incoming data to provoke the Fed further or not.
A sideshow to the big show of Fed hike has been the talk from several FOMC members about
reducing the Fed’s balance sheet which means selling bonds. Before I go into this any further, let me say that I don’t see this as a ‘risk’ this year or until the Fed has hiked at least three more times... if then. Why do I see this as a distant risk? First, with the potential for fiscal stimulus we have the consequence of a deeper Federal deficit and more bond issuance as a result. The new Treasury Secretary has indicated that he’d consider longer-term issuance, perhaps 40-yr bonds, but in any event the result for coupon and bond issuance would mean upward pressure on yields. The Fed at this stage would not want to add to that potential by reducing their balance sheet. And if and when they choose to reduce said balance sheet, they are likely to go very gingerly. In context, the Fed has $195 bn of Treasuries maturing in 2017. Heretofore, that’s been rolled over (and you thought QE was all done!). The MBS reinvestments are bit more difficult to grasp – they’ve been running around $30 bn per month but that’s likely to come down according to my friend Lou Crandall of Wrightson. He relays that it could drop to $20 bn with reduced Principal and Interest payments, presumably due to higher rates. The Fed could alter what it’s buying with the maturing paper which would have an impact on the curve. For instance, the CB could buy shorter paper in an effort to reduce the duration of their SOMA holdings. This would tend to create some steepening pressure on the curve as the private sector would have to buy the additional long end supply the Fed wouldn’t be buying. The same holds true if the Fed were to reduce its purchase of MBS; private investors would be the ones to absorb the supply, all long duration, and so drive mortgage rates at least a bit higher.
There is no doubt the Fed would like to do this, reduce its balance sheet. I doubt the economy would like it as it would put upward pressure on rates to an extent we can’t really forecast (depends on many moving parts, monetary- and fiscal-policy wise). That said, higher rates, say 10-year Treasuries over 3-3.25%, won’t sit well with the housing market or, I suspect equities. But then bond strategists are always skeptical of stocks; it’s our nature. Another tangent of relevance is the state of money supply and velocity. Velocity (the rate at which money turns over in the US economy) has been dropping like a stone. It stands a 1.44, the lowest level since about 1950, and has fallen over 4% YoY. At its peak in in 1997 it was 2.2. In a nutshell, this suggests that the private sector rather than spread money about was, in the word
sof one Fed study, ‘hoarding it.’ Weakness in velocity correlates with low inflation; there are no signs it is picking up.
TECHNICAL ANALYSIS Correlation: US 10-Year Treasury Note Yield and WTI Oil – Strengthening towards recent highs
Key Points •
There are ample excuses for the decline in velocity even as money supply (M2) rose during the QE episodes. Economic uncertainty was one of them; people wanted to stay liquid. Even low interest rates may have been an excuse as people needed to save more to offset low returns (ironic, no?). Yet another element is lack of financial innovation post crisis. Financial innovation would tend to create liquid (emphasis on liquid) alternatives to holding money. Whether through risk aversion or regulation, there’s been painfully little innovation which in turn has contributed to the reduction in velocity.
•
•
•
The correlation between US 10-Year Treasury Yields and WTI Oil is positive and strengthening. As the top panel illustrates, WTI Oil has recently broken out of an inverse head and shoulders pattern, and current consolidation should resolve higher with eventual scope towards the pattern target at 71.32. As noted in the Special Study, gains in oil should push up CPI then, ultimately, US 10-Year Yields which, despite consolidation, remain in a broader uptrend and should eventually resolve higher (see the US 10-Year Yields analysis). The 60-period correlation has room to strengthen further towards the 0.7612 February 2016 peak then possibly the 0.8762 September 2015 peak, potentially in conjunction with both instruments breaking out of their current ranges.
January 31, 2017 Treasury Market Commentary
Daily Commentary, 1/31 There was another in what's been a series of abrupt dollar/rates stop-out trades experienced through January Tuesday morning that partly reversed over the rest of the day but still left yields down moderately at the close and the dollar more so. On the other hand, the additional impact of month-end buying ended after a large dollar-driven drop in yields in the morning ended up being limited, and our desk generally saw other investors selling and paying, looking to come out of month-end short ahead of the FOMC meeting and employment report. The latest bout of quick, coordinated downside in the dollar and rates
started with the dollar gapping lower during televised comments from President Trump at a meeting with healthcare executives, which quickly spread to a substantial rally in rates again also. A disappointing ECI report that showed broad labor costs not actually showing much of any pickup yet through 2016 from the longstanding 2% trend was also supportive in not putting pressure on the FOMC to do much Wednesday. …At 3:00, benchmark Treasury yields were 1 to 3 bp lower after cutting bigger dollar-driven morning gains in half in the afternoon, during which the month-end bid ended up being lighter than expected and was sold into by fast money investors after earlier short covering. Another large, unswapped corporate bond deal to wrap up a record month for corporate issuance month was also a drag on the rates market in the afternoon. A solid rebound in Italian government bonds versus Germany – 10-year spread 183 bp v. 188 bp Monday and 164 bp a week ago – and smaller improvement by France – 60 bp v. 61 bp Monday and 49 bp a week ago – from multi-year high spreads was also a notably more positive development compared to the more risk off tone in other markets. The 2-year yield fell 1 bp to 1.20%, 3-year 1 bp to 1.46%, 5year 3 bp to 1.91%, 7-year 3 bp to 2.25%, 10-year 3 bp to 2.45%, and 30-year 3 bp to 3.05%. The month-end duration extension in TIPS was above average, and our desk saw good real money buying of long end real yields into the 3:00 close, but there was offsetting fast money selling into that bid, resulting in modest underperformance in the longer end and flattening of the breakeven curve. The 5-year inflation breakeven was little changed on the day at 2.03%, 10-year down 1 bp to 2.06%, and 30-year down 2 bp to 2.15%.
February 1, 2017
FX Morning
FX Daily 2/01 More verbal intervention… Peter Navarro, the Director of the National Trade Council, has joined President Trump by verbally intervening in FX markets, this time singling out the JPY and the EUR. Overnight, Japan’s MoF FX policy chief Masatsugu Asakawa put Japan’s monetary policy in the context of the country's desire to fight inflation. The highly indebted Japanese economy will have to keep domestic funding rates way below its nominal GDP growth in order to grow out of its debt. Accordingly, its real yield levels should remain lower than elsewhere which creates JPY weakness as a second round effect. Yesterday, President Trump said "You look at what China’s doing, you look at what Japan has done over the years. They play the money market, they play the devaluation market and we sit there like a bunch of dummies." Japan’s Finance Minister Aso will
explain Japan’s position when visiting Washington on the 10 February. …and its limitations. President Trump seems to imply with his comments that the BoJ should run tighter monetary conditions to allow the JPY to rally. Sure, the JPY would rally should the BoJ pre-emptively tighten, but the issue of Japan’s debt sustainability would immediately come back on the agenda. The BIS' latest private sector debt analysis concludes that a 1 percentage point increase in the household debt-toGDP ratio tends to lower growth in the long run by 0.1 percentage point. The negative long-run effects on consumption tend to intensify as the household debt-to-GDP ratio exceeds 60%. For us, the message is clear: highly indebted economies need foreign demand support via a weak exchange rate, allowing them to move away from becoming a credit risk. For the US the choice is not only between a higher or a lower dollar. It will also have to take the second round effects of its policy into consideration. High debt countries, running tight monetary conditions and consequently a higher FX rate face increasing credit risks down the road. China has proved this statement over recent weeks. As it has tightened its monetary policy and allowed the RMB-TWI to appreciate it saw its credit spreads widening, pushing corporate funding costs higher.
Trump's conundrum. Economies running high trade surpluses with the US and having over invested in globalisation seem most vulnerable to the US trying to move supply chains back into the US. The same Peter Navarro who intervened yesterday said a couple of weeks ago that ‘it does the American economy no long-term good to only keep the big box factories where we are now assembling ‘American’ products that are composed primarily of foreign components,’ adding ‘we need to manufacture those components in a robust domestic supply chain that will spur job and wage growth.’ A weak USD policy seems to be consistent with this approach, but it does not answer the question of how the US will impose a weaker USD when similarly requiring more capital to relocate its supply chains back home. Higher capital needs suggests higher domestic savings inspired by higher yield or a higher USD driven by capital imports. Click here for more. The US administration's communication lacks clarity on this conundrum and hence its market impact will be limited to position squaring. USD Positioning
January 31, 2017
US Economics Employment Cost Index Disappointing report, showing not much of any pickup in labor costs in 2016 compared to the sluggish 2% trend in the prior six years. The employment cost index slowed to 0.5% in Q4 after three 0.6% gains, lowering the year/year rate to 2.2% from 2.3%. That left 2016 growth about the same as 2.0% in 2015, 2.2% in 2014, 2.0% in 2013, 1.9% in 2012, 2.0% in 2011, and 2.0% in 2010. … Volatility in sales commissions only explained a little of the ECI softness. Excluding incentive paid occupations, we estimate (doing our own seasonal adjustment of NSA reported data) that the overall ECI also rose 0.5% in Q4 and was up 2.3% year/year. Private industry overall ECI and wages and salaries excluding incentive paid occupations both rose 0.6%, a tenth better than the 0.5% gains including incentive paid occupations. Full year impact on private wages was a little more noticeable. Versus overall private sector wages rising 2.3% year/year, up from 2.1% in the four quarters of 2015, private wages ex incentive paid occupations were up 2.5% in 2016 compared to 2.2% in 2015. Any way you look at it though, this report continued to show little pickup in the longstanding sluggish trend through the end of last year even as the unemployment rate reached the FOMC's estimate of longer-run full employment
employment report well over time. The percentage of respondents saying jobs are currently "plentiful" rose to 27.4% from 26.0% and the percentage saying jobs are "hard to get" fell to 21.5% from 22.7%. The net result of +5.9% v. +3.3% in December was a positive sign for the upcoming employment report. The net view ("good" minus "bad" ) of current business conditions also improved to +13.2% from+10.8% … Consumer spending plans have stayed more cautious, however, with the percent of respondents saying they plan to a car ( 12.0% v. 13.9%), house (5.2% v. 6.7%), or major appliance (51.1% v. 52.6%) in the next six months down in January and down since the election.
February 1, 2017
China Economics January PMI Suggests Industrial Activity Still Held Up Bottom Line: January's official manufacturing PMI slipped less than the market expected, suggesting underlying industrial activity growth may have held up relatively well amid slightly better external demand and front-loaded loan disbursement at the start of the year. Meanwhile, the PMI input price reading indicates that PPI likely decelerated MoM but picked up further YoY in January. However, we expect economic growth and PPI to soften from 2Q17 onwards amid a softening housing market, reduced policy support, and higher comparison base
January 31, 2017
US Economics Conference Board Consumer Confidence Positive report, even if the overall index pulled back a bit from the 15-year high hit in December. The overall Conference Board consumer confidence index pulled back to 111.8 in January from 113.3 in December, which was the highest reading since 2001. The expectations gauge (99.8 v. 106.4) fell 7 points after spiking 20 points in the prior two months post-election, but the current conditions index (129.7 v. 123.5) rose to a ten-year high Within current conditions, there was a good gain in the question on current labor market conditions, which is a component of the Fed's labor market conditions index and tracks actual trends in the
Tue 1/31/2017 9:38 AM
U.S. Week Ahead: President Trump's Fiscal Programs really should just be about growth ... The previous 10-year growth period, from 2007 through 2016, spanning the final two-years of the Bush-43 Administration and the eight-year run of the Obama Administration can be chalked up as the WEAKEST 10year growth period in recorded history of the United States of America (using GDP accounting methodology), dating back to 1929 – see Chart 1. The historical trend growth rate average is +3.40429% per year on an average annual basis !
The current 10-year average growth rate of just +1.331% is even lower than the 10-year average during the Great Depression +1.333% - Chart 1 !
1. 2.
Long investment in 5-year and 10-year TIPS, Front-end steepeners, currently the EDM7 versus the EDM8 contracts (but the EDM7 versus EDM9 contract spread looks attractive to us), 3. 2s-10s yield curve steepener in Treasuries and swaps – see Chart 2. 4. Our models continue to forecast higher yields across the yield curve (due to the risks previously outlined) – see Table 1. Good Luck to All !
NatWest Markets Closing Notes
January 31st, 2017 Recap and Comments: …With that as a backdrop, tomorrow’s FOMC meeting may give an opportunity to refocus some attention on the inflationary and economic impact of Trump’s policies that were the primary drivers of the “Trump Trade”. The FOMC statement comes amid a steady uptick in market inflation expectations, which has continued despite more mixed price action of late in nominal USTs and a sell-off in the USD. But we expect the FOMC statement to be little changed overall, though a mention of fiscal policy cannot be ruled out. We think a more complete update on the Fed’s thinking will be detailed in Chair Yellen’s Humphrey Hawkins Testimony on Feb. 14th/15th.
…Maintaining our Investment Stance In light of these myriad risks, we remain “nimble” but we are maintaining our investment themes of:
Strategic/medium term bias (changes in bold): • Direction: Bullish medium term, but see near term correction/chop in yields. Weeklies have rolled bullishly, though dailies are overbought and showing reversal patterns so could see some consolidation. • Curve: Flatter long term, but think we may consolidate. Given this, we took profit on our thematic 2s10s flattener as it hit target (ahead of schedule). We will look to re-initiate on corrective steepening.
• • •
Curvature: Neutral 5s on 2s5s10s. Like 7s vs. 5s and 10s. Inflation: Looking for pullback before re-evaluating longer term longs (still). FX: With “Trump trades” under pressure to start the year and our short-term rates market view turning more bullish, we’ve become less positive on the near-term USD performance vs. the majors. Our medium-term view is still squarely positive on the USD against EUR and JPY, less so against GBP.
ECI
Current trades (changes in bold): • As per year-ahead, received 7s vs. 5s and 10s at +1.5bps, target -2.5bps, stop on close over 2.5bps. • Also as per year-ahead piece, long EDZ7/EDZ8 at 43.5bps, target 65bps, stop on close below 35bps (looking to add on dip to ~39bps area once technical momentum looks more positive). JANUARY 31, 2017
January 31, 2017
Employment Cost Index (2016 Q4) The Fed’s preferred measure of wage inflation, the Employment Costs Index, increased only 0.5% q/q, softer than expectations (consensus & NWM 0.6%), and a slowing from the 0.6% q/q pace registered in the prior three quarters. The y/y rate moderated to 2.2%, down from 2.3%. From the Fed’s perspective, nothing in these numbers suggested any sign of overheating. In terms of the details, wages and salaries (which accounts for about 70% of the headline measure) only increased 0.5% q/q in the three months ending December, while benefits (accounts for the roughly 30%) decelerated to 0.4% q/q following a 0.7% spike. Wages and salaries were up 2.3% from Q4 last year, while benefits were up 2.1%y/y. Both private sector and government compensation also increased 0.5% q/q in Q4. Despite the low unemployment rate, perhaps wage inflation is not showing much of an acceleration because the unemployment is only now at the CBO’s latest estimate of NAIRU (see chart). If our forecast for the unemployment is realized, wages should accelerate more convincingly as the unemployment rate pierces through NAIRU. Wages and the unemployment rate
FI SPECIAL TREASURY REFUNDING WHAT LIES AHEAD? Key points The Treasury announced that it expects net
borrowing of $57bn in this quarter. We expect the 3y, 10y and 30y issuance sizes due to be announced on Wednesday morning to remain unchanged at $24bn, $23bn and $15bn, respectively. Over the near term, with little clarity on fiscal needs,
the Treasury is likely to focus on increasing bill issuance while keeping coupon issuance unchanged. The sharp rise in demand from government MMFs and increasing collateral needs for margin purposes calls for increased bill issuance to meet investor demand. The suspension of the debt ceiling, which is due to
expire on 15 March, is likely to be on the top of the agenda for the new Treasury secretary. We expect bill issuance to decline by $150bn by mid-March, as the Treasury will be required to reduce its cash balance from $382bn to $23bn on 15 March. With the reduction in bill supply, demand is likely to
shift to the Fed’s ON RRP programme, exerting further widening pressure on the bills vs OIS basis. We recommend front-end spread wideners to position for such a move. Over the longer term, however, we expect coupon issuance to increase and a reversal of the cuts to frontend coupon and TIPS issuance we have seen over recent years. As per CBO estimates, debt held by the public is projected to increase from 77% of GDP now to 89% of GDP by 2027, based on current law. Preliminary
estimates show that future policies could further increase deficits by $2.5tn over the next ten years. Another important consideration for the longer term is
the potential for tapering of reinvestments. If the Fed starts tapering asset purchases in mid-2018, we can expect an additional $100bn of supply, assuming 50% of the run-offs are reinvested in 2H18. The topic of ultra-long bond issuance resurfaced at the first press interview with Steven Mnuchin, the nominee for Treasury secretary. We believe the bar is still high for the Treasury to issue ultra-long bonds, especially over the coming year.
Recommendation Enter into front-end spread wideners by going long 2y swap spreads. Position for further widening of the 3m bills versus OIS basis.
Graph 8: Average maturity of debt outstanding at historical high
Will they or won’t they? The topic of ultra-long bond issuance resurfaced at the first press interview with Steven Mnuchin, the nominee for Treasury secretary. The new leadership will likely want to continue to increase the average maturity of the debt outstanding which is already at historical high (see Graph 8) as deficits are expected to increase. The Treasury has been looking at ultra-long bond issuance since 2011, and it has been unwilling to extend issuance to maturities beyond thirty years. We believe the bar is still high for the Treasury to issue ultra-long bonds, especially over the coming year. The Treasury will probably issue more 10y and 30y bonds or introduce a 20y maturity bond if deficits spending starts to ramp up. The average maturity of debt will continue to rise with the current issuance schedule. Hence we see little need to extend maturities out the curve beyond the 30y…
FEBRUARY 1, 2017
FI DAILY FI DAILY - NEXT UP FOMC MEETING Market Update At the FOMC meeting the statement is likely to
acknowledge the further progress made towards achieving its dual mandate of full employment and price stability, but fall short of guiding the market towards a rate hike at the March meeting. The market is pricing in just two rate hikes for this year, although the Fed median dots suggest the possibility of three. The risk is of a more hawkish tilt following recent comments from Fed speakers and Chair Yellen’s speech on the Economic Outlook and the Conduct of Monetary Policy, which is not currently in the pricing. The market is currently pricing in less than a 20% probability of a rate hike at the March meeting (see Graph 1). A strong employment print on Friday could further embolden the Fed to act sooner to tighten monetary policy.
On Friday, we get the January employment figures and our economists expect a 170k change in non-farm payrolls, 0.3% mom growth in average hourly earnings, and an unchanged unemployment rate at 4.7%. A strong print would boost the Fed’s confidence and willingness to act sooner than June. We recommend positioning for this view by way of whites/greens steepener. Conditionally, we favour 3m forward 2s10s bearish flatteners. In a standard form, the entry point on the position picks up roughly 11bp to the forwards. One can improve the cushion on the position for an adverse bearsteepening scenario by selling some of the upside on the 2y leg.
FEBRUARY 1, 2017
FX DAILY WE'RE GOING ON A FEER HUNT... …We still think the outlook for the US dollar in 2017 is mainly a function of whether the US economy is going to be strong enough to encourage the FOMC to tighten enough that real 10-year yields rise towards 1%. If that's the case, the dollar rally's got another 5-10% in it, DXY targets are still for a peak in a 106-110 range, with USD/JPY peaking below 130 but above 120. And the FOMC meeting is today's main event even if lots of people aren't paying attention. They won't change policy, they will remain in waitand-see mode, but inflation is rising and the economic data are solid. Meanwhile, we said we wanted to short EUR/USD around 1.08 and here we are...
In our analysis, equities show some resilience to moderately bearish bond scenarios, although this resilience likely decays as shocks intensify (see lefthand chart below). For now, still-attractive levels of equity risk premium (ERP) indicate some scope for equities to absorb some rise in bond yields. A moderately bearish bond scenario, particularly if accompanied by a change in the policy mix with more emphasis on fiscal easing, could well prove supportive for equities. Focusing on the equity/bond relationship, we note that the more highly leveraged equity indices tend to be more exposed during bond sell-off periods. We prefer core euro equities (France and Germany) to peripheral euro (Italy and Spain). Also, during persistent bond sell-off periods some equities markets seem to exhibit a stronger than average sensitivity to the global bond index. This is particularly true for Korea, less so for China.
Monetary policy newsflow: losing momentum
FEBRUARY 1, 2017
MULTI ASSET SNAPSHOT PORTFOLIO ALLOCATION IN A RISING YIELD ENVIRONMENT The secular trend in yields that has persisted since the '80s is about to end. The end of the bond party (the title of our latest MAP ), will come about from a mix of factors, including the bottoming of inflation expectations and a pickup of global growth, along with the theme of change in the policy mix with a rotation from monetary into fiscal policy.
In a rising yield environment the natural response for asset allocation is to lower the duration exposure of portfolios. On the bond side of the allocation this process is relatively simple. However, extending the concept of duration to other asset classes is not straightforward. Here we use our Q-MAP framework to gauge the sensitivity of different asset classes to moderately bearish bond scenarios (based on our analysis of multi-asset quarterly returns from 2000 onwards).
… The end of a secular trend in yields Our rates strategies main theme for 2017 is that of a global build-up of term premia, implying steepening pressure on yield curves (see here). Indeed, years of extremely accommodative monetary policy have taken global yields to historical lows, adding to a secular trend that has persisted since the ‘80s. The end of the bond party (also the title of our latest MAP), will come about from a mix of factors mentioned previously, including: the bottoming of inflation expectations, a pickup of global growth, along with the theme of change in the policy mix with a rotation from monetary into fiscal policy (the latter is structurally bearish for bonds since it implies higher levels of issuance and deficits). As we discussed in a recent note (see here), the rebalancing of portfolios in a context of a build-up of global term premia, and after years of duration build-up, will likely help drive the normalisation process for bond yields in 2017. All this suggests that the secular trend for lower yields may have found a bottom in late 2016, with significant implications for other assets classes. There are nuances, however, in the expectations for a build-up of term premia across different jurisdictions. In Japan, yield curve control should cap the potential for any significant steepening momentum. In the US, the term-premium build-up may be tempered by a more hawkish than expected Fed. Indeed, the minutes of the December FOMC minutes reveal some willingness on the part of the committee to step away from a “gradual” approach to policy normalisation. The market continues to be more inclined towards a 2+2 scenario for 2017
and 2018, versus the 3+3 scenario implied by the median of the ‘blue dots', indicating significant scope for an hawkish repricing of expectations. In Europe, on the other hand, the ECB will reduce the size of its asset purchases program in March, and our economist’s core expectation is for tapering from June onwards to phase out purchases all together by January 2018 (see here), supporting the steepening momentum on the European curve. Faced with such environment, the natural tendency from an asset allocation perspective is to lower the duration exposure of portfolios and shift duration allocation to jurisdictions and/or maturities that are least exposed to the build-up of term premia. These were measures that are implicit (and explicit) in our latest MAP recommendations (hold allocation to US and Japanese bonds while reducing allocation in Europe, for example - see here). There are, however, important implications from this expected bond dynamic to other asset classes, and for the broader allocation exercise, and we explore these next.
31 January 2017
Trading the FOMC
We expect the Fed to keep policy unchanged at the January 31 - February 1 FOMC meeting. Fed officials are watching and waiting while Congress and the administration debate potential policy actions. Thus we do not anticipate any overt signals about the March meeting, nor hints about the reinvestment policy. Statement edits should be fairly minor. Markets are pricing in a negligible 0.3% chance of a rate hike for the upcoming meeting, but 29% by March and near certainty by June. We see the rates market largely pricing in a nonevent this week. A hawkish surprise in the language should increase the markets’ pricing of more than 2 hikes this year, in our view. We think this dynamic should strengthen the USD and flatten the 5y-30y curve, given that the Fed funds curve in 2017 is a little flatter than after the December 2016 meeting.
31 January 2017
Global Macro Strategy FOMC Preview: Waiting for more data and fiscal promise Will the Fed signal a March hike? Find out why inflation and fiscal policy uncertainty will keep the Fed and markets in wait-and-see mode FOMC Preview: Waiting for more data and fiscal promise We expect the January FOMC meeting to be a neutral event and do not expect the Fed to signal a March hike. The market is priced for less than 5% chance of a hike at this meeting and around 20% for March. In terms of economic developments, since the December FOMC meeting, payroll data has been slightly softer than expected but wages have rebounded. Equity markets have moved higher marginally while the dollar has weakened. If anything, the recent resilience in the equity markets could cause a more hawkish shift on the margin, given the higher correlation between equity markets performance and the Fed's policy shifts. Separately, the January meeting is important for long-term policy goal updates. We do not expect a shift in balance sheet guidance. Realized inflation data is soft and market priced inflation is low On the inflation front, December core PCE came in at 0.1% with Y/Y core PCE running at 1.7%. It is notable that the 3month annualized core PCE is running at only 1% (SeeFigure 2). On market priced inflation, the Fed's measure is likely to be close to 2% (This is in CPI terms), which the Fed is likely to characterize as low, in our view (See our past analysis inFigure 6). On the survey side, University of Michigan's median 5year/5-year inflation expectations moved higher from 2.3 (alltime lows) to 2.6 while the NY Fed's 3-year inflation expectations rose from 2.71 to 2.83 (Figure 3). Thus, the Fed is likely to consider surveys to be stable. Albeit, some surveys are near lower end of their range. On balance, realized economic and market data is mixed and the Fed will likely want to see further progress before indicating another hike. Our economics team expects next hike to be in June in line with current market pricing. What about rates in the context of fiscal outlook? What's in the price? In recent speech, The Economic Outlook and the Conduct of Monetary Policy, the Fed Chair Yellen noted, that there is potential for changes in fiscal policy to affect the economic outlook and appropriate policy path. However she noted that the size, timing, and composition of such changes remain uncertain. That said, the bond market has run ahead of the enactment of fiscal policy. From just prior to US elections, 10-
year nominal rates have sold off by more than 70bp. About half is attributable to real rates and half is attributable to breakevens. Here our analysis – which we discussed in the 2017 outlook - indicates that a reasonable size fiscal packet could move nominal rates by 20bp-100bp (when 10-year rates were at 180bp, seeFigure 4). Thus, the 70bp shift higher in US yields already prices in a large amount US fiscal stimulus, in our view.
hence allowing for unique insights to be used into the investment process. We explicitly show that only in top quintile of dispersion and bottom quintile of correlation environments have active managers in aggregate beaten their respective benchmarks. Unfortunately for active managers, since 2007 macro factor risk has driven correlation to historically high levels. We believe the ingredients are in place for potential future outperformance.
Aggressive bond market pricing makes receiving fixed attractive Therefore, until fiscal policy becomes active and credible, the reflation thesis crucially hinges on a dovish Fed that stays behind the curve. Along this point the market is pricing in about two hikes for 2017, which is at our economics team estimate for 2017 hikes. It is notable that over the past few years, the Fed has wanted to hike eight times but was able to hike only twice. The global uncertainty has not dissipated. As such, we like buying duration outright at these levels and in the US, we particularly prefer buying longer-dated TIPS (see 2017 TIPS outlook). Also on a cross market basis we prefer to focus on real rate compression rather than breakeven or nominal trades in USTs vs. Bunds. Long 10y US TIPS vs German linkers holds tightening potential from both legs in our view. For tactical trades, our analysis suggests that over the past two years, the front-end has tended to sell-off going into the FOMC meetings and rally thereafter (Figure 5). If we do not get a hawkish surprise at this FOMC meeting, we would expect 2s, 5s and 10s to rally over the next week.
Active management to add even more value in the brave new world As a consequence of ageing demographics leading to a world of low earnings growth, as well as living in a very unpredictable geopolitical environment, we believe that equity market returns are likely to be subdued over the next ten years, and as a result return dispersion is likely to remain high. Accordingly, superior active managers should continue to earn an economic rent. The trend of AUM shifting might still continue, however, active management will only grow in importance, as the passive ecosystem needs active management for efficiency. What to invest in? In this environment, (to reaffirm) we prefer active exposures over passive exposures. Strategies that are likely to perform well are: high quality growth, high quality income, sector specialist funds, and hedge funds (in particular, equity, quantitative, merger arbitrage, macro, and volatility).
31 January 2017
Q-Series Active vs Passive: How Will the World of Investing Evolve? (part 1 of 2)
January 31, 2017
There's a tectonic shift occurring in asset management, but not for the broadcast reasons. What is the future of active management? Who are the likely winners?
Economics Group
Tectonic shift taking place but not entirely for broadcasted reasons It is not new that in aggregate, actively managed equity funds have been underperforming and losing market share, whilst index funds and ETFs have gained share. The common explanation is normally associated with lower cost structure and higher operational scalability; however, this is not the full story. The reality is that technology has driven both market efficiency and a proliferation of choice which have allowed investors to specifically select the exposures they are comfortable with at the right price.This is causing a fundamental shift in how investors think about capital allocation, track risk adjusted returns and remunerate underlying managers.
Pulling back a touch from its recent run rate, total employment costs increased a still solid 0.5 percent in the fourth quarter. The trend in employment costs remain firm amid a tight labor market.
The rationale for active managers underperforming is multi-dimensional In a nutshell, active managers tend to outperform when dispersion of returns is high, and correlation of returns is low,
Employment Cost Pressures Remain Firm in Q4
… Upward Compensation Growth Pressures Remain With the labor market at or close to full employment in most Fed officials’ eyes, wage pressures are likely to broaden and strengthen in the coming year as the U.S. economic expansion lengthens and possibly strengthens. If these pressures materialize as we expect, consumer inflation is likely to accelerate at or above the Fed’s
target, providing further justification to hike interest rates multiple times this year.
•
claiming jobs are hard to get has fallen meaningfully in line with the unemployment rate. The labor market differential, which measures the difference between those stating that jobs are plentiful minus those stating that jobs are hard to get, jumped up 2.6 points to 5.9 percent.
January 31, 2017
Economics Group Consumer Confidence Retreats in January Consumer confidence fell 1.5 points from its recent high to 111.8 in January. The entire decline was due to a slight pull back in optimism for the outlook for the next six months. Assessments of present conditions rose. Consumers Report Improved Labor Market Conditions •
Consumers’ assessment of current employment conditions has improved along with the tightening U.S. labor market. The proportion of consumers
January 31, 2017
Economics Group U.S. Home Prices Extend Gains in November The S&P CoreLogic Case-Shiller National Home Price Index extended recent gains in November, rising 0.8 percent. At 185.2, the index is at a record high. The 20-City and 10-City indices also edged higher.
January 30, 2017
Economics Group Special Commentary
Is ECB Policy Tightening Coming Into View? Executive Summary Real GDP in the Eurozone rose 0.5 percent in Q4-2016, the 15th consecutive quarter in which growth has been positive on a sequential basis. But because economic growth has been generally sluggish over that period, inflation has remained well below the ECB’s target of “below, but close to, 2 percent.” Consequently, ECB monetary policy has turned even more accommodative over the past few years. We forecast that the pace of economic activity in the euro area will gradually gain traction as exports accelerate and as the effects of monetary accommodation make their way through the economy. In our view, the ECB will deem that further policy accommodation is not needed as inflation slowly creeps higher. But it will also conclude that policy tightening is not needed either, at least not in the foreseeable future. In other words, we believe that the ECB will be on hold for a considerable period of time, as the Fed was between October 2014, when it finally ended its own QE program, and December 2015, when it hiked rates for the first time in nine years. Of course, any downside shocks that materialize, such as the potential election of Marine Le Pen as the next president of France, could weaken growth and cause the ECB to administer further policy accommodation.
