Eurozone spreads: Cheap 30y ATS, expensive 5y Fin. Eurozone spreads: ... tracker, selected published articles, trade rev
StreetStuff Daily Rem
March 16, 2018
15 March 2018
Global Rates Weekly
Marching on •
In the US, we believe the March FOMC outcome is likely to show a slightly better outlook with a median of three hikes each in 2018 and 2019. Separately, the Q4 17 flow of funds data show a demand shift to domestic investors. We maintain our long 10y UST recommendation, given elevated forward yields.
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In Europe, headline volatility in Italy around coalition prospects will remain a source of uncertainty until early April at the least. That said, we continue to believe that Italy offers too high a risk premium over Spain in the cheapest 5y5y fwd sector. Elsewhere, we do not find the large April EGB redemptions, including ECB’s holdings, to be a significant market-moving factor on its own. In the UK, the OBR’s latest forecasts point towards continued medium-term fiscal risks. While 10yr ASW look rich on the curve with gilt 5/10 ASW box at historically rich levels, the weakness of the revenue base suggests that risk towards higher issuance lie tilted towards the upside in the medium term.
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United States Marching on We believe the March FOMC outcome is likely to show a slightly better outlook with a median of three hikes each in 2018 and 2019. Given that this is already a consensus view, the Fed reaction function around developments in money markets will be closely watched. We maintain our long 10y UST recommendation, given elevated forward yields.
…Next week, all eyes will be on the March
FOMC when the Fed will also be updating its summary of economic projections and the statement will be followed by the press conference. We believe the overall message would be that the Fed has gained confidence in its baseline economic outlook and is likely to continue to gradually remove accommodation, as short rates rise and as the balance sheet shrinks further.
BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… …We believe the revised economic projections should translate into a somewhat higher policy path, although the median for 2018 is likely to remain at three hikes. At the December FOMC meeting, six Fed participants expected to hike three times this year (Figure 3). We believe that that group is likely to remain the majority. Some dovish Fed participants are likely to shift from two to three hikes (such as Governor Brainard and President Bostic) and perhaps one or two Fed participants could shift from three hikes to four hikes. In our view, there is a greater probability of the 2019 dots showing a median of three hikes (compared with current 2.25). Figure 4 shows that four Fed participants projected hiking to 2.625% (equivalent to two hikes from the 2018 median) and three projected hiking to 2.875% (equivalent to three hikes from the 2018 median). Only one likely needs to shift from the former to the latter for the median to go to three hikes. Given the revisions to growth and the unemployment rate, we believe that is more likely. Making monetary policy restrictive in 2019 seems a more reasonable decision than doing so in 2018, with inflation still below the target.
…In terms of trades, we have been recommending being long 10s and we maintain that view. As discussed above, the March FOMC outcome is likely to hew close to consensus with risks balanced around that view. In terms of risks, the SEP showing four hikes as the modal outcome (even if not median) in 2018 would be perceived as hawkish. On the other hand, the Fed stressing the inflation miss and the development in money markets as a reason to remain cautious would be perceived as dovish. In our view, the rally from the recent highs in yields is largely a reassessment of term premia and the expectation of short rates in the forward space, such as 5y5y, are still elevated. Hence, we maintain our long 10y UST recommendation.
Euro Area April PSPP redemptions are not a big deal Headline volatility in Italy around coalition prospects will remain a source of uncertainty until early April at the least. That said,
we continue to believe that Italy offers too high a risk premium over Spain in the cheapest 5y5y fwd sector. The other key focus topic for the EGB market is the upcoming large cash flows in April, particularly from the ECB and its potential market effect. We do not find this to be a significant market-moving factor on its own.
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For the remaining $10trn in debt and Libor loan exposures the conversion could be less organized and more contentious. We wonder if official institutions might be natural early issuers of SOFR-based floaters.
UK Fiscal risk has not diminished OBR’s latest fiscal forecasts do little to suggest that the medium-term fiscal picture has improved. With net issuance set to rise after FY18/19, fiscal pressure is likely to increase, leaving intermediate forward asset swaps vulnerable to a fundamental correction.
Japan Growing presence of foreigners in JGB market Overseas FX reserves and private investors have a growing presence in the JGB market, likely contributing to the richening of short-term JGBs. However, such pressures are unlikely to re-emerge, given that USDJPY xccy basis should remain contained.
15 March 2018
US Money Markets SOFR and Libor transition update The Alternative Reference Rate Committee (ARRC) recently released an update on the paced transition from Libor. The first steps in this process – publication of the overnight rate and futures trading – will begin within the next two months. • The Fed will begin publishing overnight SOFR data on April 3. On average, the SOFR rate trades about 5bp over the RRP rate. • The overnight SOFR is sensitive to changes in bill issuance. If SOFR were published over the past two weeks it might have been trading 15 to 18bp above the RRP rate. • Overnight SOFR also exhibits some balance sheet sensitivity. Like its component repo rates, it cheapens on quarter-ends. • CME will launch two sets of SOFR futures contracts after the Fed begins daily publication. They will be 1m and 3m maturities. • The ARRC’s paced transition plan includes the publication of an official, forward-looking term SOFR rate – but this is not expected until late 2021. And it is unclear how to construct this rate so that it is IOSCO compliant. • Addressing legacy contracts and derivatives are the biggest hurdles facing Libor replacement. • ISDA will take a role in converting interest rate derivatives using a set of standardized definitions and protocols.
March 15, 2018
Lyngen/Kohli BMO Close: Hard to Fade the Flattener …As a theme, we remain focused on the ugly side of inflation – namely the damage done to consumers’ real purchasing power and the potential corporate profit impact of higher input costs. The combination of a weaker dollar and rebounding commodity prices has put upward pressure on import costs and, as evidenced by the CPI data, this hasn’t been passed along to the end user. Higher production costs which aren’t passed through simply lead to profit-compression. It’s no coincidence that falling profit margins are a classic indication of late-cycle stress and we’re reminded that the present expansion has already grown somewhat long in the tooth. That said, expansions don’t die of old age, but they do wither on the vine as the nourishment of policy accommodation is drained… …In light of the largely range-bound price action, we were not surprised to see Thursday’s volumes uninspired at best. Overall, cash traded at 86% of the 10-day moving average. 5s were the most active issue taking a 32% marketshare and 10s were a distant second place with 27%. The front-end combined for 24% with 2s and 3s taking 13% and 11% respectively. 7s claimed an average 10% and 30s took a slightly higher than usual 7%.
Tactical Bias: Whether it’s Mueller or March Madness, we are content with the notion that the economic data is poised to take a backseat to external influences on the Treasury market. That isn’t (just) our way of washing our hands of what happens on Friday, but rather an acknowledgment that the limited data slate and Spring Break distractions could trigger a choppy session lacking sustainable direction. We’ve been caught wrong-
footed by the impact of rate-lock Fridays recently, so we will concede the relevance of this flow potential ahead of the weekend. The corporate tax cut has certainly improved the position of many firms and a pickup in M&A (and associated issuance needs) has led to several significant new deals. We have no insight here, but we see little reason to fade this trend. This alone could present a material challenge to the 10-year sector’s ability to close below the 40-day moving-average of 2.807%. Nonetheless, we maintain that 10-year yields will touch 2.75% long before 3.00% -- yeah, that was bolder call when 10s were at 2.95%, although still germane as the Treasury market continues to consolidate in the upper-end of this year’s trading range. In terms of breaching 3.00%, we are now more focused on the 30-year sector, which saw yields slip to 3.041% on Thursday as the long-bond continues to outperform. The solid auction on Tuesday has emboldened the flattening trend and the 30-year has benefited as a result. 5s/30s flattened as far as 43.4 bp, making grudging progress toward our 40.3 bp target and 2s/10s hit 53.4 bp – just shy of the 50 bp near-term resistance. While we ultimately expect these levels will relent and the curve flatten further, the chances are good that the cycle-lows turn into an important battleground as participants positioned for a steeper curve challenge any attempt to breakout on the downside. There appears (for now) to be a waning correlation between stocks and yields which we’ll attribute to the fact that neither 10-year yields nor the major indexes are near their extremes…
15 Mar 2018
Global Rates Plus - Too early to fade the bond rally
with the rise in ECB QE reinvestment – which implies a further fall of about 10bp could be possible. Higher Fed dots are already in the price: Next week’s FOMC meeting brings risk to the Treasury market from (1) the widely-expected upgrade to the Fed’s SEP forecasts; and (2) how the new Chair’s rhetoric is interpreted. For (1), we see the risks to yields as tilted more to the downside because – for the first time since the SEP was introduced – the 2-year OIS is already above the 2-year yield implied by the dots. So even though we expect the dot-implied 2y yield to rise, it need not cause market rates to rise too. As for (2), Chair Powell is no doubt planning a smooth transition and would like to keep markets calm, so we have to call these risks evenly balanced. Event risk from developing trade controversies and geopolitics seems to be biased to rise rather than fall .
Overall, therefore, we advise against entering renewed short duration positions at present. Also in this week's Global Rates Plus Eurozone: Latest Japanese buying data support OATs Eurozone spreads: Cheap 30y ATS, expensive 5y Fin Eurozone spreads: Upcoming rating reviews – our take UK: 2s10s tactical steepeners look increasingly attractive US: TIPS and Trade – stay long US breakeven targeting 2.30% Japan: Yen-denominated ODA to drive super-long basis Flow analysis Credit ratings snapshot, Treasury issuance calendar, ECB QE tracker, selected published articles, trade review, contacts & disclaimers
Too early to fade the bond rally There are still plenty of near-term downside risks to yields: it’s too early to try to fade this bond rally, we argue. Where in the range? Since we recommended taking profits on outright short duration for the rest of H1 (see In a Range for the rest of H1, then a sell-off in H2, 1 March 2018), the US 10y note yield has been stable around the middle of our 2.75%-2.95% range, but the Bund fallen slightly below our 0.60%- 0.80% range.
There are still plenty of near-term downside risks to yields Specifically:
Higher ECB QE reinvestments still weighing on Bund yields: Although Bund yields are just below the bottom of the range we have in mind for H1 (arguing for a new short), the yield fall seems to be fitting in well with the rise in QE reinvestment, as we discussed on page 7 of In a Range... (top chart), which implies a further fall of about 10bp could be possible.
Higher ECB QE reinvestments are still weighing on Bund yields: the Bund rally seems to be fitting in well
Higher Fed dots already in the price: Next week’s FOMC meeting brings risk to the Treasury market from
(i) the widely-expected upgrade to the Fed’s SEP forecasts; and (ii) how the new Chair’s rhetoric is interpreted.
US: Where next for Libor/OIS?
As for how Chair Powell is interpreted by markets, he is no doubt planning for a smooth transition and would like to keep markets calm, so we have to call these risks evenly balanced. But regarding the SEP revision, we see the risks for yields as tilted more to the downside – because for the first time since the SEP was introduced, the 2-year OIS is already above the 2-year yield implied by the dots (bottom chart). So if the dots rise as our economists expect to 2.125% at end-2018, and 2.875% at end-2019, the dot-implied 2y yield will rise but it need not cause market rates to rise too. Event risk from developing trade controversies and geopolitics seems more likely to rise rather than fall. Overall, therefore, we advise against renewed short duration positions at present. Laurence Mutkin BNP Paribas London branch
…The pace of the recent widening in 3m Libor/OIS looks extreme as a reaction to higher T-bill issuance alone, but seems to start anticipating lower banking reserves as the Fed unwinds its asset portfolio. This process could have unintended effects including wider basis with lower liquidity. We do not expect a material or sustained tightening ahead. Shahid Ladha & Timothy High, BNP Paribas Securities Corp
15 Mar 2018
Macro Matters BIG PICTURE: ECB and Fed – A tale of two exits We compare how the Fed and ECB have gone about reducing a monetary accommodation, to see what lessons can be learned.
US: TIPS and Trade – stay long US breakeven targeting 2.30%
THEMES OF THE WEEK ECB: Gradualism Its continued focus on patience, persistence and prudence suggests the ECB will keep to a cautious approach in its exit strategy. The next step should be a change in its forward guidance, unlikely to come before June.
US FOMC: Shifting up With tax cuts and a spending package passed since its December meeting, we expect the Committee to revise up its economic forecasts and rates projections at its March meeting. …Since the FOMC’s last forecast meeting in December, we saw a heady Q4 GDP print (see: US GDP: Domestic demand exploding); Congress passed both tax cuts and an additional spending bill (see: US Tax Tracker: Tax and effects and US: A Budget Deal*); while economic momentum has remained strong amidst synchronized global growth and financial conditions that, while are a
bit tighter than when the Fed last met, still remain loose (see Table 1) As a result, we expect the Committee’s median forecasts for growth to be revised upwards. Already, the Committee has signaled a stronger economic outlook, both in its January statement that saw it upgrade its economic assessment (see US FOMC: Firing on all cylinders), as well as in Fedspeak since, particularly recent focus on headwinds turning to tailwinds. Both the January statement and tailwind rhetoric signal quite clearly that the FOMC is set to mark up its forecasts. Specifically, we expect the Committee to revise its 2018 and 2019 forecasts as follows: for real GDP (q4/q4) +0.5pp (to 3.0%) and +0.3pp (to 2.4%), for the unemployment rate (q4 average) - 0.1pp (to 3.8%) and 0.2pp (to 3.7%, along with possibly lowering the longer run unemployment rate by 0.1pp to 4.5%), and for core PCE (q4/q4) +0.1pp (to 2.0%) and +0.0pp (to 2.0%). These changes carry the same tension as the Committee’s December forecasts: we expect forecast unemployment and inflation to remain too high and too low, respectively, given the Committee’s expectations for GDP growth.
of increasing stress. Japanese politics: Paper trail The government has been dealt a blow by the admission that the finance ministry rewrote official documents relating to a controversial land sale. Prime Minister Shinzo Abe’s re-election as party head might be in jeopardy. Argentina: Farms feel the heat from dry spell Extraordinarily dry weather conditions in large farming areas look set to depress Argentina’s output for the 2017–18 agricultural season. South Africa: Positive feedback loops Lower external vulnerabilities, soft inflation, likely rate cuts and fading credit ratings risk should add up to positive feedback loops, keeping the rand well supported.
15 Mar 2018
Global FX Plus - Health Check on the USD Bear Trade: Still Room to Run Weekly FX key themes: Connecting the FOMC dots
Along with its revised economic forecasts, we anticipate a bumped-up rates projection profile. We expect to see the median 2018 rate dot shift up to 2.25-2.50%, implying four hikes for the year (from three in December), and for the 2019 dot to shift up to about 2.875%, implying two hikes (same as in December). We expect the median 2020 implication to remain for one hike. Additionally, it is possible the FOMC will raise the long run rate to 3% on the basis that the real equilibrium rate has risen. .
US: Consumers – great expectations While recent retail sales figures have disappointed, consumer confidence is very high and income expectations are strengthening. Overall consumer debt issues are small, but there are pockets
Fed dot plot could shift higher, but will the USD follow? GBP vulnerable heading into an eventful week. AUDUSD has upside potential.
The FOMC gathers for its March meeting next week, which will conclude with the release of new projections and Chairman Powell’s first press conference. A 25bp rate hike is fully priced, so focus will be on signalling around how much further tightening lies ahead. Our economcis team expects the dot plot to include a fourth rate hike for 2018, up from three at the time of the December projections. Markets are currently pricing three hikes and a result in line with our expectations could put some further upside pressure on US yields. However, markets are unlikely to fully price four hikes quickly, given data and fiancial conditions dependency of the Fed forecast. Moreover, we would in any event expect USD benefit to be short-lived even if yields do advance, with the USD perhaps echoing patterns of the past year by weakening in the aftermath of rate hikes. The USD remains under structural pressure to weaken back towards sustainable equilibrium levels versus the core currencies and has been unable to gain as US yields have advanced versus core currencies for the
past year. Our positioning analysis framework suggests USD shorts have now been cut back considerably, leaving more scope for the USD to reweaken as the risk environment recovers. It will be an eventful week ahead in the UK, with the Bank of England meeting and a key EU summit getting underway. While UK officials have signalled that they are close to reaching an agreement on a post-Brexit transition period, there appear to be significant areas of disagreement that still need to be resolved. We believe current levels of the GBP reflect insufficient risk premium for political uncertainty and continue to recommend long EURGBP positions. As for the Bank of England, we expect the message from the MPC to remain hawkish but with a May rate hike now 85% priced in we see limited scope for the central bank message to offset political factors. We remain constructive on the AUD heading into the February jobs report and minutes of the March RBA meeting. Pricing for RBA tightening remains low relative to other G10 central banks, leaving the AUD with scope to gain ground if data begins to surprise to the upside or RBA messaging begins to shift. We remain positioned for gradual upside in AUDUSD via a derivatives recommendation.
USD has not benefitted from Fed repricing since November
EURUSD should be principal beneficiary as USD shorts rebuild
FX may be lagging the recent passage of event risk, according to BNP Paribas FX Positioning Analysis and STEER™. We see scope for USD short exposure to build further. EURUSD should be the principal beneficiary. The shift to long JPY exposure observed in recent weeks could be pared back in the near term; but we expect structural JPY demand flows to ultimately dominate.
US Rates at the Bell
March 15th, 2018 Traders Tab:
We Come in Peace: Speaking on CNBC, trade hawk and White House trade adviser Peter Navarro kept it pretty light/cool regarding the administration’s tariff plans. He said that tariffs “can be applied in a way that won’t provoke trade wars”, while saying that Trump will make an announcement in the coming weeks regarding the China trade investigation.
Recap & Discussion: …USTs closed slightly cheaper/flatter as
domestic equities/energy stabilized somewhat in choppy conditions, while WH trade adviser Peter Navarro kept it pretty light regarding the administration’s tariff plans, saying the US “comes in peace”. Neither politics nor data meant much for front-end USTs, which are still beholden to Libor/OIS, which extended through 52bps this morning as 3mL jumped 3.25bps Thursday to 2.1775, the highest since 2008, prompting sales in March and June ED$. As for the house view, we think part of the recent frontend cheapening (on top of the additional supply) might be attributable to corporates holding onto more cash(repatriation plans?) This is a similar dynamic as that being seen in the CP market, where money fund WAMs have decreased in anticipation of outflows. On the data side, today's reports also revealed improved component readings (little changed headline readings) for both the Philly Fed and Empire State that suggests little confirmatory evidence of an industrial sector slowdown. Specifically, the Philly Fed’s ISM-adjusted measure surged to a 45-year high of 61.8 from 56.3. The Empire State
ISM-adjusted measure rose to a robust 57.3 from 55.0 as well. The trade price report also beat estimates with firmness in core prices (exports 0.4%, imports 0.5%) but restraint in the headlines… …Technically, not a lot of moving parts today, but a few notable observations in credit space (fig. 1), while domestic equities remain in consolidation mode (DJIA/SPX) as we show in (fig. 2). On the close today, US IG OAS has made a new higher high (wider spread, divergent from equities), while the US BBB spread over 10y USTs has also made the first close above its 200dma since 2016 (137bps). In equities, the wedge consolidations in SPX & DJIA futures remain intact, but we’re closely watching how these patterns resolve (odds favor continuation to downside imo). As for risk-off triggers to keep an eye on, we think it may be Euro-centric, with SX7E (EU Banks) the first cyclically-sensitive sector abroad to make new lows in the downtrade (fig. 3). Additionally, despite closing tighter today, the 10y Italy-German spread is at a critical juncture (at 200wk moving average), with momentum diverging wider.
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arrangement. Such an agreement would support our long-held optimistic base case of a smooth Brexit, but no legal guarantee yet. The transition arrangement is part of the withdrawal agreement under Article 50 TEU. Its draft legal text remains subject to dispute, not least on the question of the Irish border. Even if there is some progress at the summit, nothing is resolved until everything is resolved. A positive outcome next week would be negotiations moving on to future trade. We compare the opening positions and conclude they are far apart.
15 Mar 2018 10:19:49 ET
RPM Daily Pressure on the Short Side
In North America – Long cash (+1.3) / short futures (-2.7): $4.5m DV01 longs added across the UST curve, mainly in the belly. The weekly changes show clear flattener flows, with +$21.1m in 1030y vs -$0.1m in 2-5y. The libor strip remains extended short and in profit. Across cash and futures, risk has been reduced, leading to somewhat less extended positioning.
In Europe – Long cash (+1.1) / short futures (-0.8): In Germany, flatteners remain with only small changes in open interest yesterday. Here too, flattener flows are evident from weekly changes. $7.9m in 10-30y vs $0.3m in 2-5y. In Equity / FX – S&P (+1.8) / EUR (+2.7): The market remains long EM equities at 3.4 in futures and 2.6 in ETF, but still somewhat off the extended long positioning seen in the beginning of the year.
15 Mar 2018 16:46:12 ET
European Rates Weekly Extending the rally (mostly) on tactical factors
15 Mar 2018 14:04:18 ET
UK Economics View EU Summit Preview: We Remain Brexit Optimists •
The UK government hopes that by next week’s EU Summit both sides can agree on a transition
We extend the bullish duration rally target, mainly on tactical grounds, but are beginning to eye the impact of the weak global credit impulse. ECB speeches want to hold your hand because they are exiting APP this year. We think late 2019 Eonia is in the process of getting too rich. Policy/economic divergence make Fed impacts for € rates more nuanced than
before. Watch $ inversion fear to supercharge €5s30s flattening.
A directional update Our tactical directional bias is getting more bullish and we are countenancing the idea of € long end rates trading below fair value estimates, which in 10yr Bunds, currently stands at 0.53% (on the constant maturity yield, RV0002P 10Y Index). The rationale to extend our bullishness from an earlier decision to buy (European Rates Weekly: Pulling the buy trigger, 15th Feb) lies in some worrying growth signals, inflation fear receding, positioning and a likely move by the Trump administration to hit China with more tariffs, which initially for bonds is positive. 15 Mar 2018 12:48:24 ET
Global Credit Strategy Focus What is happening with CDX IG volatility?
CDX IG implied volatility remains high in the aftermath of the sell-off — While CDX spreads and HY volatility have retraced a significant portion of their move, IG volatility is still high relative to spreads and HY volatility. We attempt to explain this. Increased hedging activity in CDX IG a potential driver — We argue that investors are currently preferring CDX IG as a tail hedge over HY, which in turn is keeping implied volatility high in CDX IG. We outline the reasons why. We believe that IG volatility is likely to come down relative to spreads — Our analysis shows that IG spreads are unlikely to widen to levels implied by IG volatility in the short to medium term. We therefore expect convergence to occur with implied volatility coming down from current elevated levels. Please consider voting for us in the Credit Derivatives category in the 2018 All American Institutional Investor survey.
Outside the US, companies which export to the US look most exposed. Korea and Taiwan look vulnerable through autos and electronics. China’s economic exposure is large, but direct stock market exposure is low. Those investors concerned about the direction of US trade policy should look to markets or sectors which are less exposed to the US. Australia, certain Eurozone countries and even parts of Japan are relatively less exposed. More locally driven and less growth sensitive sectors are Telecoms, Utilities, Retailing and Insurance.
15 Mar 2018 12:24:03 ET
Weekly Supply Monitor Euro, US and UK Supply Outlook US The US Treasury will issue $11bn of 10yr TIPS next Thursday. There are no UST cash flows that are eligible for reinvestment next week.
US net cash requirement (NCR) over the next 4 weeks On a settlement date basis, the NCR is neutral for USTs next week as there is no supply/ cash flows settling over this period (Figure 20). 20. US weekly cash flow profile for next four weeks, USD billions
15 Mar 2018 19:28:04 ET
Global Equity Strategist
16 Mar 2018 02:07:33 ET
Trade Wars: Equity Market Impact
Japan Rates Weekly
Changing our rates outlook
Direct economic impact of recently announced tariffs is small. However, Citi’s equity strategists suggest retaliation by other countries and an escalation into trade wars would have profound implications for economies, capital markets and companies. In the US, a retaliation by other countries could pose risks for exporters. Aircraft manufacturing, capital goods and defense stocks could be vulnerable.
We think there are major obstacles to a change in monetary policy by the BoJ, and have pushed back the timing at which we expect the first
rate hike until 2020 H1. We think the BoJ will use a new “comprehensive assessment” to raise both short and long rates simultaneously. Given concern about economic weakness due to the consumption tax hike, we do not expect the market to factor this BoJ action in until the start of 2020. For the time being, volatility is likely to remain low and the market stay in a boxed range, with 20y occasionally dipping below 0.5%. JGBs are likely to weaken when the BoJ again starts to reduce the size of rinban operations, and swaps then outperform. JPY LIBOR fixings may not rise much, given the impact of forex forwards.
Deutsche Bank 15 March 2018
Fed Notes - What to expect from the March FOMC statement and press conference Peter Hooper
15 March 2018
US Economics: The Week Ahead Next Week's Highlights The March FOMC meeting is the key event next week, and important data releases include existing and new home sales as well as durable goods. We expect the FOMC to hike rates 25bps at their March meeting. This move has been well telegraphed and rates markets are pricing for a near-certain rate increase. We expect the SEP (“dots”) to shift in a hawkish direction, as inflation and wage data have been solid and recent fiscal stimulus is likely to push up both growth and inflation. We expect the meeting statement to remain largely unchanged, but there have been some hints that the balance-of-risks may become more hawkish. This is also Jerome Powell’s first meeting as Chair, and he is likely to stress policy continuity with former Chair Yellen. We expect headline durable goods orders to increase 1.0% MoM, partially offsetting the January decline, as airline orders were a bit stronger in February. We expect ex transportation orders to post a modest 0.3% gain, a significant slowdown from the Q4 average growth of 0.9%. We expect February existing home sales to decline 0.6% MoM, a third sequential decline, as pending home sales fell sharply in January. New home sales in February are likely to improve 3.7% MoM due to warmer weather in February.
We preview next week's FOMC meeting with particular focus on three key questions: (1) does the Committee still see risks as “roughly balanced;” (2) will the median dots move up, and in particular, will they signal four rate hikes this year; and (3) how will the new chairman perform in the press conference, and what changes in style/messaging might he signal? …This brings us to the dots. Economic developments dictate an increase in the Committee’s expected path of interest rates relative to the December forecast. For example, a traditional Taylor rule would prescribe an upward revision to rate hike expectations for year-end given our expectations for the downward revision to unemployment and upgrade to inflation. Given the lags in the effects of monetary policy changes, it makes sense to raise the path of rates sooner rather than later. On this basis, we expect the median forecast to move up to four rate hikes this year. However, this could be a close call. To raise the median, four median dots will have to move up. We are guessing this will be Powell, Dudley, Quarles, and Williams, though Kaplan, who also was likely at the median in December, has hinted at some upside risks to his expectation as well. On the other hand, Powell and Quarles could choose to keep the Committee’s options more open and save this move for June after more data have come in. Perhaps more importantly for the market, we expect the entire path of rate hikes to shift up modestly, with the median dot for 2019 rising to 2.9% (from 2.7% in December), and the terminal rate forecast rising to 3.3% in 2020 (from 3.1% in December). Part of this revision is justified by a modest upgrade to the median long-run nominal neutral rate, which we see rising by 0.1 percentage points to 2.9%. Such a revision only requires the upward shift in one dot from the median (assuming
that Yellen’s dot was at the median in December), and could be justified by the Fed’s narrative that headwinds, which have kept r-star low, have shifted to tailwinds. This message has been adopted by even some of the Committee’s more dovish members, including Governor Brainard. This upgrade to the entire path would also be supported by the expected further tightening of the labor market and associated shift in risks towards greater overheating, which implies that the Fed may have to raise rates further above neutral. The risks to our view are clearly that the Committee is reluctant at this point to signal such a shift in a more hawkish direction and that the long-run r-star and the terminal rate remain unchanged….
16 March 2018
Early Morning Reid Macro Strategy While markets have spent much of the last 24 hours struggling for direction there is still an underlying feeling of caution in the air. The unpredictable headlines which seem to be coming out of Washington on an almost daily basis now is certainly keeping markets on edge and its perhaps little surprise that the S&P 500 has now fallen every day this week and has notched up its first four-day losing streak of the year. By the way today actually marks 10 years to the day that JP Morgan originally agreed to buy Bear Stearns for $2 a share. As a bit of fun, we looked at the EMR from that day and we were reminded that that week also included the Eliot Spitzer scandal, the Fed announcing the introduction of the TSLF and a market priced roughly 50/50 for a 100bp Fed rate cut the next day! That’s one way of making current markets look dull.
16 March 2018
Hsueh On Oil - Strong supply, stronger demand Strong supply, stronger demand This week's data releases support an ongoing narrative whereby the robust drivers of US supply growth are balanced, or even possibly swamped, by stronger-than-expected demand growth. On US supply, the EIA's Drilling Productivity Report supports a largely unchanged view of the future growth profile insofar as moderate rig count growth is accompanied by further productivity growth. This sustains upside risks to our supply growth estimate (+1.5 mmb/d yoy total liquids in 2018) as we have held productivity flat in our projections. Productivity growth was helped by a material drop in Permian drilling days per well from 24.1 to 21.4, and a less impressive drop from
17.7 to 17.1 days in other regions, Figure 1. The Permian drilled to completed ratio remains depressed at 0.78, Figure 2, so far defying expectations of a recovery as pressure pumping equipment is delivered. Gasoline demand growth at +400 kb/d On the demand front, US product demand growth has been on a tear, running at a rate of +1 mmb/d in the year to date, Figure 3. This is likely a result of accelerating economic activity, with high PMI readings for both manufacturing and services. Perhaps less importantly there has been an increase in heating degree days (1825 HDDs in the first 11 weeks), and there is an easy year on year comparison with last year's warm Q1 (only 1571 HDDs in the first 11 weeks). Demand growth was composed of gasoline (+404 kb/d), other oils (+325 kb/d) and propane and propylene (+203 kb/d). This along with the strong January crude oil import figures for China and India, Figure 4, is likely to result in some further upward revision to our 2018 demand growth assumption. Additionally, this makes us less confident that rising vehicle efficiency will bite as soon as we have projected, lifting our 2019-20 demand growth estimates from 1.15 towards 1.30 mmb/d yoy. Note this would still run significantly below the nearly 1.6 mmb/d growth rates implied by the IMF's global GDP growth figures of 3.7% in 2019-20.
Fundamental upside risks more plausible These fundamental revisions would bias balances more towards modest deficits through 2020. All in all we are more cognizant of upside risks to our year-end Brent target of USD 60/bbl, assuming that there is some follow-through over the year from strong year-to-date demand data, and as always, given a continuing OPEC commitment which we have no reason to doubt for the time being.
15 March 2018
Special Report - Waiting to inhale: A breather mode and an extrapolationist view of the curve Post-2013 curve evolution exhibits a distinct “breather” pattern which consists of two modes: the market inhales during short episodes of volatile bear steepening followed by extended exhale periods of bear flattening grind. first two months of 2018 are just a continuation of this pattern. This is consistent with selling curve gamma in the flattening mode and owning it during the steepening episodes. Continuation of the “breather” pattern suggests a limited scope on both sides of the curve slope. This applies especially on the flattening side -- we are currently near what appears to be the lower limit on 2s/10s and the risk of further flattening is seen as limited. We are buyers of 1X2 curve floor spreads and contingent curve floors.
15 March 2018 | 11:11PM EDT
US Daily: From Headwinds to Tailwinds: Implications for the Hiking Cycle and the Longer Run Dots (Mericle)
The idea that the headwinds of years past have now become tailwinds for the US economy has emerged as a popular theme among Fed officials. In today’s note we ask what this means both for the hiking cycle and for the longer run dots, the FOMC’s estimate of the neutral rate (or r*). The implications for the current hiking cycle are straightforward. As Governor Brainard noted last week, tailwinds such as the fiscal boost, easy financial conditions, and stronger global growth raise the short run
neutral rate, implying that a higher policy rate will be required over the next couple of years to at least limit further overheating. As a result, we expect the FOMC to begin to raise its near-term interest rate projections at the March meeting. The implications for the longer run dots in March are less clear. While some models of r* that the FOMC might consult make at least a tentative case for raising the longer run dots, especially if participants think that easier fiscal policy and stronger global growth will persist, other influences such
as market forwards and consensus expectations do not push for a change. As a result, we think upward revisions are more likely to come later.
monthly transactions data suggest these investors purchased $92bn in January, which more than reversed the outflows over the prior two months. Over the last six months, foreign official investors have purchased a net $21bn per month of US securities, and custody data from the Federal Reserve Bank of New York indicate that foreign official investors added another $46bn to their Treasury portfolios in February. Therefore, we see little evidence of broad diversification away from USD-denominated reserve assets at this stage. This is also the case for China specifically. Our estimate of China’s valuation-adjusted holdings of long-term US Treasuries increased by $1.5bn in January, following an increase of $6.5bn in December. China’s holdings of all US securities (both short-term and long-term) have continued to increase modestly, as holdings increased by $18bn in December after remaining roughly unchanged in November. Selling of US securities related to foreign profit repatriation did not show through in this report as much as we had anticipated. Short-term holdings and long-term Treasury holdings increased in low-tax jurisdictions in January (country-level statistics on other asset holdings for January will not be released until next month). We still expect to see large declines in overseas asset holdings over the coming months, concentrated in low-tax areas such as Ireland and the Caribbean.
…In short, some model estimates that FOMC participants are likely to consult make at least a tentative case for raising the longer run dots, especially to the extent that participants think that easier fiscal policy and stronger global growth will persist. But the overall message from the sources above is mixed, and the views of professional forecasters and investors do not suggest any urgency to raise the longer run dots now, just six months after the median fell to 2.75%. Our view is that r* is higher than that and we think the FOMC will come to that conclusion too, but more likely at a later date.
15 March 2018 | 5:57PM EDT
TIC Data: Still Few Signs of FX Reserve Diversification Our estimates based on valuation-adjusted custody holdings from the TIC data system suggest foreign official investors net sold $33bn of US securities in December 2017. However, our projections using
15 March 2018 | 12:28PM EDT
US Daily: Tariffs on Imports from China: How, When, and on What (Phillips/Taylor)
We expect the Trump Administration to announce tariffs on imports from China in coming weeks, as part of an intellectual property-related investigation that could also include restrictions on Chinese corporate investment in the US and restrictions on the export of intellectual property to China. Tariffs under this “Section 301” investigation are meant to offset claimed economic damages, which in this case might range from around $60bn at the low end of estimates to more than $200bn at the high end. Media reports suggest the White House is considering tariffs equivalent to the very low end of the range.
It is not clear what categories of goods might be affected by the tariffs, but we believe the White House will use a few different criteria to make the decision, including the bilateral balance in the product category, the tariff rate differential, the share of imports that go to final uses (e.g. consumption) rather than downstream production in the US, and imports from China as a share of total US sales. Whether the industry has been named as a priority in the “Made in China 2025” report might also be a factor. We find that power tools and small electrical appliances top the list of potential targets for US tariffs based on a substantial bilateral trade deficit, higher tariffs applied in China versus the US, and high share of imports going to final (in this case, consumer) use. Sporting goods, toys, jewelry, and consumer electronics including TVs rank highly as well. Slightly lower on the list, in our view, could be aviation and marine navigation equipment, rail equipment and ships, as well as furniture and household appliances.
15 March 2018 | 4:45PM EDT
Where to Invest Now: 9 Years and Counting Key Conclusions: Earnings-driven bull market will continue as S&P 500 rises 4% to 2850 at year-end 2018
Fundamentals: 2.7% economic growth; 14% EPS growth; Buybacks a key source of net share demand
15 March 2018 | 10:11AM EDT
USA: Philly and Empire Fed Indices Improve on Net; Initial Claims Edge Lower; Import Prices Rise BOTTOM LINE: The Philly Fed manufacturing index declined by slightly more than expected, but the underlying composition improved. The Empire State manufacturing index rose by more than expected in March, and underlying details were favorable. Import prices rose by more than expected in February as lower oil prices were more than offset by a solid gain in imported consumer goods prices. Initial jobless claims declined by a bit more than expected to 226k, after rebounding from a 49-year low in the previous week. Our
preliminary estimate for our March Current Activity Indicator is 4.3%, compared to 4.8% in February and the prior three-month average of 4.0%.
Modest upside: Capex, tax reform, earnings growth, and share buybacks outweigh risks from rising interest rates and escalating trade conflicts. Optimism: Recession unlikely as deregulation and tax reform have lifted consumer confidence and business optimism to highest levels in years. Playbook: Tight valuation dispersion means stocks with highest expected growth trade at a discount relative to history.
Economy: GS economics forecasts abovetrend 2.7% GDP growth, core PCE inflation of 1.8%, and 4 Fed hikes in 2018 (market implies 3). Earnings: Sales growth of 6% and a tax reform-assisted 50 bp margin expansion to 10.5% will drive 14% rise in EPS to $150 Money Flow: Positive net demand for shares only because Buybacks offset aggregate net selling by combination of other ownership categories.
Strategies: (1) Offense: Firms investing for the future; (2) Defense: Lower risk from rising inflation and rates
1. Firms investing for the future: Stocks consistently redirecting Cash Flow from Operations back into the company through capex and R&D. 2. Secular growth stocks: Companies with the fastest expected growth offer value relative to history 3. Reduce exposure to macro risks: Firms with low labor cost and strong balance sheets reduce the risk from wage inflation and higher rates.
We forecast S&P 500 will rise by 4% to 2850 at year-end 2018
to 11-year sector rose almost $2 bln. The biggest decline was the $1.9 bln dip in the 2- to 3-year sector.
US Economics & Rates Strategy Treasury Market Commentary, March 15 European long-end rate rally continues as supply is finished for the week in Europe. Norges Bank signals an earlier start to rate hikes. The 2s30s curve hits a new low as long-end stability was met with a new cycle high in the 2yr yield. S&P 500 down a 4th straight session. US 10s close at 2.83%. March 15, 2018
JEF Economics Primary Dealer Positions: Positions Rebound After Month-End
In the week ended March 7th, Primary Dealer positions rose $18.4 bln to a net long of $209.3 bln from $190.8 bln, reversing a nearly-equal decline in the prior week due to month-end pressures. Treasury positions rose $17.3 bln while positions in other asset classes were relatively little changed. …Treasuries
Overall Treasury positions rose $17.3 bln to a net long of $78.4 bln. Overall coupon positions rose $5.8 bln to a net long of $43.1 bln. Bill positions rose $11.9 bln to a net long of $20.7 bln. TIPS positions rose $214 mln to a net long of $9.5 bln, and FRN positions fell $693 mln to a net long of $5.1 bln. Coupon positions were mixed across the curve. The biggest
increase was in the 3- to 6-year sector, where positions rose $3.7 bln. Positions in short coupons (less than 2 years to maturity) rose $3 bln and positions in the 7-
…The 2s30s curve flattened another 2.5bp today to close below previous lows observed this year near 77bp while the very front end of the Treasury market pushed higher in yield in front of next week’s FOMC Meeting. 2y Treasury yields closed above 2.28% for their highest yield level of the year while 30s were flat on the day. As we head into Fed week, participation in the higher-yield story is becoming increasingly isolated to the very front of the US term structure with each day seeing shorter-term technical measures arguing for a stalling of higher yield momentum at intermediatematurity levels. The 5y yield has been an interesting example. Even as 2y yields push towards new highs, 5y yields have put in lower highs on each subsequent push higher in yield since failing at 2.70% in late February. And today, despite a 1.5bp rise in yield, 5y Treasuries saw their 5-day moving average close through the 15and 20-day moving averages for the first time since November 2017. Both parts of the term structure have the potential to be right depending upon the resolution of the hard data vs soft data disconnect, sequential path of inflation given a known base effect story impact on the YoY levels and the outcome of the Fed meeting next week. The 10y closed up 1bp to 2.83%. …The bigger story from the latest inflation data continues to be that more of the gain in Core can be explained recently from historically outsized “oneoff” type moves (apparel/motor vehicle insurance) in only a couple of sectors with little to no headline pressure given the evolution of retail gasoline and food prices over the last couple of months. In the
Housing Market Index – the majority of the decline to a still very strong level can be explained by a drop in Buyer Traffic to its lowest level of the last 4 months. The move in Buyer Traffic over the next couple of months will be worth watching as it has historically been led by the University of Michigan Current Conditions for Buying Houses Index by about 3 quarters. Currently that UMichigan index is falling as fast as was observed in 2005/06 due mostly to components related to the move higher in interest rates. At least in cyclical sectors such as Auto Sales and Existing Home Sales (both of which have negative YoY rates) higher interest rates and in some regions of the country the elimination of the SALT deduction (for housing specifically) appear to be having more near-term impact than the still yet to be fully observed impact of the cumulative take-home pay gains…
…GDP tracking We continue to track 1Q GDP at 1.6%.
March 14, 2018 US Economics: Retail Sales: Tax Impact and Seasonal Bias Retail sales disappointed in February— again. This marked the third consecutive weak reading in the retail control group that we believe indicates payback from anticipatory tax-driven spending in 4Q plus possible downward seasonal bias. We are now tracking 1Q real PCE at 1.2% and real GDP at 1.6%.
March 15, 2018
FOMC Preview: A Hike and Hawkish Bias | US Economics & Rates Strategy We expect the Fed to hike its target range by 25bp at its March meeting with a hawkish bias in its projections. While too early to call for 4 hikes this year, the FOMC moves decisively in that direction. Our strategists suggest maintaining UST 2s30s curve flatteners.
At the conclusion of the March 20-21 meeting, we expect the FOMC to: • Raise the target range of the federal funds rate to 1.50-1.75%. • Acknowledge fiscal stimulus while continuing to see "near-term" risks to the outlook as "roughly balanced". It will also continue to stress it is monitoring inflation data "closely", given the continued shortfall vs. goal. See our side-by-side mock-up of potential changes to The March FOMC Statement. • Change the SEP to include faster growth with corresponding lower unemployment rate, but leave core inflation unchanged. We also look for the median assessment of longer-run unemployment to move lower. • Show a pronounced upward drift, but leave the median number of hikes at 3 this year, raise the median path to 3 in 2019 and leave 2020 at 1. We think the longer-run neutral rate remains unchanged, though it is a close call. US Rates Strategy • With fewer dots contributing to the calculation of the median (15 dots for the 2018~20 period and 14 dots for the longer run), the movements of each dot become more important for projecting the median. As a result, we encourage investors to place more emphasis on movements in the mean of the dots in each year and the longer run instead of movements in the medians. • We continue to suggest UST 2s30s flatteners. If the dot plot shows a much larger increase in the 2018 and 2019 mean dots than in the 2020 and the longer-run mean dots, as our economists expect, then we expect the yield curve to flatten in response.
March 16, 2018
Muni Strategy Brief: AlphaWise META: The State Tax Boom - Less Than Meets the Eye State tax revenues have surged over the past few months. Upon closer inspection, this appears driven by a confluence of onetime factors (repatriation, capital gains, tax reform), not a sea change in states' underlying financial condition. Hence, we remain underweight the sector. In just two months (December and January), states have surpassed their full-year expectations of revenue gains from tax reform. We look at three one-time drivers, and one fundamental driver:
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Repatriated hedge fund profits: A 2008 tax law mandating the repatriation of hedge fund profits by the end of 2017 was estimated by the Joint Committee on Taxation to raise up to $25 billion for the federal government alone; yet, it still evidently caught some Northeast states by surprise. Capital gains: The S&P 500's nearly 20% increase in calendar year 2017 explains the eightfold increase in income tax collections in Tennessee, a state that levies income tax only on investment gains and income. We think a strong stock market last year explains a significant portion of the upside in California and New York income tax collections. Federal tax reform & base broadening: The federal tax reform effort modestly broadened the individual income tax base. These benefits to state tax revenues are real, but they do not explain the surge over the past few months in general fund collections. Economic growth: Better economic growth matters to state tax collections, especially in states without an income tax like Florida, Texas, and Washington. Ultimately, however, nominal GDP growth of 4-5% does not square with our Muni Early Tax Analysis (META) indicator posting an 18% YoY increase in general fund tax collections.
What does it mean for muni investors? Although an extra dollar is always good, we think most of the increase in revenue is related to one-time drivers: hedge fund repatriation, capital gains, and federal tax reform. Underlying growth is still good, but not good enough for us to take comfort that states can easily grow their way out from under deferred capital and pension liabilities. Thus, we remain underweight state and local credit.
Total revenues
March 16, 2018
FX Morning Hans W Redeker
…The Libor-OIS spread has reached its highest level since 2012. With Treasury funding requirements staying high and the Fed unlikely to add liquidity into the system, the spread is likely to stay wide for now. The wide spread has increased USD hedging and funding costs, splitting the FX spectrum into two halves. Hedging costs are important for foreign holders of US assets funded in traditional surplus areas like Japan, Northern Asia, Switzerland and Norway. Rising hedging costs suggests investors should either reduce currency protection or cut the underlying asset holding. It is the risk structure of the underlying asset holding which determines how portfolio managers react to rising rates. The more risk is embedded in the portfolio, the higher the likelihood of reducing asset exposure. The consequence of QE has been that foreign-based holders of US assets, particularly Japanese investors, have accumulated risk in exchange for higher yield. Now as rates rise, the asset exposure (both FX-hedged and unhedged) is more likely to be cut, leading to repatriation flows back into surplus currencies such as the JPY. Previously, when risk exposures were less significant, the response to higher rates was more likely to reduce currency protection, pushing the JPY lower. The funding impact works in the opposite direction, explaining why the USD has strengthened against EM and cyclical currencies, but has traded heavy against the lower yielding surplus FX world. The USD-funded long EM carry trade is now at risk as the significant rise in LIBOR rates has reduced the attractiveness of this carry trade. Despite the US yield curve flattening further, the USD has stabilised at a low level, showing an increasingly pro-cyclical trading behaviour.
March 15, 2018
FX Pulse: Preparing for a Corrective USD Rebound Hans W Redeker
Signs not to be ignored. The USD has increased its procyclical behavior recently, weakening in line with the slowdown in US data. Hard and soft data have decelerated, with the Atlanta Fed's GDP tracker down from 5.4% to 1.9% for 1Q. The DXY may still see new index lows over time, but the odds of USD entering into a corrective, tradable rebound have increased. In the unlikely scenario of growth slowing down for good, equity markets may weaken. Related portfolio rebalancing needs could then spill over into cyclical and EM currencies, pushing USD higher. With hindsight, our decision to turn from bullish to neutral on EM on Monday
appears timely and risks are tilted toward weakness here. Two scenarios... Nonetheless, our base case remains that the global economy stays strong and the US economy picks up again in 2Q. Seeing supportive data while the US output gap is closed will lead markets to either price in higher inflation risks or a higher long-term output potential for the economy. In both cases, the USD would likely rebound. ...one outcome. Funding costs on their own tell us little about funding flows. The relationship between anticipated investment returns versus funding costs and the availability of funding itself are better guides to explaining why we strongly believed in a weaker USD despite rising bond yields. Rising inflation expectations or markets concluding that US output potential is rising both have the capacity to push the anticipated US terminal rate higher - and our research shows that cyclical and EM currencies trade lower when US term premia break higher. Sell cyclical FX/EM currencies. We use any final legs lower in USD to prepare our portfolio for a tradable 4% DXY rally. To this end, we expect procyclical, highyielding currencies like TRY to keep weakening and we remove our long BRL vs AUD position. We look ahead to the G20 meeting next week. We expect no fireworks but will be attentive to any shifts in policy communication.
… Our conclusion. The conclusion we draw is that robust liquidity conditions may soon be a thing of the past. Turning a risk-bullish into a riskbearish view will be the consequence. The current risk rebound will offer a good opportunity to get positioned. Ultimately, the JPY, USD,and the CHFshould outperform while, within G10, AUD, CAD, GBP, NZD, NOK,and SEK should weaken. In EM, we regard TRY, MXN, COP,and IDR as most vulnerable. April might be the time to get positioned for these moves as, by then, the strong Q1 earnings reports may have become priced into the equity market and policy changes and their impact on global savings start to become clearer to investors.
Desk Strategy
US Markets Closing Notes, March 15th 2018 Cross Asset | Strategy Daily 15 Mar 2018 Recap and Comments: It was a relatively light news day with the FOMC still in blackout, no top tier data releases, and what I am assuming was a fair bit of attention turned towards the start of the NCAA tournament in the afternoon. Nevertheless, the Treasury curve flattened for a fourth straight day, but in contrast to the prior 3 sessions, today’s flattening was of the bearish variety. While the bond didn’t exactly make a run for it after breaking out of recent ranges yesterday, it did remain relatively well supported considering the sell-off further in on the curve. (chart) This pushed 5s30s to within several bps of the December flats. Meanwhile, 10-year yields once again started to struggle at around the 2.80% level overnight, and spent most of the US session inching higher. As we mentioned yesterday, this is the fourth session in March where we have seen 10s touch 2.80% but ultimately fail to break through. It’s also worth noting that on an admittedly short time horizon, 2.80% represents the 50% retracement of the selloff from the spike highs in earlyFeb (chart) and it does seem like there is a little bit of congestion built up around that level. Overall, today’s Treasury moves were relatively modest on an outright basis, and given the lack of data or meaningful policy commentary it didn’t seem like there was any overarching fundamental theme at play. Price action was similarly muted in other assets with the S&P 500 essentially flat, 10-year BEIs were up by about half a bps, and oil was up by about 20 cents per barrel. One thing that was most certainly not muted was the continued meteoric rise in LIBOR/OIS. Last Friday, the spread surpassed the widest point seen during 2a7 reform in 2016 and has shown zero signs of slowing down this week. Today the spread is up by almost 2bps after increasing at an average of ~0.9bps per day over the last two weeks and is hovering just below 50bps. We wrote pretty extensively about our views on LOIS in a Front-End Dispatch two weeks ago, in which we (thankfully) recommended against trying to fade the rise to 40bps, as of the time of that publication. We won’t rehash our analysis of the drivers of this move as our views of the main drivers of the widening in LOIS have not changed all that much since putting out the more detailed piece. Regarding the relationship between
LIBOR and bills though, it was very interesting to us that yesterday 3-month bills got hammered (+~4bps vs. OIS) and today LIBOR/OIS makes its biggest jump since lateFebruary. This co-move was even more conspicuous when you that 90-day financial CP rates have been down or flat the last three days (as per the Fed’s CP data), which is not what you would expect to see if there had been an some exogenous spike in USD funding demand. This just furthers our belief that much of the LIBOR widening has been a response to rising bill rates, rather than a meaningful increase in banks’ funding needs….
Desk Strategy
FX Risk Radar | All roads lead back to globalization
FX | Strategy Weekly 15 Mar 2018 It’s been a very eventful few weeks for global FX markets. We’ve had high profile leadership changes in the US administration and international trade policy announcements. The mix of global growth has shifted, with the major economies seeing strong, but crucially, largely inflation-free growth. A few central banks have tweaked their guidance, while others have or expect to have their mandates changed. Here we briefly set out what we believe are the key themes and risks that will drive global currencies through the next six months. Most, if not all can be traced back to (de)Globalisation. Markets may take heart from new White House economic adviser Kudlow’s free-trade credentials, but it's too early to believe that the point of peak tension has passed.
Strong, wage inflation free growth suggests that the FOMC may have to do something similar on 21 March. Last Friday’s strong employment number reduces its ability to delay shifting its policy guidance. The New Zealand government’s RBNZ mandate review is due by end March. Further changes by G20 central banks are likely, most obviously in Eastern and Central Europe. Central bank governors and financial ministers come together for a G20 meeting on March 19/20. This seems an obvious opportunity to discuss “flexibility”. Central banks’ sensitivity to USD weakness | Cool | There’s a faint aroma that the level, rather than just volatility, has become more of an issue for the ECB. In part, it’s linked to “Protectionism”. The message from the White House appears to have been “let your currency appreciate against the USD or expect tariffs”. However, it’s also related to the USD’s loose correlation with the US yields (see "US growth, the Fed and the USD"). … US growth, the Fed and the USD | Warm | We previously compared the current stimulus on the US economy to “pouring petrol on a barbecue”. What does this look like? +313k payrolls, +54k two month back revisions. Chief FOMC dove Brainard echoed the hawkish language of Powell last week, with headwinds shifting to tailwinds. This hints that the Fed is set to change gear in March. So the dots, particularly the longterm dots, will be an important USD driver. The link between the USD and yields has been weak, but this could change if US growth starts to outpace Europe more clearly. …Global Growth | Cool | Peak global growth has become a greater focus in recent weeks. US data suggest we’re not there yet, but the upside is clearly more limited. Growth may slow, but it seems set to stay at a relatively robust level. This is supportive of USD/EM FX shorts.
Protectionism | Warm | While the Trump administration’s tariff announcement last week was less aggressive than widely feared, protectionism will be a key driver of currencies for the remainder of 2018. It has its origins in Globalisation. It’s also key to “Populist Politics”, “European Politics” and “Brexit”. It’s also strongly linked to “US growth, the Fed and the USD”. For now, the focus is on exemptions and possible retaliation. While this most obviously lies with trade, it may spill over to the recycling of FX reserves (Read: buyers strike of Treasuries). The next US Treasury currency manipulator report is due in April. FX policies, bilateral trade balances and current account positions can see more focus. There may be no winners in a trade war for countries, but the same isn’t true for currencies. The USD may suffer in the early engagements of a trade war, but ultimately could strengthen if the intensity was to hit a high level.
GLOBAL STRATEGY WEEKLY
Central bank policy flexibility | Warm | Strong growth, low inflation and loose financial conditions continues to put stress on central bank policy frameworks. Norges Bank has led, stressing its flexible approach to policy.
A trade war and competitive currency devaluation was always going to be the end game in our Ice Age thesis as a global deflationary bust destroyed wealth, profits and jobs. But it looks as if it might be arriving sooner than we had anticipated. Increasing trade tensions are
MARCH 15, 2018
FORGET STEEL & ALUMINIUM: TWO KEY US TRADE ISSUES ARE COMING CENTRE-STAGE Albert Edwards
an inevitable consequence of the side-effects of QE pursued by central banks - especially the ECB. In the near term, there are a couple of trade issues rankling the US Administration far more than steel and aluminium that could easily trigger a full-scale trade war. More immediate is the impending result of a US probe into China's alleged theft of intellectual property. And boiling away in the background are Germany's, and now too the eurozone's, outsized trade surpluses. President Trump is a most unusual politician. Like him or loath him, he seems to be doing something politicians seldom ever do: namely, attempting to fulfil his election promises. This is most unusual! Internationally, the US is by no means the laggard when it comes to broken political promises. Italy easily wins that award, which is perhaps one reason why the electorate has turned its back on mainstream political parties - more on Italy later. Clients who meet me in one-on-one meetings know I have views about global economics and politics that are not normally voiced in polite company. But they seem to appreciate that it is not just the equity market outlook on which I am prepared to give a radically different, if not heretical, view - for there is plenty of mainstream mush out there. Using Japan as a template for the economic and financial Ice Age unfolding in the west, I made one major contrarian prediction. To those in the noughties who said a bust in the US and Europe would be nothing like the 90s bust in Japan - I agreed. I thought it would be much worse because the west did not enjoy Japan's high levels of equality and social cohesion. Confronted with Japanese-style pain, western electorates' anger has boiled over. In that context, I have always viewed competitive devaluation and trade war as a likely end-game of the predicament we find ourselves in. It's just coming sooner than I expected!
as inflation lags. We maintain our bearish bias, as improving fundamentals and gradual policy normalisation still support higher yields.
We expect the persistence of the flattening bias on
the US curve, with a reset of ranges from the current 50-70bp in 2s10s, consistent with 1.5% for IOER, towards the 25-45bp range consistent with the two-hike scenario for 1H18 (2% for IOER). The ECB remains patient, persistent and prudent, but continues to make contingencies for upcoming rate hikes. The ECB wants to be predictable, and it is happy for rates to follow forwards, as long as they correctly price the ECB message, that is. That means we need the right entry levels for trades. In particular, paying 12x24 Eonia at levels close to -17bp is looking attractive again. We favour bearish trades with positive rolldown, and we consider adding protection via longs in 2y Bonos, as it helps improve the risk/reward on e.g. 2s10s Bund steepeners. The ECB is making progress with its new EUR unsecured overnight benchmark rate. It intends to begin publishing regular rate runs for the new rate in 2H18, once the final methodology has been decided. BTPs remain relatively rich, even as investors sell paper and the long-term political outlook becomes more ominous. We still like long Italy CDS and longs in Bonos. We also see relative value opportunities between RFGBs, DSLs and RAGBs. For the UK, we are looking for some clarity on the MPC’s view on policy, whether there will be an agreement on the Brexit transition and on 2Q supply. We expect the front end of the curve to struggle into the May BoE meeting.
… Is the rise in front-end rates an implicit rate hike?
MARCH 15, 2018
FI WEEKLY OPTIMISM WANES The Fed is poised to hike rates at its meeting next week, but we do not expect the median dots to move to four hikes for 2018. Global monetary policy is likely to stay accomodative
The sharp increase in bill issuance and the rise in bill rates have put pressure on all front-end money market rates. The availability of collateral has exerted pressure on general collateral rates, while bills across the curve are now trading cheap relative to OIS (see Graph 3). Libor rates and other credit instruments that are closely linked to Libor, like commercial paper (CP) and floating rate notes (FRNs), have also risen sharply (see Graph 4). While there has been good demand for the additional supply of bills from money market funds (MMFs) and reserves managers, this has come at a price borne by the Treasury. With net bill issuance widely expected to top $400bn, we think issuance will continue to pressure the front end, with the seasonal increase in bill supply not likely to ease until April, when tax receipts start to come in. This could have a meaningful impact going into quarter-
end, when money market rates typically come under pressure owing to balance-sheet constraints.
The impact does not seem to be limited to front-end money market rates – just over the past week, the 2yT rate has moved 3bp higher (from 2.25% to 2.28%) without a meaningful re-pricing of the fed funds path. Fair value for the 2yT, consistent with the path currently priced in for the fed funds rate (see Graph 5), is 2.22%. The 2yT is therefore trading roughly 7bp cheap to fair value, likely expressing some of the recent supply/demand pressures at the front end of the curve.
… The Bund-Treasury spread has widened roughly 20bp ytd, with Bunds outperforming in the early February market turmoil and in the subsequent consolidation. Carry arguments may continue to be supportive, as US, Japanese and UK investors pick up between 49bp (for UK) and 78bp (for US and Japan) relative to 10y domestic yields on the 10y Bund (see Graph 7). However, in a context where monetary policy recoupling is a significant driver for the normalisation of global yields, we expect the Treasury to lag and the Bund-Treasury spread to be biased towards some tightening. The fact that we expect significant support for 10yT around the 3% level (see the rationale for our rates forecasts here) adds to the argument for outperformance of US Treasuries in a further normalisation of global yields. MARCH 15, 2018
AMERICAN THEMES SPECIAL REPORTS THE CHALLENGE: FUNDING A TRILLION DOLLAR DEFICIT The full impact of tax cuts will be visible after April 2018. For FY18, we project a budget deficit of 3.8% of GDP. In 2019 and beyond, the deficit will likely exceed 5% of GDP.
US federal deficit on track to exceed $1.0tn… for years The federal budget deficit is unlikely to reach this level in 2018. Through February (and five months into the current fiscal year), it has shown a limited response to fiscal policy. The widening of the deficit should be significantly more pronounced after April, and we expect it to exceed $1tn in FY19. Without new fiscal efforts to curb this trend, we see no end to the deficit exceeding $1.0tn. Fiscal policy can help the economy or lift inflation It is true that a rising deficit can stimulate the economy. With a 4.1% unemployment rate and population growth below 0.5% a year, the upside to US GDP could be modest. If not growth, spending could lift pricing or imports. Importantly, the increased spending announced in February is less than meets the eye. Increased spending caps can add to GDP in 2018, but are less robust in 2019, and current legislation points to a fiscal cliff in 2020.
Fed officials see fiscal spending as a stimulus In his testimony to Congress, Fed Chair Jerome Powell said the economic outlook could improve meaningfully from the Fed's December projection. Didn't Fed forecasts have some expectations for tax cuts? Moreover, spending evidence available so far in 1Q18 is tepid. Is such certainty justified? We revise our issuance forecast for CY18 This is based on changes to our deficit projections. Following the increases in bill and coupon issuances announced at the February refunding meeting, we expect the Treasury to ramp up coupon and TIPS issuance in 2H. Ramping up bill supply is not without problems While the additional bill supply is being absorbed by the markets, the Treasury's borrowing costs are also moving higher with the sharp rise in front-end rates. This brings into question the rationale behind ramping up bill supply at a time when the Fed is hiking rates and the deficit is poised to rise sharply
MARCH 15, 2018
FX WEEKLY CHANGING FX REGIMES OFFER LITTLE HELP TO DOLLAR BULLS KIT JUCKES The collapse of FX/interest rate correlations is more exciting than most of the moves we've seen in major currency pairs over the last week, as FX vol drops back to early January levels. A ‘risk-off' bias in markets generally reflects growing concern about US trade and fiscal and geo-policy in general. And as US data softens, the possibility that we've seen a peak in bond yields for now is reflected in concerns that the US is heading for easy fiscal and monetary policies. That's another factor weighing on the dollar, offsetting the help it gets from risk aversion.
The direction of policy travel by the BOJ and ECB matters, given their large external surpluses and cheap currencies, and both the yen and euro will be stronger in due course. The UK has a big current account deficit, very loose monetary policy, and a cheap currency. None of those factors is set to change much. Norway has an expensive currency, a huge surplus, and less easy monetary policy than many. The Norges Bank has also indicated that it is close to tightening monetary policy, and NOK remains our favourite G10 currency.
16 March 2018
Market Musings FOMC Preview: Too Soon for Four •
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15 March 2018
Rates Model Portfolio Update
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US 5s30s Curve Steepeners Trade We initiate 50K DV01 of 5s30s Treasury curve steepeners (using on the runs) at 43.9bp, targeting 60bp and stop of 36bp. The curve has flattened
recently and tactically looks poised to steepen (Fig 1).
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Along with yet another 25bp hike, Fed officials should sound somewhat more upbeat at the March FOMC meeting, with the balance of risks now skewed to the upside. But the median dot is likely to remain at three hikes for 2018 in our view, even as the distribution drifts higher — which may be dovish for a market anticipating the Fed could indicate four hikes for this year. We do expect a higher median 2019 dot, rising to three hikes. We also see some risk for the median longer-run dot to shift up to 3%, but in our base case it remains as is. On the outside chance that Powell announces a press conference at every meeting, the knee-jerk market reaction would be sharply hawkish.
Rates: Rates have fully priced in the March hike and a total of 3 hikes in 2018 and a neutral rate of 2.65%, which is not far from the Fed's median dots as of December. Given the sharp repricing higher of rate expectations in recent weeks, we think that an unchanged 2018 and long run dot should modestly bull steepen the curve. We are long 3y Treasuries and in 5s-30s steepeners. FX: Though the USD has lacked a major directional impulse recently, we think the USD stands to be tactically supported. We look for gains to be concentrated against the dollar bloc and the EUR, while the JPY may be the outlier.
15 March 2018
US Economic Comment Q1 GDP tracking at 1.4% Consumption is even weaker than we had allowed for We expected a rebound in real consumer spending in February, but the retail sales report said no. We are now tracking Q1 real consumer spending at a 1.3% q/q annual rate, down 0.2 pt from our earlier tracking estimate, and even that pace builds in a
strong rebound in retail sales in March. About ¼ pt of the weakness reflects belowtrend utilities usage, but the real culprit is goods consumption— weakness in month-tomonth retail sales from December through February and slipping unit auto sales. Our updated GDP tracking also includes almostoffsetting small revisions to business equipment investment (down a little) and inventory investment (up)—on a combination of prices, aircraft deliveries, and auto production. Durables shipments in February could have a significant effect. Sub-1 ½% pace drastically understates underlying support for demand growth We believe the slow GDP growth will prove temporary. Faster labor income growth and smaller tax payments support strength in consumer spending. And while retail sales have been soft on a monthly basis since December, the y/y pace has not faltered (see chart)—implying more momentum than the quarterly comparison would suggest. Energy price gains argue for ongoing energy-sector business investment, and we see signs of rotation into nonenergy investment as well LINK. All spell faster underlying growth than the sub-1½% GDP pace we’re tracking for Q1. 15 March 2018
US Economic Perspectives US Inflation Monthly for March 2018 The February CPI reading was about in line with expectations The headline CPI increased 0.15 percent and the core CPI increased 0.18 percent in February. After upward surprises in December and January the slowing of inflation in February to a level consistent with the FOMC's inflation objective will reduce concerns that the FOMC will need to raise interest rates sharply. Among the components surprises were offsetting with somewhat weaker increases in owners' and tenants' rent and declines in prices for cars and medical services that were offset by continued strong increases in apparel and motor vehicle insurance. Core PCE is projected to have increased 0.22% in February Based off of the CPI and PPI data we project that core PCE prices increase 0.22 percent in February. The somewhat unusual occurrence of PCE prices increasing more rapidly than CPI prices is a result of much higher medical service price increases in the February PPI than in the CPI.
We continue to expect core PCE inflation of 2.1% in 2018 and 2.0% in 2019 An ending of transitory factors, previous declines in the dollar, and a tightening in the economy all add to a pickup in inflation this year relative to the 1.5 percent increase in core PCE prices in 2017. Nonetheless weak energy and food prices keep headline PCE prices inflation a bit below the FOMC's 2 percent inflation objective both this year and next. The core CPI rises notably faster than PCE prices and is expected to increase at a 2.6 percent pace this year. Our projection for core inflation this year is on the higher side of consensus In 2018 our projection for core PCE inflation is slightly higher than consensus and the FOMC's most recent Summary of Economic Projections from December. However, we expect the FOMC projections to move up as they fully incorporate the host of incoming data since December. AHE increases was eased in February, but CPH was revised up As we expected the strong average hourly earnings reading for January was an anomalous blip and the February increase was rather soft. On the other hand, compensation per hour in the nonfarm business sector, the broadest (and also most volatile) of the wage measures, was revised up notably in the second half of last year to show a 2.9 percent increase in the most recent 4 quarters. We expect wage growth to move up With the unemployment rate low, and expected to fall further, survey measures showing a tight labor market, and 12-month price inflation projected to move up, we forecast average hourly earnings growth will increase from 2.5 percent in 2017 to 3.1 percent this year and 3.5 in 2019.
March 15, 2018
Economics Group
Is There Residual Seasonality in the Nonfarm Payrolls Data? Our analysis suggests residual seasonality in the initial estimate of first quarter nonfarm payrolls
since 2010. We attribute this seasonal disruption to the 2.3 million drop in payrolls in Q12009, the largest drop since 1945. … Our initial findings lead us to believe February will likely be the rogue month in 2018. In a forthcoming report, we plan to discuss the potential outlier in 2018, as well as examine residual seasonality among the remaining quarters in our sample period. One thing remains certain from our analysis; residual seasonality exists in the initial estimate of first quarter nonfarm payrolls data. March 15, 2018
Long-Term TIC Flows Have Solid to Start 2018 Foreign demand for U.S. long-term securities accelerated in January, with net purchases rising $63.2 billion. Private foreign investors did the bulk of the buying, with equity inflows remaining particularly robust. Foreigners Net Sellers of Treasuries to End 2017 There was less demand growth for U.S. long-term fixed income in January, though foreigners were still net purchasers. Corporate bonds saw relatively flat flows, while strength in private buying of Treasuries was somewhat offset by some foreign official selling. It will be interesting to see in future months’ data if some potential softening in U.S. equity inflows is offset by inflows into U.S. fixed income amid higher yields.
March 15, 2018
Agency MBS Alert: January TIC Data – Great Start Net Purchases Substantially Positive The TIC data for January 2018 released today showed that foreign investors bought $22.5 billion in agency bonds. Of the total agency bond purchases, $20.5 billion were in agency MBS. Adjusting for prepayments, MBS demand may have been $8.7 billion. After weak numbers in the latter part of 2017, January was a welcome break. Japan Led the Way with Taiwan Substantial as Well Japan led the way with $13.8 billion in purchases of agency bonds. Taiwan was next at $4.7 billion. Note that in the case of the United Kingdom and India, we note that prior transactions have not translated into commensurate changes in holdings, and therefore, the domicile of the purchases is uncertain. December MBS Holdings Were Materially Higher In addition to the purchase data, the TIC system also discloses the holdings of agency MBS in aggregate and agency bonds by country (form SLT), albeit with a onemonth lag. The data showed a $5.7 billion increase in MBS holdings by foreign investors in December. This is more than the $2.9 billion suggested by transaction data. The data are reported on market value, and despite the rate selloff in December, holdings increased more than transaction data. Taiwan Led the Way on Holdings Increases Total holdings of agency bonds increased $0.3 billion in December. Taiwan added $5.1 billion but Japan reduced by $6.5 billion and China by $3.6 billion. The Caribbean, Ireland and Luxembourg added substantial amounts of agency bonds.
March 15, 2018
Economics Group
Import Prices Rising and It Is Not Energy Import prices moved up again in February, led by the largest monthly gain in nonfuel prices in nearly seven years. Steel and aluminum prices were up ahead of recent tariff plans, but the impact to CPI should be small.
the mean rather than a return to the supercharged growth experienced in the late 1990s or the mid-2000s. World export volumes and industrial production have strengthened relative to the 2015-2016 period, but the upward momentum began to lose some steam late last year as favorable base effects began to fade. After growing 3.2 percent in 2016 and 3.6 percent in 2017, we look for real global GDP growth to climb 3.5 percent this year and next, in line with the long-run average (Figure 1). Given the structural headwinds to faster growth in place today, however, 3.5 percent annual growth is a tougher lift than it was in previous expansions, meaning that there are better cyclical conditions in place than that growth rate would historically suggest. Prospects continue to be relatively bright in the major advanced economies, led by a synchronous acceleration in economic activity in the United States and the Eurozone. Industrial production in advanced economies is growing at the fastest year-ago pace since February 2011, when the world’s economies were still climbing back from the Great Recession (Figure 2). In the United States, a weaker dollar, more stable commodity prices and a stronger global backdrop have helped boost exports and manufacturers. The recently enacted tax package has begun to provide a boost to aftertax income for consumers and businesses, and a second fiscal stimulus tied to the spending side of the budget should also begin to take effect next quarter, providing another boost to domestic demand. On balance, we expect the cumulative fiscal stimulus to help propel real economic growth in the United States to roughly 2.6 percent this year and 2.8 percent in 2019.
March 15, 2018
Economics Group
Builder Confidence Slips Slightly, but Remains Elevated The NAHB/Wells Fargo Housing Market Index (HMI) fell 1 point from February's downwardly-revised 71, marking the third consecutive drop since surging to an 18year high of 74 in December. March 15, 2018
Economics Group Special Commentary Global Chartbook: March 2018 Executive Summary
The global economy has continued its slow-but-steady upward swing in Q1 as economic growth around the world has broadly remained solid. That said, the improvement in global growth is more of a reversion to
March 15, 2018
Foreign Exchange Research
Monthly FX Update
In This Issue: • The U.S. dollar’s weakening trend has paused as swings in global market sentiment have at times supported the greenback, while a possible further adjustment in the expected pace of Fed tightening could contribute to further greenback consolidation in the near term before a resumption of longer-term U.S. dollar depreciation. • Major central banks outside of the United States have hinted that monetary policy could become less accommodative over time, which, in our view, should support foreign currency strength, particularly as those central banks become more active in the second half of this year and beyond. • Emerging currencies should firm over the medium term given careful global monetary policy moves, still solid global growth and potential for a return to more benign global markets
U.S. Dollar Index (USD) Outlook
The U.S. dollar should be reasonably stable in the near-term but softer over the medium-term. Solid growth and a modestly hawkish shift in Fed rhetoric could support the greenback for now, while existing FX short positions may also limit losses in the near-term now. Still, concern over wider budget and external deficits could weaken the U.S dollar over time, as should a resumption of global monetary tightening which should see an eventual return to global monetary policy convergence.
Technical Watch
Technicals for the U.S. dollar index are leaning negative. The 20-day MA remains below the 50-day MA for now. The RSI is neutral at 49, while other momentum indicators hint at near-term softness. Initial support is seen at 89.41 (March low) and 88.25 (February low). Beyond that, expect further support at 87.62 (December 2014 low). Expect layers of resistance from prior highs at 90.93 (March), 91.00 and 92.64 (both January), 94.22 (December), and 95.15 (October and November highs). Also, downtrend resistance (since March 2017) is currently at 91.50.
