Nov 10, 2017 - steepening in coming sessions. From purely a technical vantage point, duration traders should carefully w
StreetStuff Daily November 10, 2017
BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… •
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Initial Unemployment Claims Stephen Stanley Chief Economist
Initial jobless claims rebounded in the week ended November 4 by 10,000 to 239,000. The figure is probably inflated by around 5K by ongoing filings in Puerto Rico associated with Hurricane Maria, so the four-week average of 231K (which happens to be yet another 44-year low) is probably not far off in terms of the underlying trend. The number of new filers seems to be settling in the 230K’s, precisely where it was running before Harvey began a period of disruption.
In Europe, we like bearish expressions that feature low downside and limited negative carry. We recommend closing reds/greens EONIA steepener and initiate pay EUR 2s/5s/10s while maintaining pay Dec 2018 EONIA. In EGBs, we are also maintaining short 10y Italy vs Spain and short 10y France vs EONIA trades. In the UK, the long end of the curve is likely to remain resilient into year-end, as demand has picked up and supply remains limited. The unwinding of paid cross market positions has steepened the 15yr sector versus the long end in the forward space. We recommend opposing the steepening via GBP5y10f/5y20yf flatteners.
United States Running in place We recommend a convergence trade between 5y UST and Bunds, as we believe the path of hiking cycle in the euro area is too benign and 5y USTs provides an attractive hedge. We maintain our 3s10s curve-flattener view; given the diverging Senate and House tax reform plans, it may take some time before it is finally enacted.
I think it is helpful to periodically put these readings in context. It was rare to see a sub-300K reading from the mid1970s until a few years ago (less than 100 such readings over a roughly 40-year period). Currently, initial claims have been below 300K since February 2015, a run of over 140 consecutive weeks. Little wonder that the unemployment rate is on its way below 4%, another exceedingly rare occurrence.
…In terms of trades, we recommend a convergence trade between 5y UST and German government bonds (Figure 4). We believe the path of the hiking cycle in Europe is too benign, given the ongoing strength of the recovery in the euro area. However, a key risk to being outright short in German government bonds is a sharp slowdown in the US. This will likely be put a dent in the ECB’s plan to normalize policy, as otherwise the EUR is likely to strengthen significantly. We believe going long 5y USTs provides a hedge. Further, the convergence trade does not have negative carry/roll-down, unlike being outright short in Europe. We also like the trade in conditional form (buy ATM 1y*5y EUR payers funded by selling high strike EUR payers), given that the vol difference improves the entry level on the trade.
9 November 2017
FIGURE 4 5y UST-Germany spread looks too wide
Global Rates Weekly
Running in place •
In the US, we recommend a convergence trade between 5y UST and Bunds, as we believe the path of the euro area hiking cycle is too benign and 5y USTs provide an attractive hedge. We maintain our 3s10s curve-flattener view; given the diverging Senate and House tax reform plans, it may take some time before it is finally enacted.
Separately, we maintain our flattener recommendation in the US. With this month’s long end auction finished, supply concession should unwind. Further given the diverging Senate and House plans, it seems that it will be a while before a common plan is devised that has a high probability of passing Congress. Separately, the flows data show steady demand for US fixed income. Figure 5 shows that US fixed income funds have had inflows of about $200bn year-to-date, compared with $100-150bn over the past few years. The pace has not slowed even as yields have declined. On the other hand, despite the rally in the equity markets, US equity funds have not had much in terms of inflows this year (Figure 6)
Euro Area Enough of carry for now We like bearish EUR rate expressions that feature low downside and limited negative carry profiles. We recommend closing reds/greens EONIA steepener and initiate pay EUR 2s/5s/10s while maintaining pay Dec 2018 EONIA. In EGBs, we are also maintaining our recently initiated short 10y Italy vs Spain and short 10y France vs EONIA trades.
UK Better to burn out than fade away Favourable supply demand dynamics leave the long end well supported into year-end. Recent flow has distorted the 10-15yr sector in forward space. We recommend GBP 5y10yf/5y20yf flatteners as the recent resteepening has decoupled from the term structure.
Japan Challenging quest for YCC liftoff The BoJ continues to stress its accommodative stance, even as major European central banks head towards a “liftoff” from extreme easing following the Fed’s lead. However, we believe that the BoJ itself will start searching for a YCC “liftoff” opportunity. We forecast that the BoJ will raise its target for 10y yields in Q3 18.
Thu 11/9/2017 4:19 PM
Lyngen/Kohli BMO Close: Tale of Two Bills …Tactical Bias: While the machinations of the current tax cut proposal continue through Congress with the Senate having released their own proposal at 3:00 PM, we’re focused on what the implications of the current proposal in the House might mean for CPI and for future elections. We’re well outside our comfort zone in forecasting what the final shape of the bill will be or how it will be interpreted by the public at large, but we’d argue that the bill in its
current form presents two fairly significant risks which make us stronger buyers of Treasuries on any significant yield pop. The first risk, associated with the State and Local Tax (SALT) deductions is something we’ve been on about and a risk that Mnuchin himself acknowledged in the past few days. Namely, that while it’s politically appealing to increase the relative tax burden on states with high local taxes, this happens to be the same set of well-heeled consumers that contribute a great deal of consumption to the US economy. It’s not clear how increasing the relative tax burden of a set of (likely) financially savvy consumers won’t be a headwind to more persistent GDP strength. Another risk, one that revolves around the size of the mortgage interest deduction that ends up in the final bill really goes back to our focus on CPI. While we’re not entirely certain of what will pass the House and the Senate (current House proposals have a cap at $500,000 while the Senate proposal is rumored to keep it intact), we’ve little reason to expect that reducing the deductibility of home mortgage payments even for the relatively affluent will do much to help the housing market. Though the size of the negative impact will remain a subject of some debate, and there are good arguments for not subsidizing the housing market in this way, it will only present a headwind to continued housing price gains. Given the weak, though persistent, long-term tether between rent and home price appreciation, we’d argue that anything depressing home prices will eventually filter through to CPI, which is particularly at risk given its shelter based strength. While we can’t know if either of these risks will eventually materialize given the extensive horse trading that generally accompanies such legislation, we’ve got them on our radar at least as risks that may manifest if some version of the tax bill is eventually passed. With that as a backdrop, we’ll remain longer-term buyers of the long-end on any steepening pressures that arise, from the eventual passage of a tax bill (perhaps not the current proposals) or on any other ostensible “risk on” event that keeps risk assets well bid. Even if we were not already pessimistic about
the prospects of the bill passing, we’re pessimistic of its overall ability to propel GDP durably higher. CRG Metals vs. Foodstuff Price Index
Global Rates Plus - The 2018 story of supply Global QE purchases are set to fall sharply in 2018; we expect the ECB’s QE purchases to decline by EUR 310bn and the US Federal Reserve’s balance sheet to shrink by USD 230bn in 2018. We estimate the amount of gross issuance less QEbuying (including reinvestment) will rise by 5% (USD 160bn) in 2018. Meanwhile, net issuance less QE-buying excluding reinvestment is set to move from negative territory to a large positive amount in 2018 (an increase of USD 780bn next year). Market size to rise sharply in 2018 after falling in 2017: • We estimate that G4 net issuance less QE-buying excluding reinvestment, ie the ‘float’, will rise by USD 600bn in 2018 after falling by USD 180bn this year: a significant USD 780bn difference. • The marked increase will come from both sides of the ledger – higher net government issuance and a reduction of QE purchases.
remain relatively stable as central bank monetary policy tightening remains modest. Also in this week's Global Rates Plus Eurozone: Smarter shorts Eurozone spreads: Sovereign spreads to contract further Eurozone spreads: 8y to 10y Bonos still cheap UK: Round-up into the year end US: It’s the Chair MBS: Prepayments likely to slow into year end Japan: Overshoot in progress – long 30y JGB Australia: In neutral Inflation: How well are global breakevens pricing in rise in oil?
US: It’s the Chair Jerome Powell is expected to provide monetary policy continuity: After serving as a member of the Board of Governors since 2012, Powell has been nominated to replace current Fed Chair Janet Yellen in February 2018 (contingent on likely confirmation by the Senate). Powell has not dissented from a Fed decision. We expect little change in monetary policy under Powell’s centrist view. In his June speech, Powell was balanced between strong job growth and weaker inflation. Using our hawk/dove distribution and known changes in FOMC, we find the average position of the voting committee in 2018 to be less dovish than in 2017 (top table). NY Fed President Dudley announced his retirement for mid-2018. The choice of a Fed Vice President will be key.
Flows to rise more modestly: •
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We expect total flows, ie, gross issuance less QEbuying including reinvestment, to rise more modestly in 2018 to USD 3.25trn from USD 3.09trn: a smaller USD 160bn difference. This change is smaller than in the ‘float’ due to a fall in redemptions in the US and Europe which raises the float, and a rise in US and EUR QE reinvestment which limits the rise in flows.
With the pace of global QE buying already slowing and set to fall further in 2018, we expect bond yields to rise next year. In addition, we expect inflation breakevens to rise as core inflation increases and a steepening of the real yield curve to drive up real yields, even though real policy rates are likely to
Potentially more open to macro prudential reforms than Yellen: In his appearance before the Senate banking committee in June, Powell said he supported more regulation post-crisis, but added there’s room for improvement. “The whole idea is to preserve the significant core reforms that were made but to go back and clean up our work.” On the administration’s regulation plans, Powell described them as a “mixed bag,” and that “there are some ideas in the report that make sense, maybe not as expressed there, but it would enable us to reduce
the cost of regulation without safety and soundness.” In his first public remarks since being confirmed, Vice Chairman for Supervision Randal Quarles said on Tuesday that the Fed will take “a fresh look at regulation.”
Swap spreads are starting to anticipate potential for deregulation, especially at the 30y. We keep our long 10y UST vs. swaps trade idea due to deregulation, directionality and carry (bottom chart). Total futures positioning has fallen from USD 38.4mn DV01 to USD - 116.7mn DV01, shortest since April. There are net shorts (or flat) in all contracts, except for US – positioning here is +12,673 contracts (least long since April). The long position in TY - held since short covering buying in May – vanished in the reporting week ending 31 October with selling of 150,000 contracts in one week.
Strong data hitting a technical speed bump for now Economic data, particularly positive or negative surprises compared to expectations, tend to drive changes in rates (top chart). The 10y UST troughed at 2.01% on 7 September and reached 2.47% on 27 October after a strong Q3 GDP report. The q/q change in the 10y UST yield has been running positive since the summer.
While there are technical hurdles to overcome, we believe that there are fundamental reasons for rates to push higher and the curve to steepen led by the belly: (i) strong GDP and labor market, (ii) BNPP expects a fiscal boost to growth in 2018 of 0.6pp, and (iii) the Fed balance sheet unwind will pick up steam as the caps are raised. As a result, we continue to propose the following trades for consideration: Buy 5y5y atmf swaption payer at 65bp. Target: 115bp. Stop: 50bp. Current: 66bp. Carry: -0.9bp/month. Pay 6m fwd 2s5s10s swap at -5bp. Target: 13bp. Stop: -10bp. Current: -4.5bp. Carry: 0.5bp/month. Pay 6m fwd 2s5s swap curve at 18.75bp. Target: 40bp. Stop: 13bp. Current: 16.5bp. Carry: 1bp/month.
Macro Matters - 9 November 2017 BIG PICTURE: Current accounts – cause for concern? Current account imbalances are becoming more concentrated in advanced economies. Too many countries run far too large surpluses, concentrated in northern Europe and parts of Asia. This is disinflationary and risks protectionism.
However, rates have fallen in the last week. Why did the market hit a speed bump? First, it appeared oversold technically (RSI, top chart) and, second, net speculators have been building short positions in five of the last six weeks (lower chart):
THEMES OF THE WEEK Eurozone inflation: Pause for thought Most of the surprise fall in core inflation in October should prove temporary, but past euro appreciation should limit any major rise for the near term. We remain confident that core inflation will re-establish an upward trend in 2018.
US: 50-year low unemployment rate on the horizon The unemployment rate does help to explain wages, but it is a faulty guide by itself and we need to look at, in addition, the participation rate of the 25-54 age cohort. The unemployment rate could well fall to 3.5% in this cycle. Japan: Dissecting the Abenomics growth story Under Prime Minister Shinzo Abe’s economic policies, annual nominal GDP growth has averaged 2.2%, boosted by special factors. Growth in real terms has averaged only 1.4%. Construction investment has been the growth engine.
09 Nov 2017
09 Nov 2017
Global FX Plus Finding Funders Weekly FX key themes: G10 CPI a focus as tax bills progress
Economic Desknote US 50-year low unemployment rate on the horizon
The unemployment rate does help to explain wages, but it is a faulty guide by itself and we need to look at, in addition, the participation rate of the 25-54 age cohort. Equations including unemployment rate and participation rate variables suggest wages will accelerate to 3¼% on a 2-year forecast horizon The Phillips curve isn’t dead as long as we correct the labour market slack term, which also gives longer lags from the cycle to wages. The unemployment rate could well fall to 3.5% in this cycle.
We expect optimism on US tax legislation to increase as tax bills inch through the Congressional process. We see downside risks for GBP heading into this week’s UK CPI release. In contrast, we remain bullish on SEK, with CPI data another possible catalyst for currency recovery.
US Rates at the Bell November 9th, 2017
Trader’s Tab Don’t Call it a Comeback: After noting technical exhaustion signals yesterday in 2s7s and 2s10s, today’s px-action (‘outside day’ up in 2s10s & 5s30s) and future flow was steepener conducive as two jumbo TY/WN (flattener unwind) blocks printed in AM, the first major indication that the multi-week thematic dampening of curves/vol could be reversing. Given the lockstep relationship in implieds and curve, today’s evidence of credit and (Japan/German/US) equity vol may suggest further steepening risk (just maybe not of the bearish variety).
Recap & Discussion: …Net-net, it would appear the Senate Bill isn’t all that more optically attractive or appetizing to the WH (given offset of SALT deductions and upper-tier tax rate drop), especially given the delay in the “priority” corporate tax
rate cut. In sum, accountants can probably sleep easy, while cross-asset vol sellers might want to keep one eye open tonight as Japan and German equities (among other asset-classes) have begun to look more vulnerable. Additionally, after noting technical exhaustion signals yesterday in 2s7s and 2s10s (fi.g 1), today’s px-action (‘outside day’ up in 2s10s & 5s30s) and future flow was steepener conducive as two jumbo TY/WN (flattener unwind) blocks printed in AM, the first major indication that the multi-week thematic dampening of curves/vol could be reversing. Flow-wise, the standout block was a +17.6k TY buy vs. -4.7k WN sale ($1.3mn DV01 unwind) in the AM, which is a significant reversal of the 10 consecutive days of flattening in long-dated curves. With front-end outperformance (>5% jump in TU OI in last week) and weakness in WN contracts contributing to the move, the 6bp jump in 30y Bunds (large RX sell block of $1.7mln DV01 at 7am, combined 20k of RX contracts sold throughout the day) also helped the curve to break its recent trend. Positioning-wise, we are starting to wonder whether RX’s net-long RPM of +2.3 normalised is getting a bit heavy, another potential tailwind to steepening in coming sessions. From purely a technical vantage point, duration traders should carefully watch the resolution in Nikkei futures and USDJPY into the Friday close, with the current daily price structure and weekly candles looking very suspect; (fig. 2) shows last night’s NKY pre-special-quotation kerfuffle resulting in a ‘pin-bar / doji reversal’ pattern against channel resistance with losses tacked on afterhours, while USDJPY (fig. 3) shows a potential breakdown towards the 200dma at 111.75. Especially given the recent hesitation to engage in the UST market from yen-based accounts, with the 3-month moving average of net Japanese foreign bond purchases negative for the first time since May, a risk-asset correction could potentially mean the realignment of demand (despite limited fx-hedged value). 09 Nov 2017 12:48:24 ET
Global Macro Strategy Weekly Views and Trade Ideas – EUR Won’t Be Weak Forever … Yields may also rise more in the EA than in the US over 2018 assuming not too large a US fiscal stimulus. The massively negative net cash requirement (NCR) in the EUR bond market during the QE period (defined as gross supply less
redemptions, coupons and ECB buying) will give way to a much reduced one in 20181. This should lead core EUR yields higher as term premia normalise. In turn, higher local yields and reduced ECB buying should slow bond market outflows on the balance of payments which reflect large scale semi forced buying of USTs by EA bond investors. Our calculations suggest this is more bearish a development in the EA than in the US. Given that UST yields are already relatively high compared with nominal r* type calculations (Figure 7 top charts), there seems little reason why supply dynamics necessarily imply much higher US yields from here. Or, in other words, supply dynamics are pretty much priced in. Comparing the two markets, Figure 7 bottom RHS suggests that 10y yield spreads between USTs and Bunds may narrow 60bp medium term while a comparison of Figure 7 bottom LHS and Figure 6 top LHS would suggest something more like 100bp. 7. US Net Supply Dynamics Less Bearish Than EA
09 Nov 2017 17:11:55 ET
European Rates Weekly The game plan The risk of a temporary year-end squeeze in Bunds remains so sell France as the duration vehicle for a bearish 2018 view. Forward steepeners attractive on supply technicals & stellar growth. The growth backdrop motivates tension to adapt ECB guidance with Q2-18 feasible for a shift in ECB pricing. The ECB can only prevent a meaningful rise in 10yr equivalent BTP supply hitting the private sector with a 7-yr PSPP maturity extension. That looks
unreasonable but higher DV01 buying should stay part of the ECB toolkit. … This leaves us with the following gameplan
The year-end duration squeeze on ECB purchases remains in play but is the set up for shorts into 2018 as net supply measured in DV01 becomes far less supportive and ultimately calls for Bunds nearer 0.75%. France is the better execution for short duration (see below). This should play out as ongoing steepening with forward steepeners still attractive on technical of supply and because the yield is a leading growth indicator. Heading into Q2-18, and post the Italian elections, the scope for more front end and 5yr volatility on ECB guidance tweaks emerges and plays out as bearish and with more caution on steepeners as the front end could begin to move at this stage.
Mature in US, Immature Elsewhere The buyback theme is maturing in the US. Volumes are already above 2007 levels and balance sheets now look stretched. However, outside the US buyback volumes have been muted and leverage is lower. We expect ex-US buybacks to catch up.
Current Ex-US Buyback Screen It is Overweight Japan and Canada. The screen is Underweight Europe and EM. It has a diverse sector spread, which should help limit its exposure to big shifts in macro factors. 1. US Buyback Achievers Index Rel To US, Ex-US Buyback Stocks Rel To ACWI ex US
09 Nov 2017 16:30:00 ET
Global Equity Strategist Buybacks Go Global US Buyback Recovery Has Stalled Buybacks carried out by US corporates recovered strongly post crisis and reached $573bn in 1Q16 (12m trailing), 10% above the previous peak in 2007. However, volumes have slowed since 2016. The latest figure of $471bn in 2Q17 marks an 18% drop compared to a year ago.
US Buyback Stock Outperformance Has Stalled The cyclical recovery in buybacks was encouraged by the stock market. Between 2010 and 2015, the Nasdaq US Buyback Achievers Index beat the MSCI US benchmark by 24%. However, the relative performance of US buyback stocks has stalled since 2015.
Ex-US Buyback Stocks Still Outperforming Buyback stocks have continued to deliver outside the US. Outperformance has been especially healthy in Japan.
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US Market Bored Of Buybacks … The US has led the way in the current cycle. Since 2011, US corporates have bought back $2.8trn worth of their shares (16% of average market cap). Buybacks carried out by US companies recovered strongly post crisis and reached $573bn in 2Q16 (12m trailing), 10% above the previous peak in 2007 (2). However, volumes have slowed since 2016. The latest figure of $471bn in 2Q17 marks an 18% drop compared to a year ago. 2. US Net Buyback* Volume (12m trailing, quarterly, $bn)
Focus Shifts Overseas It seems that the buyback theme has matured in the US. Buyback volume has stalled, and so has share price outperformance. But the story looks quite different elsewhere in the world. Ex-US buyback volumes have lagged the US in this cycle (Figure 4). In 2016 ex-US corporates bought back only $136bn of their own shares, way below 2007’s $319bn peak…
09 Nov 2017 17:27:11 ET
Global Economics View Changing the Guard at AE Central Banks
09 Nov 2017 11:21:20 ET
RPM Daily Flattener and ECB Profit Taking
Summary - Long cash (+0.3) / futures (+0.3): Profit taking driving price action as the market takes a pause on UST flatteners and ECB carry takes. However positioning remains mildly long and diverse (with largest positions in swap spreads and basis trades). North America - Short futures (-0.3) / long cash (+0.8): Around $3m DV01 was added to the short base in 30y as the market took profits on long end flatteners (as 2/30s touched 115bps). However there still remains around $15m DV01 of flatteners in plays across the curve in futures which remain in the money.
09 Nov 2017 17:26:54 ET
US Economics Flash Tax Reform Countdown – Senate Posts Tax Reform “Vision”
As expected, the Senate posted a tax plan that deviates notably in some areas from the House bill. There were no JCT scores to accompany the Senate plan, but given reconciliation instructions, the bill must not increase deficits by more than $1.5 trillion over ten years or increase deficits beyond the budget window. (Scores will become available once the bill text is posted.) Market Watch: What’s Next? – We anticipate the House and Senate will work out the differences in their tax proposals over the next few weeks. A December date for a bill to be ready for the President to sign appears aspirational. We maintain early 1Q18 as a completion date. Citi Deficit and GDP Forecasts – We posit the House will gravitate towards the Senate’s bill, which calls for delays in implementing select provisions. We will update our projections as the contours of the final (likely Senate-produced) bill become clearer.
The heads of up to six G10 central banks – Fed, ECB, BoE, RBNZ, SNB and BoJ, may change by end-2019. There is plenty of uncertainty over the next set of policymakers, but we suspect the overall change in leadership will have a slighlty hawkish tilt. We discuss the timeline of the likely turnover and the appointment process. In most cases, the government chooses the head of the central bank, but in Japan and the US the heads of the central bank (and other board members) need to be confirmed by Parliament (Senate in the US, both houses in Japan). We expect much continuity to prevail. However, the next set of ECB and Fed leaders is likely to be less enthusiastic about QE, even though policies will likely depart significantly from prior rhetoric of incoming leaders as their views are shaped by preexisting central bank staff.
09 Nov 2017 09:54:12 ET
Weekly Supply Monitor Euro, UK and US Supply Outlook Europe EGB supply next week is scheduled from Italy (estimated €13bn), Germany (€8bn), the Netherlands (€2-3bn), France (estimated €6bn) and Spain (estimated €4bn). There are only €0.3bn of coupons that are eligible for reinvestment next week.
US The US Treasury will issue around $11bn of 10yr TIPS next week. There are $22.2bn of coupons and $42.7bn of redemptions eligible for reinvestment next week.
UK The UK DMO will issue £2.5bn of 1.25% Treasury gilt 2027 next week. There are no gilt cash flows eligible for reinvestment next week.
US net cash requirement (NCR) over the next 4 weeks On a settlement date basis, $62bn of gross supply will be supported by $22.7bn of coupons and $42.7bn of redemptions settling over this period (Figure 20).
September, as gasoline prices eased and vehicle sales slowed slightly. The control group probably increased 0.3% MoM.
20. US weekly cash flow profile for next four weeks, USD billions
Deutsche Bank 10 November 2017
Early Morning Reid Macro Strategy 09 November 2017
US Economics: The Week Ahead Next Week's Highlights The CPI, retail sales, and industrial production are the key data next week. We expect a slight pickup in core inflation in October, 0.2% MoM (0.17% to be exact) versus the disappointing 0.1% reading in September. Core goods prices (commodities ex food and energy) should improve after a weak print in September. Headline CPI should rise a more modest 0.1% after increasing 0.4% in September, as gasoline prices have retraced some of the hurricane-driven surge. This would push the YoY reading lower to 2.0% from 2.2%. Industrial production likely increased 0.7% MoM in October, partly driven by recovery from hurricanes in August and September. Though the rebound from the hurricanes is likely to be short-lived, underlying fundamentals in the goods-producing sector remain robust, and we expect October to mark the beginning of a momentum rebound for US industrial production.
We expect retail sales ticked down 0.1% MoM in October, pulling back from the strong 1.6% MoM print in
The Japan swing was the talk of the town yesterday with lots happening late in the session after we went to print. Some suggested it was due to profit taking after a strong run to a 25 year high, others pointed to position adjustments ahead of Friday’s special quotation of some futures and options. This morning in Asia, markets have followed the negative leads from US and are trading lower. The Nikkei is down -0.85%, led by losses from telco and utilities stocks but is trading close to where it opened so no real acceleration of selling has occurred so far. Elsewhere, the Kospi (-0.35%) and ASX 200 (-0.3%) are down slightly while Hang Seng is up 0.11% as we type. Chinese stocks are slightly
higher and this morning, China’s Vice Finance minister Zhu has confirmed that foreign firms will be allowed to own controlling stakes (up to 51%) in local Chinese securities joint ventures. This is another step towards liberalisation of the economy. 09 November 2017
FX Blog - Alpha Alert Nikkei/FX when equity/bond correlation breaks down Alan Ruskin
Let's start off with what we think we know. It is very rare for the Nikkei to lead global equity mkts for very long, so what we are seeing today where the Nikkei is driving global markets is apt to last for days rather than weeks. As for currencies, the more common linkage has been USD/JPY driving the Nikkei (a positive correlation because of the FX implications for Japan export
competitiveness, reflation and Japanese foreign profits brought into yen) rather than the Nikkei risk off leading to capital repatriation and a stronger yen that became a very popular causal chain in the early 1990s. Of late, the 1y Nikkei correlation with USD/JPY on a levels basis is a meager 0.21. So which currency on a levels basis has the strongest correlation with the Nikkei over the last year? Bitcoin, if you count it as a currency. The correlation is interesting in so much as it probably says something about the late Nikkei run, attracting a more extreme 'spec' bid.
trying to sort out the multiple somewhat unusual factors driving the JPY. While the unusual bond-equity linkage today could well be a serious warning shot that bond & equity vols have reached their nadir, the causality where equities go down and seem to tug bond yields higher (as distinct from the more usual higher bond yields pulling equities down) probably won't last i.e, should equities go down, global bond yields won't continue going up for long.
09 November 2017
Global Financial Strategy What caused the big swing in Japan today? Volatilitytargeting strategy
So what does the Nikkei say about the USD? Interestingly, the DXY correl (on a levels basis which inflates the correlation) with the Nikkei over the last 6m has been very close to zero. While I suspect that a very weak correlation is a fair reflection of the Nikkei linkage to broader USD over the long-term, in the short-term and current circumstances there is a very real danger that the Nikkei does slide lower, driving a temporary risk off, that helps the USD vs EM and commodity FX. As for the yen, if Nikkei weakness started to impact growth/inflation expectations, and dampen nascent speculation of an end to yield curve targeting, it would play JPY negative. We should be some way off these concerns given how far the Nikkei has climbed recently. Right now it feels like Nikkei risk is pulling USD/JPY down in part via general positioning liquidation not least short JPY/carry. A stronger JPY versus the USD with risk-off is normally reinforced by US yields falling. Very unusually (and possibly the most interesting feature of today's trading) US and most global bond yields are heading up. The USD- JPY yield spread is then providing a modicum of USD/JPY support. IF we continue with Nikkei lower and more global risk appetite negativity, but US yields higher, then the signal for USD/JPY is very mixed, but probably just slightly skewed to USD higher. In any event there are surely easier currency pairs directly related to risk to trade. In an unusual world where equities slip and lead bond yields up as part of a generalized pick-up in equity and bond vol from historically very low levels, long USD/EM, and long USD/commodity FX makes more sense than
Sharp move on 9 November: stock decline, yen appreciation, interest rates rise The Japanese stock market experienced big swing on 9 November. As shown in Figure 1, the Nikkei Stock Average traded at ¥23,347 (up ¥433) at 13:20, but dropped sharply to ¥22,655 (down ¥258) at 14:30. Implied volatility continued to rise sharply from the morning on 9 November (Figure 2). Heightened volatility appears to have triggered program trades to reduce risk. Relatively large moves occurred in a short period in interest rate and forex markets too. The 10y JGB yield rose from 2.5bp at about 14:20 to 3.5bp at around 14:50 (price fell). The USD/JPY shifted to yen appreciation from ¥114.0 at about 13:20 to ¥113.5 at around 14:30. Volatility-targeting strategy The IMF pointed out in its Global Financial Stability Report (GFSR) in October that low volatility is resulting in expansion of financial leverage and liquidity mismatch and might amplify market shocks (p. 5-6). Our team has been receiving questions about the IMF's GFSR. Strategies that target volatility create risk of sudden selling of reference assets (stocks, etc.) when volatility rises. The IMF categorizes these strategies into (1) variable annuities ($440bn; 8-12% volatility target), (2) CTA/Systemic trading ($220bn; 15%), and (3) risk-parity funds ($150-175bn; 10-15%) (Figure 5).
Causes of sudden market fluctuation We don’t think that risk parity funds (which have small balances) and variable annuities supplied to individuals conducted large-scale selling on 9 November because of their low leverage. However, increase in stock (or stock and bond) volatility might trigger position cutbacks when hedge funds, CTAs, and others engage in trading with higher leverage. In fact, stocks and bonds weakened from about 13:20 in the Japanese market on 9 November….
Senate proposal is scheduled for debate in committee starting Nov. 13. The House proposal, which passed in committee yesterday (Nov. 9) looks likely to pass the full House the week of Nov. 13 as well. The accelerated timeline suggests enactment by year-end is possible, though we still believe enactment in early 2018 is more likely. 9 November 2017 | 10:02PM EST
US Daily: How Will Inflation Return to Target? (Struyven)
09 November 2017
FX Forecasts and Valuations FX Forecasts and Valuations: The buck stops here
We have left our currency forecasts for EUR/USD and USD/JPY unchanged from the last July FX forecasts and valuations publication. End 2017 and 2018 forecasts are respectively 1.17 and 1.20 for EUR/USD, and Y116 and Y120 for USD/JPY. Other than EUR/CHF, most of the other changes to G10 forecasts are relatively minor. We continue to hold to the rationale espoused in the July publication of a unique elongated topping pattern in the big USD cycle rather than a traditional 'inverted V'. For 2018, we anticipate that positive USD risks as they relate to US fiscal and monetary policy repricing are skewed to the 1st half of the year. The more EUR positive policy risks, and more negative US political risks, are skewed to the second half of the year. 2018 is then potentially seen playing to 'a game of two halves', the USD wins H1, but has a more chequered time as the year progresses, most notably against the EUR, where the ECB is slipping behind the curve.
Following the unexpected decline in core inflation this year, we revisit the drivers of our inflation forecast and the risks around it. Kicking the tires on our bottom-up core PCE model, we confirm that both macroeconomic fundamentals and sector-specific factors are likely to push core inflation significantly higher over the next 1-2 years. The acceleration is driven by pass-through from higher energy prices and a weaker dollar, declining slack and rising wage growth, the eventual drop-out of the Verizon effect, and a waning policy drag on healthcare inflation. While the model clearly supports our forecast of rising core inflation, the model projection is also a touch below our own standing forecast. We therefore now see the risks to our core PCE forecast of 1.9% by end-2018 and 2.2% by end-2019 as slightly tilted to the downside
9 November 2017 | 10:43PM GMT
Global: What lending surveys tell us about the Industrials outlook; 3Q17 USA: Tax reform released in Senate; House proposal passes committee
Bank lending surveys: Key indicator for construction, IP and autos: Quarterly bank lending surveys poll domestic banks on how demand for loans and lending criteria are changing. We find that the net of these responses for mortgage, commercial and consumer lending is a strong lead indicator for construction activity and auto sales.
BOTTOM LINE: The Senate tax reform proposal would result in a smaller net tax cut in 2018 than the House version, but it addresses most of the same issues the House tax reform bill does. The
Europe: All surveys positive and supportive of growth: Survey results across all categories remained in positive territory, pointing to continuing European recovery. Commercial surveys weakened, indicating slight tapering off
10 November 2017 | 4:19AM EST
for non-resi/IP growth. Germany rebounded sharply, but Italy and the Netherlands tapered off although both remained in positive territory. Residential construction was stable and looks strong, with the Netherlands strongest, followed by Italy and Spain. Consumer survey outlook data strengthened and is supportive of modest auto growth.
US surveys: Cautious picture across the board: Surveys across all categories declined as mortgage demand went down while tightening commercial lending criteria reads negatively for non-resi construction. More general commercial lending, however, suggests a more stable outlook for industrial production. Negative but sequentially improving consumer surveys support our view of weak but potentially turning US car sales…
… We note that natural disasters in the US could create distortions in lending surveys in 3Q17. While the hurricanes in the Southern US likely weighed on overall home sales metrics, we expect the associated damage to drive medium-term demand associated with rebuilding (see Hurricane Harvey and the potential impact on the housing market). We remain constructive on US housing macro as home prices remain solid and many categories remain close to normalized demand levels. 9 November 2017 | 5:47PM EST
Top of Mind: Late-Cycle for Longer? More than eight years into the US economic expansion, there are few signs that it will end anytime soon. But with US equity indices at record-highs, 10year Treasury yields only moderately off their lows, and valuations for both looking stretched, whether “no recession” also means “no correction” is Top of Mind. We feature perspectives from Omega Advisors Vice Chairman Steve Einhorn, Equity Group Investments Chairman Sam Zell, and our own strategists. All agree that recession risk is low today and unlikely to move substantially higher before late 2019 or 2020. But they disagree on the amount of market risk today—and what to do about it. Our own view is to stay invested rather than try to time the next equity downturn, while focusing on areas of the market levered to growth. We also ask if commodities remain a compelling late-cycle play as was the case historically (yes) and whether it is worth hedging against volatility spikes (only selectively)…
… To sum up, while incipient overheating is a concern, it is less of a risk through the familiar inflationary channel than it has been historically. But overheating can raise recession risk through other channels too. In particular, a number of Fed officials have highlighted links between overheating and excessive risk-taking in both the real economy and the financial sector. These more timeless drivers of the business cycle—the sentiment-driven swings in both financial asset prices and borrowing and investment that are often attributed to “animal spirits”— remain relevant as recession risks.
One Fed official who is particularly attuned to these risks is Jerome Powell, recently nominated to be the next Chairman. Earlier this year, he noted that “Historically, recessions often occurred when the Fed tightened to control inflation. More recently, with inflation under control, overheating has shown up in the form of financial excess.” While recession risk still looks limited today, the Fed’s ability to keep overheating contained will likely be a key determinant of how long this “late-cycle” phase can last.
9 November 2017 | 11:09AM EST
USA: Wholesale Inventory Growth Close to Expectations; Q4 GDP Tracking at +2.3% BOTTOM LINE: Wholesale inventory growth rose in line with expectations in September, but growth rates were revised up slightly on an unrounded basis. We revised up our Q3 tracking estimate by one tenth to 3.5% and lowered our Q4 GDP tracking estimate by one tenth to 2.3%. Following this morning’s data, our October Current Activity Indicator remained flat at 4.0%. 10 November 2017 | 5:02AM HKT
Asia Credit Line: Identifying "zombie" companies in China A recent comment by the Governor of the People's Bank of China highlighted a number of concerns that could lead to an increase in systemic risk within the financial sector. One of the risk factors cited was the high level of corporate leverage, with the problem exacerbated by the slow progress in resolving "zombie" companies – defined by the State Council as persistently loss-making companies that are not aligned with national industrial policies, and are heavily reliant on government or bank support in order to survive. Based on the State Council definition and an academic study on Japanese "zombie" companies, we derived a set of criteria to identify "zombie" companies in China, and used A-share listed nonfinancial corporates as our universe. Our findings are then compared with a recent IMF study that looked at the same issue by using NBS Industrial Firm Survey data. Based on our analysis, we estimate that "zombie" debt as a percentage of total corporate debt likely peaked around 10% in 2014. This has since improved, reflecting the improvement in corporate earnings since mid-2016. Using our analysis, we estimate that the materials sector contributes to the majority of "zombie" debts, though we are seeing signs of improvements that are in line with the rebound in commodity prices in the second half of last year. Hence bankruptcies and defaults are not the only way to dealing with "zombie" debts, as growth stability and supply-side measures
can also help to alleviate some of the problems. And as mentioned by Governor Zhou, financial tools such as debt to equity swap, public equity financing and private equity funding are also viable options. Ultimately, though, we think further policy action towards state-owned enterprises (SOE) reform will be key towards preventing the "zombie" debt problems from deteriorating. Our study shows that the rise in "zombie" debt in the post Global Financial Crisis period has largely been driven by state-related entities. This is why we believe SOE and local government financing reforms are the most important reforms for China corporate credit risk.
10 November 2017 | 3:38PM JST
Japan Views: Could a possible “end of deflation” declaration by the government trigger interest rate normalization?
There is a view in some quarters of the financial market that the Japanese government could soon declare that it has beaten deflation, triggering interest rate normalization by the Bank of Japan (BOJ). In judging when deflation would be over, the government plans to use CPI, the GDP deflator, output gap, and unit labor costs as relevant metrics. That said, the government has not provided any numerical criteria, and the judgment is not necessarily linked to the BOJ’s 2% inflation target. There is a possibility that all these indicators will recover to positive territory soon. This is the basis for the contention that the government could soon declare that it has beaten deflation. In our view, however, the government is unlikely to make such a claim soon, even if the relevant metrics recover. Firstly, the government likely needs to weigh the situation very carefully. Secondly, declaring an end to deflation would be a golden opportunity to publicly promote the success of Abenomics, and we thus think the government will look to tie it with an important political event. Thirdly, we think households are focused on wage growth and the government might want to achieve wage growth more significant than the last several years before making such a declaration. In our view, a more desirable option for the government would be to make this declaration before the LDP presidential election in September next year, after confirming the positive repercussions of successful wage hikes. Even if the government were to declare an exit from deflation, we believe the BOJ would need to maintain its current easing policy long-term, continuously chasing the 2% inflation target. Firstly, the government likely needs to maintain a very
accommodative financial environment to overcome the possible adverse effects of the next consumption tax hike in 2019. Secondly, higher long-term yields could become an obstacle for fiscal spending when necessary. Thirdly, we assume the Abe administration is well aware that the real significance of the current easing policy lies in the sustained period of yen weakness and stock market strength.
November 9, 2017
JEF Economics
Primary Dealer Positions: Big Swing on the Curve, 3-6Y USTs -$13.4B In the week ended November 1st, Primary Dealer positions rose $2.5 bln to a net long of $242.2 bln from $239.7 bln. Treasury positions fell modestly, dipping $2.2 bln. Positions in other asset classes were also relatively little changed as well. … Treasuries Overall Treasury positions fell $2.2 bln to a net long of $97.5 bln. Overall coupon positions fell $4 bln to a net long of $63.1 bln. Bill positions rose $3.1 bln to a net long of $21.2 bln. TIPS positions rose $1.3 bln to a net long of $8.8 bln, and FRN positions fell $2.6 bln to a net long of $4.4 bln. Coupon positions were mixed across the curve. There was a massive $13.4 bln drop in positions in the 3- to 6-year sector, which is the largest single-week drop in positions in the sector since the data was reorganized in April 2013. It should be noted that the reporting date for this week’s data coincided with an FOMC statement release and the belly of the curve tends to be sensitive to changes in sentiment about Fed policy. The reporting date was also the day of Treasury’s Refunding statement which hinted at additional 3- and 5-year supply coming down the pike. Elsewhere, there were offsetting increases in positions. Treasury coupons with less than 3 years to maturity rose a total of $7.3 bln and positions in coupons with between 6 and 11 years to maturity rose $5.8 bln.
November 9, 2017
US Economics & Rates Strategy: Treasury Market Commentary, November 9 Treasuries ended a 9-day flattening streak in an active trading day that started with the Nikkei falling 2.1%, ultra-long JGBs rallying, and EGBs selling off sharply. The Senate's tax bill summary disappointed the market with corporate tax cuts only hitting in 2019. 10y yields closed at 2.34%. … The sell-off in EGBs pushed 10y UST yields higher after having rallied by 1bp during the Tokyo session. By the time New York trading opened, 10y notes were 1bp cheaper on the day. From there, headlines surrounding tax bills kept intraday volatility supported. 10y Treasury yields reached an intraday high of 2.343% before the Tax Foundation released a statement that its dynamic scoring of the House's tax plan had an error that led to an overestimation of the impact of tax cuts on growth. They estimate that the correction would lower the impact on long-run GDP from 3.9% to 3.6%. This is likely to lead to even higher residual deficit resulting from tax cuts over than next 10 years than the $1tn estimated by the Tax Foundation after accounting for economic growth in the dynamic scoring model. The Joint Committee on Taxation's own dynamic score is not out yet, but if the dynamically scored deficit estimate is in line with that of the Tax Foundation, the bill is likely to face strong resistance from Senate deficit hawks that have voiced opposition to a tax cut that is not expected to "pay for itself" through economic growth. UST 10y yields rallied on the back of the press release, before rallying further as headlines came out confirming that the Senate tax proposal is likely to suggest a delay of corporate tax cuts into 2019. The swift, and short-lived rally, was boosted by the 30y UST auction that came 0.2bp through, although it's bid/cover ratio and dealer participation rates pointed to weaker demand than suggested by the clearing level. On the back of the auction, 10y yields touched an intraday low of 2.315%, before bouncing back and selling off into the close.
…GDP tracking We continue to track 4Q GDP at 3.4%.
November 9, 2017
FX Pulse: USD: Another Taxing Week We stick to our USD bearish story, with positive global growth indications and low inflation providing the boost for long carry positions. The recent themes that were driving the USD higher have played out and are priced in: a Fed rate hike in December and greater optimism about US tax reform passing. US 5y5y inflation expectations remain subdued even as oil prices have rallied further. We think this is because of the weak wage data and provides another reason to expect USD weakness. EM still well placed: Our favoured USD short positions are largely vs EM, such as MYR. G10 trades are focused on EUR crosses. We continue to believe that EM will rebound from recent weakness, with a weak USD, ample global liquidity and positive fundamentals being supportive factors. The main risks likely revolve around broader sentiment toward risky assets such as equities and high yield credit, rather than anything specifically related to EM, in our view. The asset class has started to experience some outflows, but these are modest so far. We are long a variety of EM FX, outright and on an RV basis. NOK weak on domestic story. We are long EURNOK as the oil industry is showing signs of weakness again. The 3m correlation between EURNOK and oil prices has started coming down, shifting focus towards the domestic economy. Next week, Oslo’s district court will be looking at a lawsuit on whether big oil companies can start new exploration in the Barents Sea and still leave Norway compliant with the Paris agreement on climate change. The uncertainty isn’t yet priced into NOK. GBP real rates are the lowest in the G10. There are increasing signs of wage pressures in the UK, resulting from a tight labour market and reduced job applications from the EU. The resulting inflationary pressures would keep GBP real rates low. Consumer-related data are to be watched closely. The EU have given the UK a few weeks to make an offer on the Brexit bill, ahead of the December 14 summit, which if large is going to be difficult to find agreement on within the UK parliament. We stay bearish on GBP.
Japan: Lower Real JPY Rates = More Risk Taking. Real rates in Japan have declined since
…
September, pushing the TOPIX higher. It is notable that, despite booming local risk appetite, JPY has not
weakened in tandem. This is unlike in 2013/2014 when the weakening JPY was leading risk appetite. The JPY weakening trend looks increasingly tired and, although we still expect USDJPY to reach our 116-117 target by Q1 18, we see increasing headwinds to JPY weakness in the long term. The success of 'Abenomics' in terms of stoking reflation suggests that, eventually, the JGB curve will steepen, as the BoJ adjusts its yield curve control policy and gradually unwinds its accommodative stance. Reflation and rising rates leads to a reduction in the savings-investment imbalance, reducing investment abroad and keeping more funds onshore.
November 10, 2017
FX Morning Daily Commentary, 11/10 Risk correction creates…. The evolution of inflation remains key for the judgement of global risk appetite. Due to higher food and commodity prices, China’s October PPI (6.9%) and CPI (1.9%) have exceeded expectations. Importantly, its core inflation rate has remained unchanged at 2.3%. Nonetheless, G-3 yield curves have steepened while equity and credit markets moved lower. Our STGRDI* (global risk demand index) has moved lower from 2.1 to 1.29. This behaviour would make sense if inflation rates were to surprise to the upside. Rising oil prices, especially when driven from the supply side, would point in the same direction. Hence, Saudi Arabia asking its citizens to leave Lebanon is not good news for either equity or bond investors as it leaves the impression that the situation in the Middle East is not yet cooling down. …opportunities especially in... Nonetheless, we regard the current risk off move as not setting the starting point for a lasting risk decline. First, the evolution of volatility within an historic context speaks against risk markets seeing a peak now. So far, long-term market peaks developed at monthly average VIX levels within
the mid-teens and not from single digit volatility levels. Secondly, US productivity growth has accelerated while wage growth has moderated in October, suggesting US unit wage growth coming down again which is a risk positive. Third, equity markets tend to rally when there is positive growth momentum. Fourth, G3 central banks are not due to change monetary course abruptly for now, suggesting liquidity conditions staying strong with commercial banks pushing their assets into higher yielding return areas helping too.
…Bearish USD call reiterated.
November 10, 2017
FX Strategy: Housing and G10 FX We explore the sensitivity of G10 currencies to the performance of their local housing markets and investigate which housing-related economic factors to watch out for. The scorecard: NZD and AUD stand out most when we combine all these factors into one currency vulnerability score as the currencies most at risk of weakness from a slowdown in the housing market. The currencies most strongly correlated with house prices are the non-funding currencies – NZD, AUD, SEK, CAD and GBP. The funding currencies (USD, JPY, CHF and EUR) have little or even negative correlation between currency and local house prices. The factors we looked at include house price affordability, how much of the economy relies on construction activity, housing supply and demand and recent transaction volumes, foreign investor participation, equity market reliance on housing industries and banking sector borrowing in a foreign currency. These are not the only drivers of currency or housing markets but something we think FX investors should pay attention to. Currency recommendations: Our vulnerability analysis suggests that AUD and NZD are most exposed to housing-related risks. We suggest selling a basket of AUD, NZD and CAD versus EUR and USD. Given that our economists do not incorporate a major downturn in housing for these markets in their base case, we also like buying downside AUD options structures, given low levels of implied vol, and cheap AUDUSD put skew, which would benefit from a potential downturn in housing. Risks to the trades include tighter monetary policy from the RBA, RBNZ and BoC, as well as
continued strong commodity performance, while housing risks might not materialise in the near-to-medium term.
US Markets Closing Notes, November 9th 2017 Recap and Comments: After nearly 2-weeks of steady outperformance of the bond on the curve, today’s session finally saw some concession built in ahead of today’s 30yr supply. To be sure, directional moves in Treasury markets were again muted, but the relative weakness in the long-bond left 5s30s testing back above 80bp and 10s30s testing 48bp on the topside as the 1:00PM refunding approached. That modest concession appeared to be enough bring buyers to the table, as the issue came in slightly through the 1:00PM bid side and underlying stats were largely in line with recent averages (though with slightly weaker buyside participation). To be sure, the pre-auction concession almost certainly helped support the issue today, though I still consider average buyside demand and a modest through bid as a strong result given the bond’s surge both on the curve and against 30yr bunds since early November. Equity markets are poised to close well off their intradays lows, but the weakness in US equities today likely contributed to the pre-auction steepening correction. Indeed, the S&P 500 probed its session lows as the 1:00PM auction approached, with the overnight sell off in the Nikkei and the myriad of revelations about the Senate’s tax plan each likely contributing to the decline. In the FX space, the USD weakened against the majors, broadly speaking, and the USD added to its overnight losses against the JPY.
Strategic/medium term bias (changes in bold): • Direction: We are still bullish, expecting the next tactical move to be lower in yields, not higher. • • •
•
Curve: We are in favor of 2s10s flatteners here, which has been our top thematic trade of 2017. Curvature: We see 10s as cheap on the curve and established longs 10s on 5s10s30s on October 13th. Inflation: We are constructive on inflation breakevens but would wait to seek entry for a pullback to the 1.65%-1.75% area. Softer CPI, and energy impacts waning in November leave us patient. FX: Stronger USD is still the base view, with the Fed looking more committed to reducing accommodation than others now.
Current trades (changes in bold): • Long 50% 10s at 2.34%, add 50% at 2.43%, target 2.20% stop on close over 2.475%. • •
Established 2s10s Swaps Flattener at 55bp, target 40bp, stop on a close over 65bp. Long 5yr UST vs. German 5yr bund at 236bp, target 220bp, stop on a close over 243bp which marks the 2017 high weekly close.
close relationship still holds with labour market conditions, especially if focused on prime age 25-54 year old workers (being over 55 myself I object to being defined as beyond my prime! Incidentally, although the over 55s have a much lower participation rate, at 40%, it is the only age group where participation has risen since before the last recession! (link) US wage inflation is doing exactly what should be expected at this point in the cycle
NOVEMBER 9, 2017
GLOBAL STRATEGY WEEKLY WHO NEEDS WAGE INFLATION WHEN EVEN VACATIONS HAVE BECOME A BUBBLE (6P) Red Robbo” has died. For many in the UK he epitomised everything that was wrong with the excessive union power in the 1970s, when CPI inflation was driven to over 20% by the unions' unaffordable wage demands. His death comes at a time when organised labour is now seen as weak and toothless, resulting in benign wage inflation - a great investment backdrop, but are investors being overly complacent? … More Americans plan to take a holiday in the next six months than ever before (see chart below). No wonder it was so difficult to book hotels in Yosemite National Park and Lake Tahoe next May! I know US consumer confidence has been booming on the back of a surging equity market, but cheap money has also prompted the consumer to book holidays galore. When the bubble bursts, households will be mighty pissed that its not just their wealth that evaporates in front of their eyes but their ability to vacation like never before. US Households ‘intending to take a holiday in the next 6 months’ surges to all time high (%)
… Gerard Minack, author of the Downunder Daily, also just wrote on this topic. He looks at a more accurate mixadjusted measure of wage inflation. This corrects for highly paid baby boomers leaving the workforce, biasing down measures of wage inflation. Minack notes that a
Indeed Minack notes that “real wage growth has been higher, for any degree of labour slack, in this cycle than in prior cycles. This fits with other evidence of labour market mismatch: in this cycle there are more job vacancies for any given level of unemployment than in prior cycles. In short, there’s an unusual degree of unmet demand, which could explain the unusually high real wages.” The Atlanta Fed Labour Market Spider Chart confirms this finding of a US labour market bursting at the seams (see chart below and link).
… This benign inflation backdrop combines with positive economic surprises. My former colleague, Paul Jackson, now at Source ETFs, points out that normally positive economic surprises of this size would generate a sizable bond sell-off (see chart below) but not now. US economic surprises normally correlate well with changes in US bond yields
NOVEMBER 9, 2017
US INFLATION FUNDAMENTALS AN UPDATE ON RENTAL (DIS)INFLATION FOCUS: An update on rental inflation Since peaking late last year, the annual growth rate of rent has declined about 20bps through September, while the owners' equivalent (OER) rent component has seen its annual rate fall by about 40bps. This month, we provide a brief update on some recent developments in the rental market and provide our outlook for the coming months. In
short, further cooling in rent and OER next year could subtract another 0.2 percentage points from the annual core rate by December 2018. UP NEXT: Core CPI could have firmed somewhat Weakness in gasoline prices in October likely limited the headline CPI to a 0.1% rise, which would push the yoy rate down from 2.2% to 2.0%. In contrast, the core rate could have firmed and posted a 0.2% advance, although that would leave the yoy rate steady at 1.7%. Several components could present some upside risk this month, including medical care, and, for a change, vehicle prices.
NOVEMBER 9, 2017
FI WEEKLY THE FINAL STRETCH We have entered the final stretch of 2017, and with just two weeks to go until the US Thanksgiving holiday, the market has a short window during which to sort out positioning for year-end. We maintain our medium-term bearish bias, but year-end typically means risk reduction, and, given how well risk assets have performed, there could be flows into bonds. Thursday's rise in yields is unlikely to mark the start of a sell-off. There are still risk events ahead - the FOMC, US
tax plans, Brexit talks and Spanish elections - but we don't expect these to alter market sentiment. Spreads tight and likely to remain so In EGBs, the spread hierarchy remains tight, and we don't see sentiment or positioning in euro area peripherals changing until the global outlook for risk sours. Thus, we like to keep peripheral risk, but with selective positioning. In soft-core, 10s30s OAT looks steep, both outright and compared with Bunds. Is growth sufficient to drive up EUR rates? In the medium term, we think so. Views on the ECB and inflation remain dovish. We see a rise in core CPI, ECB balance sheet normalisation and a slowly deteriorating German budget balance rebuilding term premiums. What will be missing is the policy uncertainty component of term premiums, but even without this, the curve can steepen. We see forward steepeners as the best way to express this view.
In the US, Treasury yields regressed as optimism over tax reforms started to wane The yield curve flattened to new cycle low and now looks too flat relative to the belly. We recommend 6m forward 10s30s and 3y forward 5s30s bear steepeners to position for this view.
… The year-end effect Barring any big surprises from the above, the market’s usual tendency is for rates to grind a little lower into year-end. There are various reasons for this: there is a tendency for market participants to reduce risk at year-end, reversing this at the start of a new year. Risk reduction strategies typically favour government bonds. Asset re-allocations may also benefit govies in 2017. High equity valuations, which may result in switches, are the most obvious re-allocation trade. For example, total returns on the Eurostoxx 50 have been 14.2% so far in 2017 against just 1% for the iBoxx Euro Sovereign Overall index. Re-allocations also apply within the bond market where government bond performance has typically lagged other markets. For instance, the iBoxx Euro Non-Sovereign Overall index has returned 1.9%, close to double that of the sovereign index. EM spreads have been on a tightening trend all year, although this has recently started to reverse which, in itself, may encourage switching into safer assets. Lastly, within funds, high cash balances, which suffer from very low returns, often get allocated to assets. Short-dated bonds are viewed as a near-cash substitute.
… United States
NOVEMBER 9, 2017
Vicious cycle
FX WEEKLY
The sharp rise in Treasury yields was short-lived, as optimism over tax reform has started to wane. As the details of the tax reform package are debated, we are less optimistic on the passage of a tax bill by year-end. The decline in risky assets and bond yields seem to reflect that sentiment. That said, the 5s30s and 10s30s curves look too flat relative to the belly. We recommend positioning for a steepening of the curve conditionally via 6m forward 10s30s bear steepeners in gamma and 3y forward 5s30s steepeners in the vega space. The more risky assets rally, the more investors worry about asset bubbles and the greater the demand for safe-haven assets, such as Treasuries, as a hedge to an eventual downturn, creating a vicious cycle of inflows into bonds. Against this backdrop and a benign inflation outlook, we think yields are unlikely to breach the 2.0-2.5% range.
G3 FX STRUGGLING TO BREAK FREE Kit Juckes The US economy is trundling along at a growth rate of close to 2% per annum. The unemployment rate is falling, but wage growth is subdued. The Fed is tightening, but slowly. Bond yields remain in narrow and low ranges. Major currencies are also stuck in tight ranges, and where there was strength in higher-yielding currencies, there is now dispersion in performance, as investors are less sure of the dollar trend and more worried about idiosyncratic events. We're trying to be patient, aiming to get long EUR/USD and EUR/JPY in November.
Yields regress The optimism over tax reform and the sharp rise in Treasury yields was short-lived (see Graph 1). As lawmakers parse through the details of the Trump tax proposal, also known as the Tax Cuts and Jobs Act, several contentious issues surfaced, making the passage of the tax reform bill less likely over the near term. While a majority of the increase in deficits (roughly $1.5tn, which has currently been approved by the House and Senate) is likely to come from the lowering of the corporate tax rate from 35% now to 20%, while benefits to individuals from personal income tax cuts are not uniform or meaningful (see Graph 2). Graph 1: Higher yield levels are hard to sustain
NOVEMBER 9, 2017
EUROPE INFLATION FUNDAMENTALS BROAD ACCELERATION IN CORE INFLATION IS UNDERWAY, YET STILL LOW Euro area focus: Broad acceleration in core inflation is underway, yet still low Euro area core inflation averaged 1.2% yoy in 3Q17, the highest quarterly average since 1Q13 and up from 0.8% yoy in 4Q16, driven mainly by the more volatile travel services and clothing & footwear components. That said, core inflation ex volatile items has also shown some modest improvement rising from 0.78% yoy in December 2016 to 0.92% yoy in September 2017. A deeper dive into the core HICP subcomponents shows that 59% of core items saw their prices accelerate in September 2017 compared with 32% in December 2016. In other words, there is a broader acceleration underway in core inflation. Nevertheless, the share of weighted core items whose prices rose by more than 1.4% yoy (average since 1999) remains relatively low. In our view, significantly quicker ULCs growth (and wage growth) will be needed for a more steady increase in core inflation.
Up next: Headline and core inflation to rise one-tenth each in November Headline inflation is set to pickup one-tenth to 1.5% yoy in November driven mainly by a small recovery in core inflation (which surprised on the downside in October flash release) to 1.0% yoy alongside a slightly higher energy component. Services inflation, which declined three-tenths in October, should recover marginally alongside a modest increase in non-energy industrial goods prices. Food prices, which have accelerated notably in the last couple of months, should also increase but only marginally in November. Medium-term call: Euro area inflation to average 1.4% yoy between 2019 and 2021 We expect core and supercore inflation to remain subdued over the forecast horizon, due in particular to muted ULCs. We expect the EUR/USD to hover around current levels through end-2017, followed by a gradual appreciation to 2021. That means that Brent oil prices in euro terms should fall from €45.6/bbl this year to €40.3/bbl in 2018.
profit net of carry. We are still holding on to our 30yr swap spread widener due to the rollback of leverage ratios. We expect total of $300bn of bill issuance shortly after the debt ceiling is lifted/suspended. We assume that the debt ceiling X-date will come sometime between February and March. Given Treasury’s cash balance estimate of $300bn at the end of March 2018, there will need to be a significant amount of bill issuance in Q1. An earlier resolution of the debt ceiling could lead Treasury to bring this supply to market sooner. A sharp increase in bill supply should widen Libor-OIS and we initiate $50k DV01 in June 2018 FRAOIS wideners. While the contract suffers from negative rolldown, we believe that the widening move will offset it.
ECB call: Given our own weak inflation outlook and the big drop from €30bn to zero, we expect at least a 3m period at €15bn before QE ends, starting from September 2018. We see the first rate hike in June 2019, but think a US recession in 2H19 will prevent any further normalisation moves.
November 09, 2017
Economics Group Special Commentary 9 November 2017
Market Musings Setting Up for the Supply Surge: Long June 2018 FRAOIS
The recent tightening in 2yr swap spreads has been a function of the cheapening of Treasuries vs Fed funds. We think that this is due to expectations of greater Treasury issuance amid Fed portfolio runoff and higher deficits. Moreover, Treasury indicated that much of the supply would be in the sub 5y sector. Supply would move GC higher and cheapen Treasuries to swaps. The cheapening of Treasuries against swaps resulted in tighter 5yr swap spreads as well. However, the pickup in bill supply will not occur until after the debt ceiling is suspended and the pickup in coupon supply will only happen after the February refunding. The 5yr has also remained special in repo and repatriation would also put widening pressure on swap spreads as dollars come back to the US, creating a shortage overseas. We therefore take off our short 5yr swap spread trade for a modest $28k
Update on Consumer Spending & Income Trends Executive Summary
In this report we take a look at the evolution of income and spending in 2017, and shed some light on the economic environment facing the U.S. economy today. Perhaps one of the most important developments for the consumer this year has been the strong increase in consumer confidence since the presidential election. However, such confidence has not translated into stronger growth in consumer spending. The economy continues to grow at a rate that has been “normal” since the recovery from the Great Recession, which started more than eight years ago. Furthermore, we also take a look at expenditure patterns that existed in 2016 and compare them with those in 2014, to see if there are any differences. We observe that the higher growth expenditure sectors are similar today, health care and rental expenditures, but that the rate of growth of these expenditures has come down considerably in 2016 compared to the rates of growth prevalent in 2014. We analyze personal income growth
over the same period, and discuss how potential weaknesses highlight concerns of future expenditure growth. … Conclusion The strong improvement in consumer confidence after last year’s presidential election has continued this year, and Americans are acting upon this important improvement by bringing down their savings rate, rather than seeing an increase in their income. While personal income was relatively supportive of consumption in 2016, the same has not been true in 2017. Thus, in lieu of a strong performance in personal income, Americans have been complementing personal income by bringing down their savings rates, as shown in Figures 5 and 6 above. However, this behavior is not sustainable in the medium-to-long run and in order for personal consumption to continue to remain the driving force for economic growth we will need to see faster growth in wages and salaries during the next several years. If this happens, then the recovery from the Great Recession will enter in the history book as the longest lasting recovery in the country’s history. We also saw some patterns of income and consumption behavior in 2016 compared to 2014. Americans’ highest growth expenditure sectors remain very similar to those in 2014: health care and rental expenditures. However, growth in those sectors has weakened considerably in 2016 compared to 2014. Furthermore, there were sectors that were contracting, or decelerating today, a sign that weakness in income growth has translated into slower consumption growth.
November 9, 2017
Rate Strategy The GI* Tract U.S. Senate Committee on Finance. The Senate has released its version of a tax proposal outlining policy highlights (see appendix on p.3 for full text). U.S. House of Representatives. Statement on Committee Passage of the Tax Cuts and Jobs Act:House Speaker Paul Ryan (R-WI) issued the following statement after the Ways and Means Committee passed H.R. 1, the Tax Cuts and Jobs Act: “Today, we took yet another critical step toward delivering real relief to the American people. I want to thank Chairman Brady and the Ways and Means Committee for making important improvements to this historic legislation. After listening to our members, the committee preserved the adoption tax credit for middleincome families, and increased targeted relief for Main Street small businesses and startups. This bill will cut
taxes for a typical household by $1,182, raise take-home pay by upwards of $4,000, and create nearly one million full-time jobs. It is exactly the type of tax cut and job growth our country needs to get back on track, and I look forward to a robust debate on the House floor.” Link - https://www.speaker.gov/pressrelease/statement-committee-passage-tax-cuts-andjobs-act Board of Governors of the Federal Reserve System. Agencies announce annual indexing of exempt consumer credit and lease transactions in 2018: The Federal Reserve Board and the Consumer Financial Protection Bureau (CFPB) today announced the dollar thresholds in Regulation Z (Truth in Lending) and Regulation M (Consumer Leasing) that will apply for determining exempt consumer credit and lease transactions in 2018. These thresholds are set pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amendments to the Truth in Lending Act and the Consumer Leasing Act that require adjusting these thresholds annually based on the annual percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPIW)[1]. Federal Reserve Bank of St. Louis. St. Louis Fed Releases New Research on Household Debt “Tipping Points”: The Center for Household Financial Stability at the Federal Reserve Bank of St. Louis and the Private Debt Project of the Governor's Woods Foundation have published new research that was presented at the second “Tipping Points” symposium in June 2017. “While our first symposium, held in June of last year, focused on the micro or household-level effects of household debts, this year’s symposium centered on the macro effects of family debts— specifically, at what point does household debt move from contributing to economic growth to inhibiting growth?” said Center Director Ray Boshara in an executive summary of the conference. “As with last year’s symposium, this year’s research revealed a number of fascinating and sometimes counter-intuitive research findings that we hope will inform future research, private and non-profit practice, and public policy[3].”
https://www.stlouisfed.org/newsreleases/2017/11/8/st-louis-fed-releases-newresearch-on-household-debt-tipping-points
November 9, 2017
Municipal Securities Research Private Activity Bond Clarification The figures for private activity bonds from the Council of Development Finance Agencies in the report we issued earlier this week seemed suspiciously low for the whole universe of private
activity bonds. They were, since they only included those transactions subject to the state volume caps, which explains why housing was a high proportion of the total. This excluded airports, hospitals, higher education and other 501(c)3’s, which together make up a large group of borrowers. We thank our careful readers for calling to discuss and we value that. In this report, we present a chart that details private activity by use of bond proceeds for all the sectors. As most of our readers know, these sectors are critical for maintaining the basic infrastructure in that keeps our economy humming. Absent some kind of replacement proposal from Congress we can only envision higher taxpayer and user costs or worse, decline in the quality of U.S. airports, hospitals, universities, housing, waste facilities and more.
