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StreetStuff Daily January 11, 2017

Tue 1/10/2017 11:49 AM

Oil Price Looks Soft Robert Sinche Global Strategist

Following the key reversal day on January 3, the first trading day of reduced supplies, the WTI crude oil price is now breaking down below short-term trend-line support (today at $52.02). The price could be setting up for a test below $50, with next support at the December 15 low of $49.95. The technical picture suggests the inventory report Wednesday could be an important catalyst, particularly on a close below $52.02 today.

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… a pickup in actual activity. To be sure, there is ample room for disappointment, but the economy enters 2017 with a tailwind in the form of renewed optimism, a far cry from where we were a year ago, when a little wobble in Chinese stocks in January had the whole world worried about a recession, which totally spooked the Fed and took a rate hike off the table until mid-year. Business investment may not pick up dramatically until some of the policy-related optimism is actually validated, but the economy seems to be in very good shape, especially if Congress and the incoming Administration can deliver on a substantial portion of its growth-friendly agenda (without sparking a trade war).

10 January 2017

US Economic Research Border adjustments: A tariff by any other name... 

Tue 1/10/2017 9:33 AM



December NFIB Small Business Optimism Index Stephen Stanley Chief Economist

…In short, small businesses are ecstatic over the

results of the election, though for now, the euphoria is mostly about expectations rather than



Following the presidential election, we revised our outlook for the US economy to include tariffs of 15% and 7% on imports from China and Mexico, respectively, in early 2017. While uncertainty about the details of the Trump administration’s trade policies remains elevated, we take strong signal from the creation of the White House National Trade Council and the appointment of Peter Navarro as its head that protectionist trade policies are likely to be forthcoming. Tariffs are easy to implement given existing executive authority, could satisfy Trump campaign promises to address the trade deficit, and could serve as an opening volley in any effort to renegotiate trade treaties. However, the administration may choose to use border adjustments over tariffs since they may allow for the passage of any fiscal bill under reconciliation, avoiding the Senate filibuster.

Economic activity and trade volumes are likely to fall under the imposition of a border tax. We show that firms



differentiated by the location of sales and the sourcing of inputs that are indifferent to the existing tax structure are not indifferent to the imposition of border tax adjustments. Exporters generally profit the most while importers are harmed. We also show that it is virtually impossible for any exchange rate movement to offset the negative effects of a border adjustment, despite claims by some to the contrary. We estimate that a 20% border tax could increase y/y rates of core inflation by 0.5-1.0pp and reduce real GDP growth by 1.0-1.5pp. Japan, which raised its VAT by 3pp in 2014, provides a useful case study for comparison. The response of inflation in Japan was consistent with what we would expect for the US. However, the decline in GDP growth was much larger at 4pp (to -1.1% y/y from 3.1% prior to the increase in the VAT), implying significant downside risk to our estimates.

6 January 2017

Global Rates Weekly On uncertain footing 3y, 10y, and 30y auctions: A decline in domestic demand 3y: Modestly weak performance amid a continued decline in demand …OTR 3s have richened sharply versus old 3s in the past few days (Figure 5). While the richening is atypical of the auction cycle, OTR3s were trading unusually cheap. The level of OTR3s versus old3s is now in line with the previous auction cycles. (Figure 4) We believe there is room for the sector to cheapen.

10y: Performance remains weak driven by a decline in domestic demand …OTR10s versus old10s have cheapened inline with a typical 10y auction cycle (Figure 2).As argued above, with year-end liquidity behind us and OTR10s trading close to average of the previous cycles, we are unwinding our long recommendation ahead of the 10y bond auction.

30y: Mixed performance amid weaker domestic demand

…Figure 7 shows that the 10sUS30s fly typically richens heading into the bond auction, although much less so during non-refunding months. Similarly, the US-WN curve steepens somewhat. Given the richening of the fly, we are turning neutral on the trade.

Lyngen/Kohli BMO CLOSING Call, January 10, 2017 …The performance of tomorrow’s 10-year auction is the far more relevant issue in gauging the near-term direction of the Treasury market. We’re certainly open to an in-range concession but would like to come out of the auction process long as we approach the holidayweekend with the caveat that the retail sales report represents the most meaningful near-term data risk. The consensus for the December release is a +0.4% gain in the ‘control group’ which would be on the upper-end of the recent range. That said, with so much economic bullishness already priced in (as implied by the GDPNow tracking estimate of +2.9% in Q4), the ‘green shoots’ are more vulnerable than the modest bid in Treasuries. The limited set-up window between the President-elect’s speech at 11am and the 10-year auction on Wednesday will materially impact auction-linked activity and should discourage the marginal bidder. That said, most overseas players and strategic/tactical auction buyers will be less sensitive to this risk – suggesting we’ll nonetheless still get a relatively accurate read on demand for Treasuries at these levels.

Tactical Bias …The 10-year chart also shows early signs that we might have a bullish head and shoulders pattern forming – a call that would benefit from a round of consolidation into the long-weekend. The ultimate projection of the pattern is the opening gap of 2.15% to 2.16%, but we’ll be a seller of the market anywhere beyond 2.20% given the current fundamental landscape. We’ve been stressing how short the market is and this week’s JPM survey confirms what we’ve seen in the CoT data with active accounts doubling the prevailing shorts to 20%, longs unchanged at 20%, and neutral positions representing 60%.

Recap & Discussion:

…With the week’s major catalysts still to come, the dormant rates px-action in the face of sequential consumer and inflation data improvement has our spidey-senses tuned to what seems like perverse staying power for bull-flattener trends in the face of the latest data barrage. As we noted yesterday afternoon, it may be no surprise that with a wildcard Trump presser tomorrow (at 11amET) and bank earnings beginning Friday morning, the market may begin to treat consensus relation trades with the respect of a barely ITM call option. Perhaps fuelling a bit of the retreat in optimism

Global Daily Macro Monitor

11 January 2017 

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Italy: The constitutional court ruling on the admissibility of a referendum proposing to overturn landmark labour-market reforms might affect the political calendar for 2017. UK: Industrial production is likely to bounce in November following a dip in October. The Bank of England’s governor appears before lawmakers. Mexico: We have revised our 2017 inflation forecast to 5.0% from 4.5% and our policy-rate forecast to 7.25% from 6.75%.

lately is uncertainty over Q416 bank results; Fitch released a bit of a glass half-empty note this afternoon regarding EPS estimates, saying that “banks' earnings likely benefited from election-related market volatility; however, overall loan growth likely remained muted during the quarter”. In line with this line of thinking, our equity strategy colleagues are flagging a slight pullback in earnings preannouncements which may suggest management teams have lowered forward expectations, while estimated 4Q16 S&P EPS has dipped from roughly +6% to just under +4% over the past three months (mostly due to healthcare). Anyhow, in our minds, the bear-trend in duration is still intact with 10s above 2.295% and 5s above 1.795%, these are the levels that we want to be broken in order to prove us wrong. Fundamentally, we also would argue that the reflation story still is dominant despite recent positioning squeezes. Similarly, we may be quite close to receiving details on the expected policies from Trump as later this week, with his press conference tomorrow a highlight for sure. As our colleague Steven Englander mentioned early this morning, the “next (rates) step has to be clarification of the content of the fiscal and infrastructure package. which may come from Trump this week or it could come from the House pushing its bill forward.”

10 Jan 2017

US Rates at the Bell January 10th, 2017

Trader’s Tab

…According to our colleagues in macro strategy, US rates positioning (ex-Eurodollars) remains quite extreme: >4 standard deviations short in TY equivalents according to their model.

US Municipal Strategy Special Focus 2017 US Municipal Outlook (Part 2 of 2) – A year of adjustments… The January rally may have more room to run We are less bearish now than we were two months ago as back then the incessant cheapening in yields had jolted even our strong conviction that the sell-off was not justified. Thus, we update our rate forecast and revise

down slightly our estimates for year-end 2017 yields. With regard to near term expectations, we find that over the last 10 years, in January, 10YR MMD and 30YR MMD yields have rallied by an average of 12bp and 7bp respectively. Year-to-date, 10YR and 30YR MMD yields have rallied by 9bp and 7bp respectively. However, in our view, in light of the issuance calendar and also signs that fund outflows may be abating, we expect long dated yields could richen by another 5 – 10bp before month end.

Credit concerns Not much has changed over the last year as far as municipal credit fundamentals are concerned. A handful of credit situations continue to deteriorate and unsustainable pension expenses and political paralysis remain the underlying maladies in most of these cases. For sure, municipal investors seem more desensitized to stress in municipal credits after witnessing more high profile bankruptcies and defaults over the last 5 years.

Sector outlook Our outlook for individual muni sectors remains a mixed bag for the year ahead. We expect to see weakness in some state and local government GOs due to financial and demographic pressures. But on a brighter note, there are two positive factors for GOs. Firstly, state and local tax revenues will benefit from an improving economic outlook and also, energy dependent states should witness alleviation in budgetary pressures now that oil prices have rebounded slightly. Secondly, the dramatic post-election sell-off in rates and the rally in equities had a positive impact on pension plan funding ratios and will likely reduce pressure on plan sponsors to reduce discount rates. By our calculations, every 1% increase in discount

rates leads to a drop of 4.97% in overall state pension funded ratios. Also, we are slightly more optimistic for certain types of revenue bonds though we have concerns for others.

Taxables

Taxable municipals should have a potentially rewarding year in 2017. We think they will tighten slightly over the course of the year vs. Treasuries, and their high coupons should give their total returns a boost on top of that. The total return for BABs overall was 6.9% last year, outpacing Treasuries and other,

tax-exempt municipals. As the priority lists of the House and of the Trump administration take clearer shape, BABs seem unlikely to return in 2017. A subsidy package such as the BABs program is highly unlikely to pass either legislative chamber because it represents a direct outlay of cash, which is anathema to Republicans at this time. Thus, at present, we expect only about $32 billion in taxable supply for 2017 (an increase of 6.6% Y/Y). …BABs have cheapened vs. corporates. After BABs significantly outperformed corporates over the latter half of 2015 and the beginning of 2016, it was the corporate market that outperformed for the last three quarters. The richness of the corporate market vs. BABs could dissipate this year, and it would offer lots of trading opportunities as it does so. While BAB yields tend to move in empathy with Treasuries, corporate spreads are more volatile and therefore can widen or tighten significantly against BABs over a period of just a few weeks. These fluctuations can create windows of opportunity where BABs make a good relative value pick, in times of both elevated spreads and tighter ones. Figure 38. Long-end BABs typically track Treasury moves.

Figure 39. Corporate spreads fluctuate, and they outperformed notably in the final three quarters of 2017.

BABs are unlikely to get called despite their high coupon and thus offer yield “kick”: Callable BABs are trading 50bp – 100bp richer vs. comparable maturity non-callables by the same issuer given that they are currently trading on a yield to call basis. But, as has been the case for some time now, the likelihood for most of these callable BABs to be refunded remains low. Thus, in our view, many of these callable bonds should actually be priced on a yield to maturity basis rather than a yield to call basis. We recommend buying callables vs. comparable non-callables, as the callables are likely to extend to maturity, and the yield kick can range from 100 – 300bp. Certain currently outstanding callable BABs may eventually make economic sense for refunding, but these bonds are relatively rare and, furthermore, almost no bonds make sense for advance refundings today. And, even in the event that a bond does eventually get called, the yield pick-up vs. a comparable short 2yr or 5yr Treasury is still attractive, in our view. 10 Jan 2017

US Agency MBS Focus Rolling in the New Year The Jan/Feb dollar rolls in FN 4.0s and 4.5s have been trading meaningfully lower than the Feb/March rolls. For example, front month rolls for FN 4s and 4.5s are trading more than 2 ticks lower than the back month rolls even though the breakeven CPRs for the two cycles are fairly similar. While investors will generally point to the difference in daycount in the two periods, we highlight that it is the unusually long accrual period for January TBA settle that accounts for a majority of the carry differential. Once we adjust for daycount and accrual periods, the FN 4.0 roll in the Jan/Feb cycle is only 0.75 ticks lower than the Feb/March cycle, which can be attributed to the difference in breakeven CPRs.

In discussions with investors, we find that many market participants adjust rolls between months using a ratio of the daycounts to scale the drop price. We note that adjustments to roll prices are a function of the difference in daycounts and not a ratio. This means that we cannot scale roll prices using daycount ratios but instead we must make an additive adjustment.

CitiFX | 10 Jan 2017 Border tax adjustment thoughts Much of the discussion on border tax adjustments makes you wonder whether the authors have passports or have ever used them 1/. It is very

appealing to argue that we can tax imports, encourage exports, have a big new revenue source (from nonvoting foreign producers) and relocalize capacity back to the US – and have a stronger dollar. And going through the analysis and examples you can see how this would work. However, the border tax discussion ignores the likelihood that other countries will do the same. This could take the form of targeting US exports specifically or having the entire global trading system shift to the border tax adjustment framework …

CitiFX | 10 Jan 2017 CFTC/Dealer Positions -Speculative Players Increasing Bets into 2017, while RV Calms Down See below charts and tables summarizing the latest CFTC Commitment of Traders (COT), Traders in Financial Futures (TFF) reports based on positions for COB 01/03 (i.e. last Tuesday), the most recent NY Fed Primary Dealer (PD) Positions report as of 12/28 as well as the Liquidity Premium Index produced by the Citi Treasuries Desk. The week prior to the latest CFTC update covers an impressive year-end rally with 10yr yields declining from 2.56% to 2.44% due to a pullback in risk assets and above-average index rebalancing flows. US Treasuries: • In the long-end we saw a dramatic increase in positioning across most categories reaching most extreme levels since 2012. According to the COT metric, speculative investors are very short. The more recent TFF classification provides further insight that the short is mostly due to Leveraged funds and Dealers, while Asset Managers are running record longs. (Chart 1). • In the short-end the picture is very similar. Asset managers are maintaining record longs vs. Leveraged Funds and (according to COT) Speculative investors. One difference is that the dealer position in the short-end is a lot less extreme than in the long-dated futures. (Chart 2)

Chart 2

We believe the Trump plan will prove even more stimulative for business investment, which is the lynchpin of our projection for meaningfully higher GDP growth over the coming quarters.

Figure 1: The surge in small business sentiment poses upside risks to growth

Deutsche Bank

11 January 2017

The Outlook MBS and Securitized Products

US Daily Economic Notes

Commercial MBS: CMBS retail closure exposure We review retail exposures in CMBS to recent announcements.

NFIB survey points to massive upside risks to real GDP growth

CLOs: Monthly review As 2017 starts, CLO and loan spreads are ripping tighter and prices are rising. Refinancings have started and are likely to continue.

10 January 2017

The sharp improvement in December was largely due to a massive 38-point gain in the percentage of respondents who "expect the economy to improve". This coincided with a 20-point increase in the percentage of firms that "expect real sales higher" and a 22-point improvement in the percentage of firms that think "now is a good time to expand." Clearly, these reactions are a ringing endorsement of the US election outcome, as NFIB Chief Economist Bill Dunkelburg noted that "The December results confirm the sharp increase that we reported after the election." As the chart below indicates, over the last 30 years the NFIB survey has been a leading indicator of real GDP growth. In turn, we believe there may be meaningful upside risks to output growth over the next several quarters. Case in point, the last time that the NFIB survey reached such a lofty level (December 2004), real GDP grew 4.3% annualized in the following quarter and 3.4% over the six quarters ending in Q1 2006. This was not surprising given that the Bush tax cuts at the time helped spur a 10.6% annualized gain in inflation-adjusted capital spending (capex) over the six quarters ending in Q1 2006. Recall that in October 2004, President Bush signed into law what was at the time the largest overhaul of the corporate tax code since 1986.

Consumer and Esoteric ABS: Class of 2006: Fitch takes rating actions on legacy SLMA private SLABS We discuss recent rating actions on 2006 vintage SLMA private credit SLABS sponsored by Navient. Transportation Debt: Prices up, spreads tighten, new issue prices at tight levels Aviation debt started the year with a strongly performing secondary market and a well-received new issue. Non-Agency Residential MBS: Monthly nonagency RMBS monitor This report keeps investors informed about interesting current credit trends and highlights important credit drivers for non-agency RMBS.

Agency Residential MBS: Surprise! FHA cuts MIPs to boost affordability The 25 bps drop in MIPs will bring more headline volatility than anything else.

Higher rates, high VA production and a sizeable number of low-MIP FHA loans in G2 limit the eligible universe substantially. …While the announcement was surprising, its impact will likely be mundane. Given the back up in mortgage rates, the surge in VA production, and the fact that only the 5585 bps MIP cohort is newly in the money (i.e. loans with higher MIPs were granted incentive when the FHA lowered MIPs 50 bps to 85 in January 2015), we estimate that only 6-11% of G2SF and 2-5% of G2MJM will be impacted. As a result, GNMA prepay speeds are unlikely to replicate Q1 2015 spikes of 15-20 CPR. Of course should rates rally, the impact will grow. We detail the changes, our analysis, and potential next steps from Washington (Carson, FHA, and the GSEs) in the remainder of this article.

Rates: Outlook 2017 - A Better Way? We expect higher rates in 2017, 10 year yields rising above 3 1/2 percent with a steepening bias.

USD/JPY. The latest market forecast for US economic growth for 4Q to be released on 27 January is 2.0% YoY, but our economist points out that growth may have slowed to around 1%. Fourth, although there may not be a crisis right now, we need to bear in mind the presence of risk-off factors other than in the US. Economic, market, and political conditions in China, other EMs and Europe, as well as geopolitical risk including in East Asia, are greater factors for concern than in 2016. However, the dominant factor for a strong dollar is how US fiscal policy will boost the economy and interest rates. Forward confidence is improving among both companies and consumers. Our latest US growth forecasts are 2.4% in 2017 and 3.6% in 2018. We see growth possibly accelerating from 2H 2017. We think the USD/JPY uptrend toward 125 will be maintained, and see a prime opportunity to buy on decline. We have seen there could be a correction to 115-110 zone in the first some months of 2017, but we found support at 115 firmer than expected. We think some market participants could start to unwind remaining USD shorts on buying on decline at about 115.

11 January 2017

Japan FX Insights - USD/JPY: Reviewing correction risk USD/JPY to maintain uptrend to 125; we see dips as prime buy opportunity The USD/JPY is losing momentum. Following the US presidential election, US interest rates rose sharply on expectations for aggressive fiscal policy under the Trump administration and speculative dollar buying surged, prompting traders to unwind short positions (e.g., hedge positions) and spurring a sharp rise in the USD/JPY. Following this initial rally, we thought the pace of rally for both US rates and the USD/JPY could correct as policy started to take concrete shape after the incoming president’s inauguration. As a first correction risk, we are monitoring any unwinding of speculative USD longs driven by the USD/JPY rally. We think the USD/JPY will likely rise quickly to 115-118 level, and estimate that Japanese real-demand traders can be cautious about buying an expensive USD. It is difficult to claim that support for the USD/JPY at the high-110s of firm. Second, there is still uncertainty concerning the Trump’s policies. If Mr. Trump again emphasizes his public commitments including tax cuts at his first press conference today after the election, this will likely be viewed as USD-bullish. His reference to capping USD appreciation might trigger a correction. Third, we see a risk that a relatively slow economy before Trump can deliver his policies could stall the

11 Jan 2017

Global Markets Daily: More Sterling Downside on Article 50 Activation (Brooks/Cahill)   

The year that has just begun will be shaped by a number of important questions. How much will the Dollar rise, driven by fiscal stimulus and a more hawkish Fed? Can China continue to stabilize the RMB, facing a strong Dollar and weakening BoP?

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With Sterling looking cheap on most metrics, can there be more downside on Brexit? On the last question, we believe Article 50 activation will see GBP/$ reach new lows With the drop in Cable since Theresa May’s speech repeating her Brexit goals, … ... the FX market is only now re-engaging after the High Court ruling in November. Our forecasts for GBP/$ stand at 1.20, 1.18 and 1.14 in 3-, 6- and 12-months, … ... with risks skewed to a more front-loaded drop on Article 50 activation in March.

3. The FX market has not yet re-engaged with selling Sterling. Net shorts have been reduced (Exhibit 2) and GBP has been one of the few G10 currencies not to depreciate substantially against the Dollar since the US elections. But, in our view, Sterling is ‘actionable’ and soon set to become even more ‘unfashionable’, despite the recent move lower, as coming political events will only increase uncertainty on the future relationship between the UK and the EU. The Supreme Court is due to rule in favour of the High Court Decision on the need for a Parliamentary vote to trigger Article 50 by the end of the month. In response, the government will need to prepare a bill for the vote to take place before the end of March (European Economics Daily: Brexit — the year ahead, 3 January 2017). This preparatory work, together with a subsequent parliamentary vote in favour of triggering Article 50, is likely to increase uncertainty even further. The kind of deal the EU and the UK will agree on will remain unclear for some time, with the UK government sticking to PM May's 'red lines' (immigration control and backing away from the European Court of Justice's jurisdiction) and the EU refusing to grant the UK participation in the Single Market under these demands. We expect the main economic consequences to be twofold: (i) an economic slowdown owing to elevated political uncertainty that reduces investment, employment and consumption as a result of higher prices, and (ii) an adjustment to the UK's external balance requiring a substantial decline in the current account deficit.

10 Jan 2017

10 Jan 2017

FX Views: Sterling back in focus 1. The UK's High Court decision on November 3 took some pressure off the British Pound. But Prime Minister May's speech on Sunday (8 Jan), which simply restated her plan to trigger Article 50 by March and leave the EU within two years, has been sufficient to pull the currency down to the October lows. Cable moved from 1.229 on Friday's close to 1.216 today. This is a testament to how vulnerable the Pound is to the repricing of a ‘hard Brexit’ scenario, as well as, in our view, the extent to which periods of Sterling strength are the result of markets not discounting the new reality appropriately, a reality that we have fully incorporated into our outlook for the currency since the referendum in June and that we have reiterated several times since (see here, here, and here)….

USA: Job Openings Little Changed in November; Wholesale Inventories Revised Up Slightly BOTTOM LINE: Job openings were slightly higher in November, according to the JOLTS report. The hiring rate was unchanged following upward revisions, while the quits rate held steady. Separately, wholesale inventories were revised up slightly from previous estimates from the Advance Economic Indicators report. The report had no implications for our Q4 GDP tracking estimate, which remains at +2.3% (qoq ar). …The report showed slightly more inventory

accumulation for the wholesale sector in Q4 than previously assumed, however the revision was not large enough to impact our GDP estimates. Our Q4 GDP tracking estimate remains at +2.3% (qoq ar).

January 11, 2017

FX Morning FX Daily 1/11 Animal spirits….US data continue coming in on the strong side, with yesterday’s NFIB small business optimism index reaching 105.8, well exceeding the 99.5 consensus expectations and accelerating sharply from the 98.4 November reading. Small business is inward looking and with this index rising to its highest level since 2004 it seems that animal spirits have come back to the US economy. Overcoming a balance sheet recession is fundamentally different from dealing with an inventory overhang-caused recession. Notably, a balance sheet recession sees capital expenditure staying weak for longer as corporates react to better demand indications by hiring into their work force instead of adding to their capital stocks. Most DM countries have experienced what we call a ‘monetisation’ of their capital stock, allowing the depreciation of the capital stock to exceed the replacement of investments. This capital stock monetisation allowed corporates to add to their cash flow and provide the foundation to engage in record equity buy-back programs. ….a long-term USD plus. At a certain point capital stocks reach a low point which is typically the case when the marginal costs of labour exceed the marginal risk adjusted cost of capital. The labour / capital ratio has increased since Lehman and with underinvestment and employment growth reaching an ever widening gap productivity declines. Surging small business optimism suggests that the US may now finally leave the post Lehman balance sheet consolidation recession behind, adding weight to our call suggesting the USD will rally. It is the US closing its output gap while others, especially AXJ, widening their output gap which suggest investment return differentials working increasingly in favour of the USD. All this happens when there are increasing signs of a international USD shortage as manifested by press reports suggesting Saudi Arabia tapping the USD market in February to cover for domestic fiscal deficits. Some stumbling blocks for the USD to clear. While the big picture turns increasingly clearer helped by reports such as business optimism, there are still some stumbling blocks for the USD to clear before resuming its rally. The US consumer has sent out mixed signals with the December consumer climate indices as provided by the Conference Board and the University of Michigan showing pre-Lehman readings, but our in-

house Alphawise Retail Tracker suggesting a retail dip in December. The US December retail sales report will be released on Friday and with the MS projection way below consensus we wait for the USD to dip before trading the USD aggressively from the long-side again.

US Small Business Optimism to Boost Capex

January 10, 2017

Agency MBS Brief Day 1 Certainty Causing Uncertainty Higher coupon CPRs and Fannie Mae net issuance surprised to the upside in December. We offer an explanation: Day 1 Certainty. It's likely that the initiative incentivized lenders to refi Fannie/Freddie loans through Fannie, and the lower closing costs helped mitigate the effect of higher rates. January 11, 2017

UK Economics | EU Exit Slowburn Slowdown A slowdown ahead: Despite initial post-referendum resilience, we expect uncertainty to drive contraction in investment and higher inflation to erode consumer spending growth. The strong starting point, policy stimulus and net exports should ward off recession, but we expect a period of weaker and more volatile growth. Inflation above target: We expect higher import prices as a result of the weaker GBP to push inflation above target. But see inflation below target by end-2018.

Risks tilted to a cut, not a hike: In response to the slowdown, we expect another 15 bps rate cut, likely in May 2017. We also see the possibility of a fiscal stimulus, as an alternative to further monetary easing. Continued resilience would keep rates on hold. Protracted political fragility: We expect political instability to recur, since the EU and UK have opposing objectives in the exit negotiations, and the country and UK politics are split over Europe, with associated risks of an early election and a second Scottish referendum. Crunch points in the negotiation will likely drive markets, and the policy response. Heading for a Harder Brexit: With the UK government prioritising national control over borders, laws and courts, and the EU stating that there can be no “cherry picking” of the benefits of EU membership without meeting the associated obligations, we see a higher probability of a hard than a soft Brexit.



Curve: Flatter. Initiated a 2s10s swap flattener last month and holding it. Near term 5s30s will hit strong support at 100bps. • Curvature: Neutral 5s on 2s5s10s – levels look fair to us at the moment. Like 7s vs. 5s and 10s. • Inflation: Looking for pullback before re-evaluating longer term longs. • FX: We expect the USD to continue its broad outperformance, most clearly vs. EM, especially in light of our expectation that it is not yet time to fade the US rate selloff. In the majors, we favor USD and GBP near-term over EUR and JPY. Current trades (changes in bold): • Entered 2s10s flattener in swaps at 91bp, targeting 72.5bp, stop on a close over 100bp. 3m carry/roll 5bp. Established Dec 2nd 2016. • As per year-ahead, received 7s vs. 5s and 10s at +1.5bps, target -2.5bps, stop on close over 2.5bps. • Also as per year-ahead piece, long EDZ7/EDZ8 at 43.5bps, target 65bps, stop on close below 35bps (looking to add on dip to ~39bps area once technical momentum looks more positive).

NatWest Markets Closing Notes

January 10th, 2017 Recap and Comments:

…If a relaxation of the “Trump trade” has been a theme in the early trading days of 2017, tomorrow’s press conference from President Elect Trump stands as an opportunity for expectations about the incoming administrations’ impact on asset markets to come roaring back to into the foreground. While it’s not clear what specific topics the news conference will touch on, or even when exactly the conference will held, the news conference may give the President Elect the opportunity to discuss upcoming fiscal stimulus, including both tax cuts and infrastructure spending. The news conference may provide fresh, near-term guidance on how fiscal expansion fits into the administrations’ early priorities, as it appears a repeal of the Affordable Care Act is a significant focus. Of course, the President Elect has also used social media to comment on specific company investment and trade and investment policy, with a focus on Mexico – any direct references would brighten the spotlight on Mexico / US relations. Strategic/medium term bias (changes in bold):



Direction: Bullish. Weeklies have rolled bullishly, though dailies a bit overbought so could see some consolidation before a later advance to 2.20%.

JANUARY 11, 2017

FI DAILY TREASURIES, PORTUGAL, SUPPLY, BOE Strategy  The

US Treasury is scheduled to auction $20bn in 10y notes on Wednesday. The 10y sector does not appear to have a clear setup. The sector is trading fair on asset swap and cheap on the curve. In addition, the 2s10s curve has flattened by more than 14bp over the past two weeks. This, combined with a recent history of weak auction performances and the current yield trading below last month’s stop-out rate, means that the auction will likely warrant some concession going in. The benchmark security is trading negative on repo, indicating a short base, which is positive for the auction on the margin. The 10y note appears to be trading fair to slightly cheap on asset swap versus the off-the-run 10s compared with the previous two auction cycles. The 10y note is trading cheap on the curve compared with 5s and 30s (see Graph 5 for the recent range of the 5s10s30s fly versus the 10y). However, the 2s10s curve has flattened over the past two weeks.

Graph 6: Current 10y trading cheap on curve versus 5s and 30s

JANUARY 09, 2017

FI SPECIAL TREASURY AUCTION PREVIEW Key points The

Treasury is scheduled to auction $24bn in 3y notes on 10 January, $20bn in 10y notes on 11 January, and $12bn in 30y bonds on 12 January.  The 10y sector does not appear to have a clear set-

JANUARY 11, 2017

FX DAILY POLITICS MATTERS MUCH MORE THAN ECONOMICS …The star of the annual Albert Edwards/Andrew Lapthorne therapy session for bears is always the guest speaker and Raoul Pal talked mostly about FX this year. I picked up expectations of parity for GBP/USD, 0.75 for EUR/USD and a peak in the dollar that takes it back to a level stronger than the 2002 peak but perhaps not as high as the 1985 one - i.e., more than 10% above current levels but possibly not more than 25% higher. Personally, I struggle to see GBP/USD getting below 1.15 and I suspect that the Euro will trough around parity at the time of the French election, coinciding with the end of President Trump's first hundred days in office. That might get a trade weighted dollar close to the 2002 peak but not above it. Still, I had a go at drawing relative real yields back to the early 19080s (with some dubious assumptions on inflation to help me on my way) and mostly, and I don't think that the move in US real bond yields relative to its major trading partners is over yet, even if it has corrected since mid-December. I'll want to be long US TIPS relative to European index-linked bonds before I want to go short the dollar, at the very least.

up. The sector is trading fair on asset swap and cheap on the curve. In addition, the 2s10s curve has flattened by more than 14bps over the last two weeks. This, combined with a recent history of weak auction performances and the current yield trading below last month’s stop-out rate, means that the auction will likely warrant some concession going in. The benchmark security is trading negative on repo, indicating a short base, which is positive for the auction on the margin.  The upcoming 30y auction will likely require some

concession to be underwritten smoothly because it lacks a clear set-up. The good reception of last month’s 30y bond is a positive for the upcoming auction. However, the flattening of the curve has made the long end unattractive on the curve and on an outright basis, as the benchmark yield trades below the stop-out rate from the last auction.

10Y auction Recent performance: The $20bn 10y note auction last month did not go well, like the majority of its auctions in the past five months. The decent concession on the day on the back of curve steepening as oil prices soared to their highest levels since July 2015 did not help the auction, which likely suffered because of a condensed schedule and proximity to the Federal Reserve’s anticipated interest rate hike. The auction was awarded at 2.485% compared with the 2.479% 1pm WI bid. It was the highest stop-out for the sector since September 2014. The 2.39x bid/cover ratio was higher than the 2.22x posted at the previous month’s auction. The indirect share of the auction (57%) was better than in the previous auction. Investment funds’ 39% share was their highest for the sector since November 2015 (see Table 2). Positioning: According to the latest positioning data, dealers were net short by $0.3bn in Treasuries due in 7-11 years for the week ending 21 December (see Graph 5).

Real yields and the dollar - a very clear trend Relative value: The 10y note appears to be trading fair to slight cheap on asset swap versus the off-the-run 10s compared with the previous two auction cycles (see Graph 7). The 10y note is trading fair on the curve compared with 5s and 30s (see Graph 8 for the recent range of the 5s10s30s fly versus the 10Y). The 2s10s curve has flattened over the past two weeks (see Graph 6).

Overall: The 10y sector does not appear to have a clear set-up. The sector is trading fair on asset

swap and cheap on the curve. In addition, the 2s10s curve has flattened by more than 14bps over the last two weeks. This, combined with a recent history of weak auction performances and the current yield trading below the last month’s stop-out rate, means that the auction will likely warrant some concession going in. The benchmark security is trading negative on repo, indicating a short base, which is positive for the auction on the margin.

taking an average of 73% (64% indirect and 9% direct).

10 January 2017

US Economic Comment Surge in small business confidence 9 January 2017

US Treasury Auction Preview Treasury will auction a combined $56bn this week, selling $24bn in 3s on Tuesday, $20bn in reopened 10s on Wednesday and $12bn in reopened 30s on Thursday. With $47.6bn maturing at mid-month settlement, the auction will raise $8.4bn in new cash. There will also be $3.1bn in SOMA holdings maturing, with the Fed adding on $1.3bn to 3s, $1.1bn to 10s, and $0.7bn to 30s. Given the move lower in yields since the start of the year and CFTC spec data continuing to show record net short market positioning, we expect to see strong auctions this week. Investors appear to have been reluctant to cover net shorts thus far in the year, suggesting that the auctions may be used as an opportunity to cover some short positions as yields have continued to drift lower. While the December long-end auctions were riddled with uncertainty as yields continued to move higher at the time, the recent move lower in yields could make investors more comfortable putting cash to work at more attractive levels. •



10s: The 10yr sector has moved off recently cheap levels both outright and on the curve, but we believe this could give investors the added conference to buy in. Recent averages suggest a 0.9bp tail, but the past 4 second reopenings averaged a stop 0.1bp through and 69% buy side takedown (62% indirect and 7% direct). 30s: The long bond has seen some support from recent lows, moving below the psychological 3% mark. The past 4 second reopenings have averaged a stop 0.2bp through the screens, with the buy side

The largest rise on record for small business sentiment, to near record high The NFIB small business optimism index surged 7.4 pts in December to 105.8—its largest rise on record to near the record high, with data back to 1974. The rise extended increases of 3.5 pt in November and 0.8 in October. Before Q4, the index had been slipping since early 2015. The gain appears to reflect election enthusiasm plus some underlying relative improvement in profits. A huge swing in expectations Some support from profits But not much passthrough into actual spending, yet The survey also showed much more modest passthough into spending. The positives: There's some hint that the inventory cycle is coming to an end: 4% of firms on net expanding inventories versus small majorities cutting inventories from Q1- Q3. The net 15% of firms planning to increase employment is a bit above recent highs.

However, planned capex has shown little move yet. Job openings slipped slightly. The share of firms raising prices or worker comp was little changed—although plans to hike prices and wages turned up. The workers per firm measure was unchanged in Dec— extending its recent zero net hiring trend…

8 January 2017

Global Rates Strategy Weekly Supply Preview We preview this week's auctions and highlight issuance & cash flows expectations over the coming months.

…Auction details The Treasury will auction $24bn of a new 3y note on 10 January (Figure 12) and reopen $20bn of a 10y note on 11 January (Figure 13) followed by the reopening of a 30y bond in $12bn on 12 January (Figure 14), for a gross total of $56bn this week.

US Treasury bond issuance, 9 January – 5 February Nominal gross supply ($144bn) over the next 4 weeks: This week issuance of new 3y note ($24bn) and reopening of 10y note ($20bn) and 30y bond ($12bn) are scheduled, totalling to $56bn in gross supply. Next week there are no nominal auctions. In the third week, the Treasury will issue new notes in 2y ($26bn), 5y ($34bn) and 7y ($28bn), in total of $88bn of gross supply. 15 January and 31 January will bring large cash flows which shall result in a net supply of $13bn over the next four weeks. Figure 15: Weekly gross and net issuance in nominal Treasuries, next 4 weeks

January 10, 2017

Economics Group Job Openings and Turnover Edge Up in November Job openings and turnover for November add further evidence that the labor market continues to tighten. Openings rebounded over the month, while quits continue to rise and add pressure on wages.

… Empowered to Quit 



The share of voluntary separations continues to trend higher. Quits, a sign of workers’ confidence in the labor market, more than reversed last month’s drop. The rising number of workers quitting their jobs is contributing to increased wage pressures as competition is heating up for companies to attract and retain qualified workers in an increasingly tight labor market.

January 09, 2017

Rate Strategy Rate Express

Treasury Auction Preview Treasury to Auction 3y, 10y Notes and 30y Bonds

The U.S. Treasury is expected to sell $24 billion of 3y notes on Jan. 10, $20 billion of 10y notes on Jan. 11, and $12 billion of 30y notes on Jan. 12. Auction Outlook The November 3y auction saw a small 0.2 bps stop through while the December 3y auction resulted in a small 0.1 bp tail. Demand for short-term Treasuries may be tempered by last Friday’s jobs report on non-farm payrolls. Although the headline payrolls missed expectations, many participants chose to focus on the strong average hourly earnings, viewed as bolstering the Fed’s plan for three hikes in 2017. The November 10y auction tailed by 1.6 bps and the December 10y auction tailed by 0.6 bps. Despite expectations of higher inflation this year, 10y Treasuries have seen yield fall 3.3 bps since Friday after U.K. Prime Minister Theresa May signaled a hard Brexit may be expected. Brexit transition related jitters could increase demand for Treasuries at this month’s auction. In November 30y bonds tailed by 1.3 bps and December saw a stop through of 1.3 bps; 30y Treasuries have also gained value since Friday, with yield down by 2.9 bps. Given the smaller size of this reopening, 30y bonds should have decent demand in our opinion. The size of indirect, which includes foreign central banks, should help gauge overseas support for the Long Bond. During 2016 several of the U.S.’s largest foreign investors have been net sellers of Treasuries.

Yield and Curves Changes Around Auctions 3y auctions have seen increasing yield after auctions in 2016 (Figure 1). On average yield rose 3–7 bps two weeks after an auction. This is a bit higher than 0–2 bps average yield change for 2013 – 2016. During the two weeks following the last auction, 3y yield rose 5–21 bps. 10y yield changes after reopening have been between -7 and 3 bps on average in 2016. This is fairly consistent with the 2014 and 2015 yield changes, which ranged between -8 bps and 1 bp. Two weeks following the last 10y reopening yield changes ranged between -3 and 13 bps.

5s/10s have changed little following a 10y reopening in 2016. The 5s/10s spread rose 0–1 bp on average (Figure 4). However, after the last reopening, 5s/10s fell 2–8 bps. 7s/10s has also had little change after a 10y reopening in 2016. On average the 7s/10s change ranged between -1 and 1 bp. After the last reopening, the 7s/10s spread fell -3 to -2 bps. The average yield change two weeks after a 30y reopening has been -6 bps to -1 bp for 2013 – 2016. The average yield change for 2016 has mirrored this closely, ranging between -6 bps and 1 bp. After last December’s reopening, yield changes were between -7 and 5 bps. On average 5s/30s rose 0 – 1 bp after a 30y reopening in 2016. Throughout 2013- 2016, the average change has been -3 to 0 bps. After the last reopening the 5s/30s change ranged between -15 and -9 bps. The 7s/30s average change was 0- 1 bp 7 days after a 30y reopening (Figure 7). After the last reopening, 7s/30s fell 7 to 13 bps.