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June 17 2015

Commentary by Eoin Treacy

Buyback Extravaganza

Thanks to a subscriber for this interesting article from investorfieldguide.com. Here is a section:

First take all cash spent on buybacks, subtract all cash raised from issuance, plus all cash spent on dividends. Then divide by current market cap for a “yield.” (net bb + divs))/market cap

Same as above, but now include net debt issuance/reduction, where companies paying down debt in addition to dividends and buybacks are ranked more favorably. (net bb + divs + net debt reduction)/market cap

We will call the first “shareholder yield” and the second “stakeholder yield” because debt is part of the equation. For these purposes, I am excluding financial stocks, because they use of debt is so much different from other sectors. In practice, you’d want to make sector specific adjustments to measurements of debt, but here I am just keeping things pretty simple.

Now let’s run at typical test of the returns for stocks in the top decile by these two yield factors. Both have been strong selection factors. Here is the rolling 3-year excess return earned since the late 1980’s by the highest “yielding” stocks.

Across the entire period, Stakeholder yield has delivered a return of 14.5%, and Shareholder yield a return of 12.4%. This means that investors have been rewarded more by buying stocks which are both paying back shareholders AND reducing their debt. But that script has flipped somewhat after the global financial crisis, arguably because interest rates have been so low. Companies taking advantage of cheap money in recent years seem to have had an edge.

Eoin Treacy's view -

Share buybacks have made a lot more headlines over the last couple of years than I remember them making before the credit crisis. This is despite the fact their weighting as a percentage of total market cap was higher than now. Some of the reasons for this include the fact that ETFs tracking buybacks are now available but also because so much debt has been issued at ultra-low rates to buy back shares.



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June 12 2015

Commentary by Eoin Treacy

Email of the day on bond indices:

I hope you are both keeping well? I would be very grateful if you would add some global bond indices to the chart library, I would propose: Citi WGBI TR Barclays Global Aggregate BofA Merrill Lynch Global High Yield JP Morgan EMBI Global Barclays World Govt Inflation Link My apologies if these, or similar, are already loaded, if so a point in the right direction would be appreciated. Many thanks

Eoin Treacy's view -

Thank you for these suggestions we continue to thrive on the challenge provided by the market. Unfortunately we are somewhat limited in what bond indices we can add to the Chart Library because investment banks tend to jealously protect access to their data. Over the years this has meant we have added a number of indices from different providers to reflect different parts of the market. The vast majority of bond indices, whether they refer to investment grade or high yield, US, EU, UK, Asia or global prices, yields or spreads can be found in the Income, Property, REITs and Fixed Income section of the Library. 

We added the Barclays Global Aggregate Corporate Total Return Index (USD) and the Barclays World Government Inflation Linked Bond 1 to 10-year Total Return (USD) Index to the Library from your list above. 

 



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June 05 2015

Commentary by Eoin Treacy

Jobs Machine Banishes Winter Woes as U.S. Payrolls Beat Forecast

This article by Michelle Jamrisko for Bloomberg may be of interest to subscribers. Here is a section:

Hourly earnings climbed from a year ago by the most since August 2013, while an increase in the number of people entering the labor force caused the unemployment rate to creep up to 5.5 percent from 5.4 percent. The report bolstered the case for Federal Reserve policy makers to begin raising rates this year.

“This only reinforces the view that the economy is a lot healthier than the GDP data imply,” said Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York, whose projection for a 275,000 gain was among the closest in the Bloomberg survey. “How weak can the economy be when we’re generating this kind of job growth?”

Broad-based employment gains from builders to trucking companies to local governments show hiring managers are confident the economy will regain its footing after faltering early this year. The dollar surged to a 13-year high versus the Japanese yen and Treasuries tumbled.

Eoin Treacy's view -

Wage growth is a big news item, and probably more important than the number of jobs created since it is a symptom of tightness in the labour market. It is all the more important because one of the key arguments used by economists over the last few years to defend QE was that there is just too much slack in the economy. The Fed has data that says inflation is low and wage growth is picking up but the Dollar is strong and bond markets are weak so the decision on whether to raise rates this year remains finely balanced. 



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June 04 2015

Commentary by Eoin Treacy

Fed Urged by IMF to Delay Rate Liftoff to First Half of 2016

This article by Kasia Klimasinska and Andrew Mayeda for Bloomberg may be of interest to subscribers. Here is a section: 

The Federal Reserve should delay raising interest rates until the first half of 2016, the International Monetary Fund said as it cut its U.S. growth forecast for the second time this year.

The lender also said that the dollar was “moderately overvalued” and a further marked appreciation would be “harmful,” in a statement released in Washington on Thursday on its annual checkup of the U.S. economy.

“We still believe that the underpinnings for continued expansion are in place,” IMF Managing Director Christine Lagarde said at a press briefing in Washington. “The inflation rate is not progressing at a rate that would warrant, without risk, a rate hike in the next few months.”

That means the Fed should wait until early 2016, even if there’s a risk of “slight overinflation” relative to the central bank’s 2 percent target, Lagarde said.

A stronger dollar, declining oil investment and a West Coast port strike in the first quarter will pull down U.S. growth to 2.5 percent this year, said the fund, which previously projected the world’s largest economy to expand by 3.1 percent in 2015. Economists surveyed by Bloomberg also expect U.S. growth of 2.5 percent this year.

Eoin Treacy's view -

I’ve met more than a few people in the course of the last week who nonchalantly predict the Fed will raise rates in September. I’m not so sure. Janet Yellen said she will raise rates this year if the data merits a move. This means she will wait until she sees what she is looking for. So far it is not present. Getting advice from a third party, welcome or not, is unlikely to have an impact on the Fed’s actions.

There is a great deal of debate about the rate of inflation but the measure used by the Fed is the PCE Deflator.  Regardless of where one might believe our personal inflation rate is the Fed’s measure is not trending higher. 



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June 03 2015

Commentary by Eoin Treacy

Draghi Says Volatility Here to Stay as Global Bond Rout Deepens

This article by Susanne Walker Barton and David Goodman for Bloomberg may be of interest to subcsribers. Here is a section: 

Draghi suggested several reasons for the rout in bonds across the region, including an improving economic and inflation outlook in the euro area, heavier issuance, volatility, poor market liquidity and an absence of certain investors. He also said that as shorter-term German bond yields rose through the ECB’s minus 0.2 percent deposit rate, making them eligible for purchases by the central bank, buying of longer-dated bonds was reduced.

Price Swings

“We should get used to periods of higher volatility,” Draghi said at a press briefing in Frankfurt on Wednesday. “At very low levels of interest rates, asset prices tend to show higher volatility. The Governing Council was unanimous in its assessment that we should look through these developments and maintain a steady monetary policy stance.”

Eoin Treacy's view -

Today saw a big move right across the government bond sector and across geographies. Rather than forecast where it may trade, the more important consideration is that Bund’s yearlong downtrend has been broken, support has been found in the region of the trend mean and that potential for additional expansion can be given the benefit of the doubt in the absence of a countermanding downward dynamic. 



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June 03 2015

Commentary by Eoin Treacy

GDP growth, miners not enough to boost market

This article by Stephen Cauchi for the Sydney Morning Herald may be of interest to subscribers. Here is a section:

"Today's GDP data underscores why we shouldn't be too concerned about the economy right now," Aberdeen Asset Management senior investment manager Jasmin Argyrou said. "Some of the worrying trends in confidence we saw late last year have reversed and although investment activity is subdued, household consumption has held up surprisingly well. This is ultimately the key for the investment outlook."

The reason the sharemarket did not respond to the data, Credit Suisse analyst Damien Boey said, was that investors are focused primarily on yield rather than growth. "Stocks have reached a point where changes to the earnings outlook or the GDP outlook at the margins don't really have a big impact, given that valuations are kind of extended," he said. "Maybe they're looking for more rate cuts as the only way up."

Bond yields rose on Wednesday and that was enough to send the market lower, he said.

 

Eoin Treacy's view -

Australian investors have been heavily invested in high yielding domestic shares, primarily banks, in order to benefit from full franking. The relative value proposition has also been bolstered by historically low interest rates and a resources sector which has been a subpar performer since 2009.

Australian 10-year government bond yields share a high degree of commonality with their other developed market counterparts. The yield has jumped over the last couple of weeks to break the yearlong progression of lower rally highs and is now trading in the region of the 200-day MA. The 3% area represents an area of prior resistance and a sustained move above it would confirm more than temporary supply dominance. 



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June 01 2015

Commentary by Eoin Treacy

Defiant Tsipras threatens to detonate European crisis rather than yield to creditor "monstrosity"

This article by Ambrose Evans Pritchard for The Telegraph may be of interest to subscribers. Here is a section: 

Mr Tsipras's article is a thinly-disguised warning that Greece may choose to default on roughly €330bn of debt in the biggest sovereign default ever, and pull out of the euro, rather than breech its key red lines.

The debts are mostly to European official creditors and the European Central Bank. The situation has become critical after depositors withdrew €800m from Greek banks in two days at the end of last week, heightening fears that capital controls may be imminent.

Mr Tsipras's choice of words also implies that Greece may turn its back on the Western security system, presumably by shifting into the orbit of Russia and China.

The article comes as Panagiotis Lafanzanis, the energy minister and head of Syriza's powerful Left Platform, returns from Moscow after securing a provisional deal with Gazprom to build part of the "Turkish Stream" gas pipeline through Greece.

Eoin Treacy's view -

The EU is both an economic and political union. Much of the commentary has focused on the ramifications of Greece leaving the Euro, defaulting on its debts and refusing to engage with its creditors. On the political front, tighter relations with Europe’s geopolitical rivals represent an additional consideration since Greece is also a member of NATO. 

This article from GlobalSecurity.org highlights how Turkey controls the Bosporus, Sea of Marmara and the Dardanelles but ships exiting the strait from the Black Sea transit through both Turkish and Greek territory in the Aegean. Increasingly friendly relations between a tactically important NATO member and Russia will be a cause for concern. It is therefore open to question whether Europe’s geopolitical interests will trump economic considerations during continued tense negotiations with Greece. 



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May 26 2015

Commentary by Eoin Treacy

Bond Traders Uncover Secret to Rates That Fed Just Does Not Get

This article by Daniel Kruger for Bloomberg may be of interest to subscribers. Here is a section: 

That pessimism has been reflected in yields on the 10-year note, which are still well below their most recent peak of 3.05 percent last year. They were at 2.18 percent as of 6:30 a.m. in New York on Tuesday, according to Bloomberg Bond Trader data.

“The Fed has opinions; the market has positions,” said Jack McIntyre, who helps oversee $45 billion at Brandywine Global Investment Management in Philadelphia. “If the data doesn’t show marked improvement soon, they’re going to get pushed back into 2016.”

Fed Chair Janet Yellen said Friday she still expects to raise rates this year if the economy meets her forecasts, with a gradual pace of tightening to follow.

 

Eoin Treacy's view -

Everyone seems to be talking about when the Fed’s first rate hike will be. However I don’t think this is the most relevant question. The bigger question is when the Fed’s second rate hike will be. The economy is doing a bit better and wages are beginning to rise. One the other hand the disinflationary pressure of lower commodity prices and the stronger Dollar has so far stayed the Fed’s hand. 

The Fed will need to begin to remove monetary accommodation if it wishes to avoid inflating an asset price bubble. This might be the deciding factor in whether they decide to raise rates in September or not. Following the first hike they will then probably wait and see what effect it has on asset prices. It could be a while before they raise rates again and it is reasonable to assume the pace of the advance will be slower than what we saw from 2003 onwards. 

 



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May 14 2015

Commentary by Eoin Treacy

DoubleLine Presentation: Summer insects

Thanks to a subscriber for inviting me to Jeff Gundlach’s presentation yesterday down the street in Beverly Hills. The presentation was an updated version of the talk he gave in May with a number of additional slides on debt issuance. I posted that presentation in Comment of the Day on May 7th

Eoin Treacy's view -

The title of yesterday’s talk “summer Insects” is in reference to a quote from the Chinese philosopher  Zhuangzi “You can’t discuss ice with a summer insect” This is in reference to the fact that almost everyone active in the bond market today has no experience of trading in a secular bear market. This is a point I have made repeatedly over the last few years not least at The Chart Seminar. If you started out in your career in 1980 and bought the dips in Treasuries for the next thirty five years you would be a wealthy person today and will have cruised into late middle age without experience of a secular bear market. 



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May 12 2015

Commentary by Eoin Treacy

Treasuries Advance as Investors Pounce After Global Bond Rout

This article by Susanne Walker for Bloomberg may be of interest to subscribers. Here is a section: 

U.S. 10-year yields fell after touching the highest level since November, fueled by a global bond selloff that started in Europe. Traders have been selling debt securities that had reached record-low yield levels amid higher inflation and economic prospects. The Treasury will auction $24 billion of three-year notes Tuesday.

"We got to yield levels where guys were happy to take their paper back," said Thomas Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp.

Treasury 10-year yields dropped three basis points, or 0.03 percentage point, to 2.25 percent as of 12:08 p.m. New York time, after reaching the highest level since Nov. 14. The benchmark 2 percent security due in February 2025 traded at 97 26/32.

 

Eoin Treacy's view -

There is a natural proclivity to follow a winning strategy until it has been proved wrong. Buying the dips in bonds has worked for years and despite the reliance on momentum that zero interest rates policies have engendered, investors still look on dips / jumps in yield as buying opportunities. The 35-year bull market is a bubble but we will not have categorical evidence it has popped until the buy the dips strategy stops working. 



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April 20 2015

Commentary by Eoin Treacy

Report from The Chart Seminar in Singapore

Eoin Treacy's view -

Last week’s event was another enjoyable visit to Singapore and was an apt time to ruminate on Lee Kwan Yew’s legacy of turning a tropical backwater into a first world private banking and high end manufacturing centre. Delegates came in from Argentina, Australia, Japan and of course Singapore which led to some interesting and varied discussions.

Singapore’s stock market is being led higher by the banking sector and shares a high degree of commonality with Taiwan and South Korea. The Index is somewhat overbought in the short-term and some consolidation of recent gains in looking likely. However a sustained move below the 200-day MA, currently near 3400, would be required to question medium-term scope for additional upside.

As one might imagine the main topic of conversation was on the outlook for the Asian region not least following China’s explosive breakout over the preceding three weeks.  Delegates were also interested in the outlook for the European region and we also looked at the S&P 500. We looked at the oil price and a number of related instruments. We also looked at gold prices and a number of miners, select Singapore shares as well as a wide range of international bank shares. We also had a wide ranging discussion on currencies. 



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March 12 2015

Commentary by Eoin Treacy

Blockheads

Thanks to a subscriber for this set of slides issued by Jeff Gundlach’s DoubleLine Fund focusing on the fixed income market dated March 10th. There are some great slides in this stack and it is well worth taking the time look through. 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

I found the comparison on page 18 between how the Fed and ECB calculate CPI to be particularly interesting.  This report from the St.Louis Fed explains the differences in calculation: 

This theory, appropriately elaborated, forms the framework for the design of the consumer price index (CPI) in the United States. However, the theory of the cost-of-living index is not the theoretical framework for the harmonized index of consumer prices (HICP) that is used to assess inflation developments in the euro area: At the time of this writing, there is no fully articulated theoretical framework for the HICP, although there is a relatively well-defined price concept, namely, “final household monetary consumption.” By eschewing the use of the cost-of living concept, Eurostat (the statistical office of the European Community) can legitimately motivate the exclusion of certain categories of prices from the HICP. The category that has attracted the most attention by its omission is the cost of owner occupied housing. In the U.S. CPI, for example, the cost of owner-occupied housing is measured on a rental equivalent basis, which is appropriate given the cost-of-living concept that underlies the U.S. CPI. That is, what is priced each month is not the cost of purchasing a home for owner occupancy, but rather the cost of the flow of services consumed each month, which can be proxied by the rental rates on similar housing unites (see U.S. Department of Labor, Bureau of Labor Statistics, 1997). Since the rental equivalence cost of consuming housing services each month is not part of household monetary consumption, it is not priced as part of the HICP. However, the net acquisition costs of new dwellings are arguably part of such consumption, and Eurostat is at present investigating ways of including such costs in the HICP (see Commission of the European Communities, 1998).



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February 18 2015

Commentary by Eoin Treacy

BOE Sees Inflation Pickup as Labor Market Strengthens

This article by Tom Beardsworth and Scott Hamilton for Bloomberg may be of interest to subscribers. Here is a section: 

The Bank of England said U.K. inflation may accelerate quickly in 2016 once the impact of plunging oil prices fades as wage and unemployment data showed labor-cost pressure is starting to build.
In the minutes of its February meeting published Wednesday, the Monetary Policy Committee said its nine members voted unanimously to keep the benchmark interest rate at a record-low 0.5 percent. It also said the slowdown in inflation will be temporary and that, for two of its nine members, the decision was “finely balanced.”

Combined with an improving labor market, the outlook for inflation is causing divergences on the MPC about when policy tightening should start. While the bank said last week it could respond to record-low inflation with an interest-rate reduction or more bond purchases, policy makers are pushing the message that such an outcome isn’t the most likely.

For the two members whose decision was “finely balanced,” the outlook means there may be a case to increase borrowing costs later this year. For the committee as a whole, the next most likely move in policy over the next three years is tightening, though one said there was a “roughly equal” chance the next shift would be a loosening.

 

Eoin Treacy's view -

The Bank of England has played a vital role in steering the UK through what has been a challenging decade to date and has so far excelled. By being among the first central banks to allow its currency to collapse during the financial crisis, the BoE insulated the economy from the global economic difficulties that were to come.

Adopting a quantitative easing strategy in an environment where inflation was coming in ahead of expectations achieved what many central banks have failed to do which is to inflate away some of the outstanding debt load. Its balance sheet has remained steady since the end of QE in 2012 and any move to remove liquidity will be gradual. 



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February 06 2015

Commentary by Eoin Treacy

Debt and (Not Much) Deleveraging

Thanks to a subscriber for this heavyweight 136-page report from McKinsey. Here is a section: 

Debt continues to grow. Since 2007, global debt has grown by $57 trillion, or 17 percentage points of GDP.* Developing economies account for roughly half of the growth, and in many cases this reflects healthy financial deepening. In advanced economies, government debt has soared and private-sector deleveraging has been limited.

Reducing government debt will require a wider range of solutions. Government debt has grown by $25 trillion since 2007, and will continue to rise in many countries, given current economic fundamentals. For the most highly indebted countries, implausibly large increases in real GDP growth or extremely deep reductions in fiscal deficits would be required to start deleveraging. A broader range of solutions for reducing government debt will need to be considered, including larger asset sales, one-time taxes, and more efficient debt restructuring programs.

Shadow banking has retreated, but non-bank credit remains important. One piece of good news: the financial sector has deleveraged, and the most damaging elements of shadow banking in the crisis are declining. However, other forms of non-bank credit, such as corporate bonds and lending by non-bank intermediaries, remain important. For corporations, non-bank sources account for nearly all new credit growth since 2008. These intermediaries can help fill the gap as bank lending remains constrained in the new regulatory environment.

Households borrow more. In the four “core” crisis countries that were hit hard—the United States, the United Kingdom, Spain, and Ireland—households have deleveraged. But in many other countries, household debt-to-income ratios have continued to grow, and in some cases far exceed the peak levels in the crisis countries. To safely manage high levels of household debt, more flexible mortgage contracts, clearer personal bankruptcy rules, and stricter lending standards are needed.

China’s debt is rising rapidly. Fueled by real estate and shadow banking, China’s total debt has quadrupled, rising from $7 trillion in 2007 to $28 trillion by mid-2014. At 282 percent of GDP, China’s debt as a share of GDP, while manageable, is larger than that of the United States or Germany.* Several factors are worrisome: half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable. 

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

The extent of debt deleveraging tends to be a subject that receives little press attention because it is so difficult to quantify. Some people are worried about the quantity of debt that has continued to climb since 2008. However the detail of who is responsible for this debt is more important. 

Quantitative easing is in many respects a transfer of debt from private institutions to government. This has allowed corporations to reduce their debt servicing costs and to lock in the lowest rates anyone has ever seen; often at lengthy maturities. Consumers have been spending less, refinancing mortgages and today’s news suggests more are getting back to work. The USA’s private sector has deleveraged and its government has become overleveraged. If the data in the above report is considered from a long-term perspective we can see cyclicality where credit contraction follows credit splurges and vice versa. 

 



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January 28 2015

Commentary by Eoin Treacy

Email of the day on Caterpillar earnings

I've attached below the transcript of CAT's conference call following its latest earnings report-I believe the company is a good bellwether for the global economy. A bit depressing, but does give you a good picture of slow growth worldwide.  Note how Chairman expects stronger dollar & how that will hurt US manufacturing.  Also note how CAT expects that there might be a quarter or 2 delay in a slowdown of their sales (they'll work off their inventory first which will hit profits right away).  Company has cautious view on mining and expects flat oil & gas prices for 2015.

Eoin Treacy's view -

As a globally diversified company with operations in power systems, construction and resources Caterpillar is heavily influenced by both the extraction and construction sectors. The sharp declines in oil, iron-ore and copper represent significant headwinds for the company’s customers who have been cutting back on spending plans. Since investment in energy projects in particular represents a significant source of income for the company the outlook is likely to remain uncertain for the foreseeable future as spending on new projects is cancelled. 



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January 08 2015

Commentary by Eoin Treacy

Treasuries Fall as Projected Jobs Strength Damps Refuge Demand

This article by Susanne Walker for Bloomberg may be of interest to subscribers. Here is a section: 

Treasuries fell for a second day before a report forecast to show strength in the U.S. labor market, damping refuge demand as the Federal Reserve considers an interest-rate increase for later this year.

Benchmark 10-year yields rose and equities gained as futures markets are pricing in a 58 percent chance of rates rising by September even as a Fed measure of inflation expectations, known as the five-year, five-year forward, dropped to the lowest level since 2001. The new-year rally in global sovereign bonds paused after driving yields to record lows as plunging oil prices lowered inflation projections.

“The market got a little bit carried away,” said Brian Edmonds, the head of interest-rates trading in New York at Cantor Fitzgerald LP, one of 22 primary dealers that trade with the Fed. “I don’t think the yields make a lot of sense. The Fed in the middle of this year will nudge rates higher.”

 

Eoin Treacy's view -

The outsized move in bonds relative to what was a modest pullback for the stock market suggests nervousness on behalf of investors that the stock market’s consistent advance will persist. With today’s rally on Wall Street, bouncing again from the region of the 200-day MA, the requirement to load up on Treasuries has dissipated at least for the short term. 



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December 19 2014

Commentary by Eoin Treacy

Year-Ahead Outlook 2015

Thanks to a subscriber for this report from Deutsche Bank focusing on the credit markets. Here is a section:

 

Historically, it has been the case that lower oil provided a net benefit to the US and EU economies, both of which were large net importers of energy. This remains the case in EU today, however we wonder to what extent this relationship might have changed for the US in recent years. Just looking at energy companies in our IG and HY indexes, we are seeing their cumulative capital expenditures since Jan 2010 at $4.7 trillion, with $1.15trln coming in the last four quarters alone. The latter figure translates into 6.5% of the total US GDP, not an immaterial figure. We realize that not all of this capex went into US shale plays, however it is just as important to acknowledge that not all US shale players are captured by our IG/HY index data. What part of this capex budget gets cut next year is subject to uncertainty, however even a relatively modest cut of 10% could translate into a noticeable 65bp impact on broader GDP figures.

What makes this issue even more consequential to the US economy, is that the negative impact of lower oil is unlikely to remain confined just to the Energy sector alone. Some of the more obvious casualties will include capital goods and materials sectors, where suppliers of drilling equipment, pipes, storage containers, machinery, cement, water, and chemicals used in shale production are all likely to experience a negative impact. Now, readers should be careful to avoid double-counting the same dollars here, as a dollar of capex by oil producer is 80 cents of inventory sold from its suppliers; only incremental value-added is captured by the GDP. Add to this list railroads, where volumes exploded in recent years as large quantities of oil were ferried by rail cars.

All these are relatively obvious casualties of a pullback in energy producers’ budgets. Perhaps somewhat less straightforward would be utilities – we wonder how much electricity was used to power all this new shale-related manufacturing, production, transportation, and refining activity? Taking one more step towards less directly impacted sectors, we think about financials, and not even in a sense of direct loan exposures to cash-flow challenged producers. Energy producers have raised $550bn in new debt across USD IG, HY, and leveraged loan markets since early 2010 (Figure 3). Lower capex budgets would imply lower need (and ability!) to borrow, thus squeezing a revenue source for investment banks.

And now to the least obvious, or perhaps even counterintuitive, candidates: think about consumer discretionary sectors, such as retail, autos, real estate, and gaming. States with the strongest employment growth in the US in the last few years were all states heavily involved in shale development – average unemployment rate in Dakotas, Nebraska, Utah, Colorado, Iowa, Montana, Oklahoma, Wyoming, and Texas is 4.1%, compared to a national aggregate of 5.8%. Average unemployment rate in oil-producing states today is lower than the national aggregate was at any point in time in the last twelve years.

While we still believe that lower oil prices would provide a net benefit to consumer discretionary areas, we think that historical parallels between energy prices and their positive net effects could be challenged in this episode given significant changes to structural characteristics of the US economy. Just as we believe consensus has consistently underestimated positive externalities of the US energy revolution in the past few years, it is positioning itself to underestimate the other side of this development now. 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

The stock market appears to be currently focused on the benign economic scenario that has allowed the Fed to signal short-term interest rates may increase in 2015. With unemployment back to trend and early signs of wage increases, along with recovering economic growth, the Fed has good reason to want to use this environment as an opportunity to replenish its arsenal of policy tools. Consumers will find that they have extra money in their pocket every time they fill up at the pump or pay of heating oil and these benefits will pass on to energy consuming sectors as well. 



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November 19 2014

Commentary by Eoin Treacy

Wages Poised to Rise as Signs Emerge of Improved U.S. Job Market

This article by Richard Clough, Victoria Stilwell and Jennifer Kaplan for Bloomberg may be of interest to subscribers. Here is a section: 

Jockeying for Houston workers goes beyond energy, according to Ray Perryman, president of Waco, Texas-based economic consultant Perryman Group. Construction and even restaurant employees have received signing bonuses, he said by e-mail.

The dearth of pay raises since the recovery began has puzzled economists and surfaced as an issue in the midterm elections. Even as unemployment fell and the economy created jobs, inflation-adjusted compensation per hour rose by only 0.7 percent over the last five years, the weakest growth for any expansion of comparable length since World War II, according to Bureau of Labor Statistics data compiled by Bloomberg.

The most likely culprit, many economists said, was the continuing drag of millions of long-term unemployed people as well as those toiling part-time. That has allowed companies to staff without having to offer fatter paychecks.

Now, the strengthening economy is starting to tighten the labor market, putting pressure on some companies to offer more raises to retain and recruit workers.

 

Eoin Treacy's view -

Since the Fed doesn’t look at energy or food prices in its measure of inflation, wages are an important arbiter of consumer health. The knock-on effect of lower labour force participation in an economy boosted by years of easy money, and more recently by lower energy prices, is that wages need to rise to encourage people back into the system. This now appears to be taking place. 



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October 24 2014

Commentary by Eoin Treacy

Insights in 140 Words October 24th 2014

Thanks to a subscriber for this edition of Deutsche Bank’s weekly missive. Here is a section on a potential evolution of the ECB’s bond buying program:

Wag the Dog - "There is no B-3 bomber" was Robert De Niro's Machiavellian lesson in getting people talking about a story by denying it. Likewise, ECB denials of a corporate bond buying plan certainly got markets talking. If it happens, this will be the central bank's third plan B after targeted LTROs and ABS purchases - plan A being buying sovereign bonds. How much ammunition does plan B-3 offer? Perhaps €550bn, after excluding financial and non-euro area issuers from the iBoxx EUR investment grade index's €1.5tn universe. One potential pitfall is that relative to GDP, this pool is overweight French issuers (one-third) and short German paper (below a quarter). The sector split is similarly skewed with one-third from utilities. Maybe buying the debt of state-owned utilities - the biggest issuer EDF is 85 per cent government held - will break taboos about outright government bonds purchases. 

Eoin Treacy's view -

The ECB has clearly stated that it intends to grow its balance sheet by a €1trillion from its current €2 trillion. It is precluded from buying sovereign bonds because of conditions imposed during the creation of the Euro so it has to look elsewhere for assets to purchase. 

One of the challenges of reanimating the ABS market is that the majority of Euro ABS have already been posted as collateral with the ECB in return for capital. Issuance of new ABS will be required to create a market for the ECB to inject liquidity into. This represents an opportunity for the banking sector but will take time to line up. 

 



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October 22 2014

Commentary by Eoin Treacy

Fears That Pimco and Other Big Firms Could Be Unable to Unload Risky Bonds

Thanks to a subscriber for this article by Landon Thomas Jr. for The New York Times which may be of interest. Here is a section: 

“Credit-focused mutual funds have seen massive inflows and have become the largest holders of corporate and foreign bonds,” José Viñals, the head of the I.M.F.’s financial-markets division, said at a news conference in Washington last week. “These inflows have created a liquidity illusion, which can amplify shocks and lead to sharper falls in the market.”

The issue has also drawn the attention of the Federal Reserve Bank of New York.

In its paper, the I.M.F. highlighted high-yield bonds issued by Ally Financial, SLM and the insurance giant American International Group. Pimco owns at least 25 percent of the outstanding debt of each of those three companies.

Outside the United States, the numbers were even starker: Pimco owned close to 50 percent of a number of foreign bonds. And it controlled over 40 percent of the debt issued by the Bank of China, just under 40 percent of the State Bank of India and close to 30 percent of the Spanish bank BBVA.

Of course, Pimco has company in accumulating outsize positions in these and other companies.

As the I.M.F. report lays out, Franklin Templeton Investments has large stakes in the high-yield bonds issued by Tenet Healthcare and the payment processor First Data, among others. Franklin has also bet big on bonds from Ireland and Ukraine. According to the fund, managers like Fidelity Investments, Dodge & Cox and BlackRock have significant, though smaller, positions in selected debt issues.

That asset management companies have emerged as the main providers of riskier types of credit to companies around the world is a little-appreciated consequence of increased regulation of banks following the financial crisis.

 

Eoin Treacy's view -

Making a call on the actual rather than perceived default risk of an institution or country and then accumulating its bonds is what a fund manager is supposed to do. Buying Italian, Spanish, Irish sovereigns in the teeth of the Eurozone’s debt crisis was a courageous step and was the right thing to do. Betting that SLM Corp (education loans) survive because the US Government bailed out Fannie and Freddie was also an astute call. 

Fund managers boosted the returns from taking these positions by concentrating their portfolios. This is particularly true of Pimco and Franklin Templeton who now hold substantial positions in a relatively small number of issuers. 

 



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October 15 2014

Commentary by Eoin Treacy

Greek Bonds Extend Selloff, Pushing Yield Up Most in Two Years

This article by Lukanyo Mnyanda for Bloomberg may be of interest to subscribers. Here is a section: 

The selloff spread today to other higher-yielding markets with Italian rates climbing the most since June. The yield on Greek 10-year securities reached a seven-month high after Alternate Finance Minister Christos Staikouras yesterday reiterated the country’s intention to raise cash by selling seven-year notes. German 10-year yields slipped to a record amid concern the global economy is slowing.

“The main factor that is pushing Greek yields higher is the uncertainty, or their plan to exit the bailout early, and the market clearly isn’t cheering for that,” said Jan von Gerich, a fixed-income analyst at Nordea Bank AB in Helsinki.

“It’s clear that they are not ready to make it on their own yet. If they need to finance themselves from markets in large volumes that is not going to work with current yields.”

 

Eoin Treacy's view -

Last week, the 2-year bonds of Germany, Switzerland, Denmark, Finland, Netherlands, Belgium and Ireland were trading at negative yields. That kind of compression in risk premia might be explained as momentum driven but one really has to question a situation where you are paying a government to take your money rather than the other way around. Since then Irish 2-year yields are back in positive territory. However considering that this list represents some of the more secure sovereigns in the Eurozone, it is worth considering the outlook for some of the weaker countries most reliant on access to cheap capital. 



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October 13 2014

Commentary by Eoin Treacy

Treasury Futures Rise as Fischer Warns on Global Growth

This article by Liz Capo McCormick and Kristine Aquino for Bloomberg may be of interest to subscribers. Here is a section: 

“If foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise,” Fischer said in an Oct. 11 speech at the IMF’s annual meetings in Washington.

Chicago Fed President Charles Evans is due to discuss current economic conditions and monetary policy in Indianapolis today.

The implied yield on the Eurodollar future contract expiring in December 2015 fell seven basis points to 0.825 percent from 0.895 percent on Oct. 10. The rate was 1.065 percent a month ago.

Minutes of the Fed’s September meeting released Oct. 8 showed authorities highlighted concern that deteriorating growth abroad and a stronger dollar may hurt the domestic economy by curbing exports and damping inflation.

Eoin Treacy's view -

As long as global growth trajectories continue to moderate the prospect of central banks raising interest rates is remote. However the need for additional quantitative easing is not obvious, not least as oil prices remain weak which represents a tailwind for the wider economy. Nevertheless, as volatility on equity markets increases, Treasuries represent an attractive safe haven from the perspective of many investors and yields have compressed. 



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September 26 2014

Commentary by Eoin Treacy

Pimco Closed-End Funds Plunge Following Bill Gross Exit

This article by Joseph Ciolli and Oliver Renick for Bloomberg may be of interest to subscribers. Here is a section: 

In the stock market, investors didn’t wait around to assess the implications of Bill Gross’s departure from Pacific Investment Management Co. -- they sold.

Pimco’s Global StocksPlus & Income Fund slipped 7.4 percent to $22.25 at 12:05 p.m. in New York, while the firm’s High Income Fund decreased 7.4 percent to $11.53, the biggest drop in almost two years. The Pimco Corporate & Income Opportunity Fund slid 5.2 percent to $17.44, and the Pimco Total Return ETF declined 0.2 percent to $108.66.

The retreat whipsawed investors who were used to hearing Gross praise the same securities as a good way to navigate his “new neutral” era of slowing growth and falling interest rates. He owned shares in 14 Pimco closed-end funds as of the start of July after adding almost $60 million of his own money in May and June, data compiled by Bloomberg showed.

 

Eoin Treacy's view -

We might never know but the departure of Mohamed El Erian earlier in the year and now Bill Gross suggests some deep dissatisfaction with the structure of the company when its two leading lights decide to leave rather than stay and work to make it better. This is a blow for

 



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September 18 2014

Commentary by Eoin Treacy

Fed Interest Rate Projections Increased

Thanks to a subscriber for this report from Commonwealth Bank of Australia focusing on yesterday’s Fed statement. Here is a section:

With asset purchase tapering close to completion and the turning point in the Fed’s monetary policy cycle approaching, focus on the Fed’s monetary policy normalisation process is growing. On this front, the FOMC released a supplementary document that outlined its “policy normalisation principles and plans”.

The FOMC stipulated that the recent discussion on the topic of normalisation is part of its “prudent planning” and did not imply it “will necessarily begin soon”. According to the FOMC, many of the normalisation principles adopted in mid-2011 remain applicable. However, in light of changes to the System Open Market Account (SOMC) portfolio in recent years and other enhancements in the tools available to the FOMC, some adjustment to the previous guide may be necessary.

All but one member of the FOMC agreed on the following key elements of the approach intended to be taken when monetary policy normalisation was deemed appropriate:

(a) When less policy accommodation is warranted, the FOMC will raise the “target range” for the funds rate. During normalisation, the Fed intends to move the funds rate into the target range “primarily by adjusting the interest rate it pays on excess reserve balances” (IOER).

(b) The Fed also intends to use an overnight reverse repurchase agreement facility and other supplementary tools to help control the federal funds rate. In our view, this is designed to keep the effective fed funds rate from falling too far below the IOER rate.

(c) The size of the Fed’s balance sheet will be reduced in a “gradual and predictable” manner, primarily by ceasing to reinvest repayments of principal on securities. The FOMC expects to “cease or commence phasing out reinvestments” after it beings to raise the target range for the federal funds rate. Selling of Mortgage Back-Securities is not anticipated to be part of the normalisation process. But should limited sales be warranted in the longer run, such sales would be communicated in advance. 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

As we approach the end of QE tapering, it is logical to ask when the size of the Fed’s balance sheet is likely to contract. Since the rally on Wall Street has been fuelled in large part by liquidity, the answer is an important one. 



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September 16 2014

Commentary by Eoin Treacy

Long-Term Asset Return Study - Bonds: The Final Bubble Frontier

Thanks to a subscriber for this heavyweight 104-page report from Deutsche Bank which may be of interest to subscribers. Here is a section:

We ask whether bonds are the final bubble in what has been a near two decade rolling series of inter-related bubbles? After the Asian/Russian/LTCM crises of the late 1990s we entered a super cycle of very aggressive policy responses to major global problems. In turn this helped encourage the 2000 equity bubble, the 2007 housing/financial/debt bubble, the 2010-2012 Euro Sovereign crisis and arguably some recent signs of a China credit bubble (a theme we discussed in our 2014 Default Study). At no point have the imbalances been allowed a full free market conclusion. Aggressive intervention has merely pushed the bubble elsewhere. With no obvious areas left to inflate in the private sector, these bubbles have now arguably moved into government and central bank balance sheets with unparalleled intervention and low growth allowing it to coincide with ultra low bond yields.

This is not to say the bubble will pop in the foreseeable future. The bubble probably needs to continue in order to sustain the current global financial system and the necessary future deleveraging. However future inflation or, even more extreme, the risk of sovereign restructuring would mean most government bondholders are unlikely to achieve a positive real return over the medium to long-term. There is a narrow corridor for future performance with yields recently moving significantly lower in many parts of the world and with debt levels still moving higher. It is because of this that we would argue bonds are exhibiting bubble tendencies.

Indeed bond yields are currently close to multi-century, all-time lows in many European countries and in their lowest decile in virtually all others. However real yields are less extreme, having been lower on 20-40% of occasions through history for most countries and are currently closer to median levels in the periphery. This is the most compelling argument for suggesting yields could still move lower in the near-term whatever the medium-term view.

Real yields are higher due to low inflation. However current inflation at the global level is not actually as low relative to history as the perceived wisdom suggests. In the US and UK it’s currently around median levels seen since 1790 and 1693 respectively. If we narrow the analysis period to the last 100 years, inflation in these two countries has been lower on 38% and 30% of the time. Looking at the same last 100 year period in Europe, inflation has been lower only 12% of the time for France and Italy and 9% for Spain. So it is here that the low inflation concerns are most justified.

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

In 2005, when the Chinese government stepped in to support the equity market it fuelled the expansion of a stock market bubble. When Fannie Mae and Freddie Mac loosened credit standards in order to make mortgages available to people who would not previously have been eligible, a bubble inflated in the subprime sector. The creation of the Euro allowed cheap capital to be funnelled to peripheral countries which had not previously had access to such abundant low cost funds and bubbles developed in property, bank and sovereign debt. These examples highlight that government and central bank actions can create dislocations in the market which fuel speculation and ultimately result in a burst bubble.



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September 15 2014

Commentary by Eoin Treacy

Australians Face Repayment Shock on High-Risk Lending

This article by Narayanan Somasundaram and Nichola Saminather for Bloomberg may be of interest to subscribers. Here is a section:

Prices in our area have increased about a quarter of a million dollars just in the past couple of years,” said Dowd of broker Ray White Baulkham Hills, adding that the number of people choosing to sell their homes at auction is at a 15-year high. “We’ve seen a sharp increase in auctions in just the past three months because people are seeing the exceptional results others are getting and saying, ‘I want what he has.’”

Martin North, Sydney-based principal at researcher Digital Finance Analytics, said inexpensive mortgages have emboldened households to take bigger loans that they may have trouble repaying.

“There’s no doubt the low rates have got many borrowers out of jail,” he said.

A 2 percentage point rise in interest rates would put more than 25 percent of households in mortgage stress within 12 months, he said. They would need to cut other expenses and increase credit card debt to keep up with repayments.

“It’s parallel to what happened in the U.S. before the global crisis,” when easy credit to high-risk borrowers inflated a housing bubble that burst, creating a wave of defaults.

Genworth Mortgage Insurance Australia Ltd., the country’s largest mortgage insurance provider for lenders, is taking on more risky policies and while house prices have gone up, “froth is being mistaken for beer,” CLSA Ltd.’s Sydney-based analysts led by Jan van der Schalk said in an investor note Sept. 10.

Lenders mortgage insurance covers losses when homeowners default and helps lenders to recoup costs.

Prepayment Shock
Loans to investors accounted for 33.8 percent of all mortgages in the three months through June, the highest level since March 2009, APRA figures show. Outstanding interest-only loans -- where borrowers can postpone repayment of the principal for a set number of years -- increased to 35 percent, the highest since APRA began reporting the data.

“For those borrowers who’ve taken out interest-only loans, there’s always a prepayment shock when the interest-only period ends,” said Serov at Moody’s, which forecasts rates will rise over the next 18 months. “In a rising rate environment, that repayment shock is greater and delinquency rates for those loans would be greater.”

Eoin Treacy's view -

Record low interest rates represent an ideal time to borrow on fixed rates since one can lock in the risk one is taking on future central bank decisions. However the temptation when credit is cheap is to borrow too much in order to purchase a home whose price has accelerated as everyone else chases the same market.

The saving grace of cities like Sydney and London has been the dearth of building which has contained supply and supported high prices. The attraction of both cities for foreign investors has also been a considerable source of additional demand which has forced locals to compete with wealthy foreigners. Record low interest rates mean that taking out an adjustable rate mortgage today is straight momentum speculation.   



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September 05 2014

Commentary by Eoin Treacy

Insights in 140 Words September 5th 2014

Thanks to a subscriber for this edition of Deutsche Bank’s weekly missive. Here is a section on the ECB’s planned purchase of Asset Backed Securities:

Buying ABS - Mario Draghi refused to put a number to the ECB’s new asset purchase programme. Let’s try for him. Of the €1tn outstanding ABS about a third is not acceptable collateral. Next consider that in order to revive the market buying everything eligible is not an option either. As a cross check the Federal Reserve owns a third of the agency MBS market in America. By that benchmark the ECB’s potential pool is closer to €200bn plus a share of any new issuance. How does that number translate into new lending? Certainly being mostly restricted to senior tranches does not free up much bank capital. And €200bn of additional liquidity only makes up for LTRO repayments year to date. What is more half of all eligible securities already sit with the ECB as repos hence the incremental liquidity is smaller still.

Eoin Treacy's view -

While the ECB has so far demurred from reinitiating outright purchases of Eurozone sovereign debt, the relatively small size of the Eurozone’s ABS market suggests that it will have little choice but to explore sovereign purchases if it wishes to increase the size of its accommodation. 



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September 04 2014

Commentary by Eoin Treacy

Draghi Sees Almost $1 Trillion Stimulus With No QE Fight

This article by Simon Kennedy for Bloomberg may be of interest to subscribers. Here is a section:

Pledging to “significantly steer” the European Central Bank’s balance sheet back toward the 2.7 trillion euros of early 2012 from 2 trillion euros now, the ECB president today announced a final round of interest-rate cuts and a plan to buy privately owned securities. His mission: to revive inflation in the 18-nation euro area.

Fully-fledged quantitative easing as deployed in the U.S. and Japan wasn’t enacted amid a split on the 24-member Governing Council, with Bundesbank President Jens Weidmann opposing the new stimulus and others seeking more. The latest round of measures pushed the euro below $1.30 for the first time since July 2013 and sent European bond yields negative.

The steps “probably reflect that President Draghi does not have unanimity, or a large enough majority for quantitative easing,” said Andrew Bosomworth, a Munich-based portfolio manager at Pacific Investment Management Co. and a former ECB economist. “The ECB is ready to do more if more is needed.”

Eoin Treacy's view -

The ECB announced a number of months ago that in addition to implementing a negative deposit rate, it would also seek to reverse the contraction of its balance sheet, explore asset backed security purchases and potentially adopt a fully-fledged quantitative easing program. The timing might not have been ideal at the beginning of the summer but with the Fed’s QE winding down, the ECB now has little choice but to pick up the slack if it is to maintain the access to liquidity on which the Eurozone’s banking sector relies.

 



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September 02 2014

Commentary by Eoin Treacy

Oaktree Is Said to Seek $10 Billion Fund for Future Distress

This article by Sabrina Willmer and Devin Banerjee for Bloomberg may be of interest to subscribers. Here is a section: 

Distressed-focused funds have found difficulty investing money as the U.S. Federal Reserve holds interest rates near zero and global corporate defaults remain low. Such defaults fell to
66 last year from a peak of 266 in 2009, according to data from Moody’s Investors Service. Oaktree this year cut the $3 billion goal on its control-investing fund by about 40 percent as it struggled to find opportunities.

The firm, led by Chairman Howard Marks, doesn’t expect the dry spell to last for long. “Credit standards have dropped and non-investment grade debt issuances reached record levels,” John Frank, Oaktree’s managing principal, said July 31 on a conference call with investors and analysts. “Aggressive extensions of credit of the sort we’re seeing today have always been a precursor to a substantial distressed-debt opportunity.”

Eoin Treacy's view -

A number of headlines have reported that covenant-lite lending has surpassed the 2007 peak again this year and highlighted that this is far from a healthy medium-term development. The momentum of lending to high risk credits is being fuelled by yield to maturity investors who cannot accept the return on Treasuries while rates are so low. Pension funds and other such groups have an expected rate of return they have to achieve. Since this cannot be gained from yields they are forced into relying on capital appreciation. So far this year, the trade has worked out with Treasury prices rallying. Monitoring the consistency of the trend will be important as the anticipated change to Fed monetary policy draws closer. 

 



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August 27 2014

Commentary by Eoin Treacy

BlackRock Appointed as ECB Consultant for ABS-Purchase Plan

This article by Paul Gordon for Bloomberg may be of interest to subscribers. Here is a section: 

The ECB contract requires BlackRock to ensure effective separation between its project team working for the central bank and its staff involved in any other ABS-related activities, the ECB spokesman said. External audits related to the management of conflicts of interest will also be made available.

The company, headed by Chief Executive Officer Laurence D. Fink, has more than $4 trillion of assets under management. It is among the largest investors in European ABS, with portfolios spanning debt backed by commercial mortgages to auto loans, according to data compiled by Bloomberg.

The final decision on the design and implementation of any ABS-purchase program will be taken by the ECB’s Governing Council, and the execution will remain the responsibility of the central bank, the spokesman said.

 

Eoin Treacy's view -

In much the same way that the Fed has been an active participant in the market for Mortgage Backed Securities (MBS), Mario Draghi made clear that the ECB is exploring options for revitalising the European asset backed market in an effort to inject liquidity into the domestic Eurozone financial sector. This is no small task since the market remains illiquid and issuance has been tepid. Appointing Blackrock as a counterparty is a first step towards what could potentially be a fully- fledged Eurozone quantitative easing program. 



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August 15 2014

Commentary by Eoin Treacy

Ukraine Tenisons Flare as Poroshenko Touts Strike on APCs

This article by Daryna Krasnolutska and Scott Rose for Bloomberg may be of interest to subscribers. Here is a section:

Tensions flared in Ukraine yesterday as the government said its army destroyed part of a column of military vehicles that crossed the border from Russia, even as Vladimir Putin denies any military presence in the country.

President Petro Poroshenko said Ukrainian forces destroyed part of a column that had arrived from Russia. The Foreign Ministry in Moscow rejected the statement and warned about a potential attack on another convoy that carries aid. Ukraine’s top diplomat, Pavlo Klimkin, said he will meet with his Russian, German and French counterparts tomorrow in Berlin.

Eoin Treacy's view -

The geopolitical stakes continue to be raised in Eastern Europe and show little sign of improving. 



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August 05 2014

Commentary by Eoin Treacy

Half-Trillion-Dollar Exodus Magnifying U.S. Bill Shortage

This article by Liz Capo McCormick and Daniel Kruger for Bloomberg may be of interest to subscribers. Here is a section: 

During the past five years, America has enjoyed some of the lowest financing costs in its history as the Fed held its benchmark rate close to zero and bought trillions of dollars in bonds to restore demand after the credit crisis.

Based on prevailing Treasury bill rates, it costs the U.S. just 0.02 percent to borrow for three months as of 8:49 a.m. today in New York. In the five decades prior to 2008, the average was more than 5 percent.

Now, with traders pricing in a 58 percent chance the Fed will raise its overnight rate by July, speculation is building that borrowing costs are bound to increase. That’s made finding buyers for the nation’s debt securities even more important.

The sweeping rule changes in the money-market fund industry may help provide that demand. Since 1983, money-market funds have been permitted to keep share prices at $1, meaning a dollar invested can always be redeemed for a dollar.

Unnecessary Risk
Institutional prime money funds, which invest in short-term IOUs issued by companies known as commercial paper, are among the funds that will now have to report daily prices which may fluctuate based on their underlying holdings, according to rules adopted July 23 by the Securities and Exchange Commission.

The SEC the will also give the funds the ability to impose fees on redemptions and lock up investors’ money for as long as 10 days when a fund faces an inability to meet redemptions.

The changes are intended to prevent a repeat of 2008, when the collapse of the 37-year-old, $62.5 billion Reserve Primary Fund triggered a run on other money funds and deepened the worst financial crisis since the Great Depression.

Still, investors using prime funds to manage their idle cash may find floating prices an unnecessary risk when differences in fund rates are so minimal, said Brian Smedley, an interest-rate strategist at Bank of America in New York.

He estimates about half the $964 billion held in institutional prime funds will flow into those that only invest in government debt and yield about 0.013 percentage point less, before the new rules become fully effective in 2016.

Eoin Treacy's view -

Governments have a knack for creating demand for their paper through manipulation of regulations. Exactly the same types of move have been introduced in the UK and Europe with regard to the insurance sector and the quality of paper they can hold to compensate for risk. Some commentators have wondered at the fact that the short end of the curve has not risen more as the prospects of Fed tightening increase. However the reality is that demand remains robust not least because of regulatory changes that necessitate funds hold short-term paper. 



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July 17 2014

Commentary by Eoin Treacy

Construction of New U.S. Homes Declines on Plunge in South

This article by Victoria Stilwell for Bloomberg may be of interest to subscribers. Here is a section: 

Construction of single-family houses declined 9 percent to a 575,000 rate, the weakest since November 2012, the report showed. The drop was influenced by a 20.1 percent plunge in the South, the biggest decrease since May 2010.

Work on multifamily homes, such as apartment buildings, fell 9.9 percent to a 318,000 rate. The figures on multi-unit construction can be volatile month to month.

Residential real estate has been slow to emerge from an early-year, winter-driven slump -- a development not lost on Yellen.

While housing has recovered from its lows, “activity leveled off in the wake of last year’s increase in mortgage rates, and readings this year have, overall, continued to be disappointing,” Yellen said this week during her semi-annual testimony to the Senate Banking Committee.

 

Eoin Treacy's view -

On my daily click through of global markets I noticed lumber prices may be rolling over; having at least encountered resistance in the region of the progression of lower rally highs following a reversionary rally. Since home construction represents a significant market for the commodity the underperformance of the S&P500 Homebuilders Index is probably related.



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July 16 2014

Commentary by Eoin Treacy

Buy-to-Let Inflating Real Estate Seen Creating Peril

This article by Patrick Gower and Neil Callanan for Bloomberg may be of interest to subscribers. Here is a section: 

Lenders provided 2.2 billion pounds ($3.8 billion) of private-landlord mortgages in April, a 57 percent increase from a year earlier, according to the Council for Mortgage Lenders.

Almost half of that by volume was refinancing. Gross mortgage lending increased 36 percent to 16.6 billion pounds and loans to first-time buyers gained 47 percent to 3.5 billion pounds in the same period.

Homes bought as rentals made up about 14 percent of new mortgages during the second quarter, according to the CML.

Lenders offer a record 637 buy-to-let mortgage products, a 37 percent rise from a year earlier, according to broker Mortgages for Business Ltd.

Lenders “who aren’t into it want to go into it; those that are there want to expand,” said Richard Sexton, a director at property appraiser e.surv. “It’s a different pool to fish in.”

 

Eoin Treacy's view -

The London House Prices Index has accelerated higher over the last two years as low interest rates, a recovering economy, strong demand from foreign buyers and low inventory fuelled prices advances. The Index has risen 30% since early 2012.  As anyone who has attended The Chart Seminar will recall; acceleration is a trend ending of undetermined duration. There is no evidence yet that the advance has ended but the first clear downward dynamic is likely to signal a peak of at least near-term significance. 



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July 09 2014

Commentary by Eoin Treacy

We will continue to swim in a sea of liquidity

Thanks to a subscriber for this transcript of a roundtable between Felix Zulauf, James Montier and David Iben from Finanz und Wirtschaft. Here is a section:

Do your clients still believe in the much-cited low return environment? The further markets move up, the more you might have a credibility issue.

Montier: No doubt. We haven’t yet reached the kind of loathing that was displayed towards us in 1999 where we were just told we were complete idiots and several clients banned us from their buildings. I think there is a broader acceptance of the power of valuation, but the longer the rally goes on, the shorter people’s memory gets. Galbraith used to talk about the extreme brevity of financial memory and I fear that’s kind of what we’re experiencing now. People are looking at last year and say look, it can go up 30%, why on earth are you saying future returns are going to be dismal.

But markets have been expensive for quite some time. How opportunistic should a value investor be?

Montier: There are two possible states of the world: either they keep rates low for a very long period of time or they don’t. Anyone who says they know which one is going to happen is either a liar or a fool or possibly a linear combination with unknown weights. The reality is, nobody knows the future, particularly when it comes to policy rates. By second guessing we’re playing some sort of ridiculous beauty contest. Therefore we should try to build portfolios which are robust and can survive different outcomes.

How do these portfolios look like?

Montier: That’s a challenge because the portfolios you want to hold in those two different worlds are almost diametrically opposed. If financial repression continues, you want to own the least bad thing out there, which is equities. In the other world, the only asset which does not hurt you when rates move to normal, is cash. So you end up with this bizarre portfolio where you own some equities where they are cheap. And you want to own some dry powder assets which protect you against inflation, provide liquidity and real return.

 

Eoin Treacy's view -

The question of when rates will normalise and what this will mean for financial markets is an important one where people tend to have some strong views. In monitoring the global liquidity situation let us proceed with the assumption that capital is mobile. Therefore money created by one central bank can be deployed just about anywhere. This means that in monitoring liquidity we cannot simply think about the Fed’s tapering. Quantitative easing might have been the most high profile of the extraordinary monetary policy tools employed but it is far from the only one. 

Despite tapering the Fed’s Balance Sheet continues to trend higher. The pace of the advance has moderated somewhat but it is still increasing. Wall Street continues to have a similar trajectory. 

 



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June 27 2014

Commentary by Eoin Treacy

Why Bond Buyers Love That Companies Are Borrowing More Than Ever

This article by Lisa Abramowicz for Bloomberg may be of interest to subscribers. Here is a section: 

Balance sheets are also getting better, with companies improving their profitability faster than they’re borrowing.

Gross leverage ratios for the average investment-grade issuer fell to 2.58 times in the first quarter from 2.59 times at the end of the year, according to Morgan Stanley data measuring total debt to earnings before interest, taxes, depreciation and amortization. That’s down from 2.73 times in 2009.

Federal Reserve Chair Janet Yellen is fueling the debt party by making it clear that she’s planning to hold benchmark rates low for a prolonged period.

And even though the amount of outstanding investment-grade bonds in the U.S. has ballooned by almost $1.6 trillion since 2008, some of that growth has stemmed from companies shifting into longer-term bonds and out of shorter-term commercial paper, Barclays Plc strategists led by Jeffrey Meli noted in a report today.

Maybe investors shouldn’t be too complacent because equations will change when benchmark yields rise, making it more costly for companies to borrow.

Also, they’re getting paid less and less to own the bonds.

Eoin Treacy's view -

The spread of BBB USD Corporates over Treasuries is almost back to where it was in 2007 at 130 basis points. Taken in isolation this tells us that demand for bonds is at least on par with where it was in the pre-credit crisis era. When we also factor in that on an absolute basis, the yield on offer for BBB bonds is at least 200 basis points lower than in 2007, the attraction of borrowing as much as possible is obvious.



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June 25 2014

Commentary by Eoin Treacy

Capex about to turn up: The missing link in the US recovery

Thanks to a subscriber for this report from Deutsche Bank which may be of interest. Here is a section: 

Spending on non-residential structures fell to unusually depressed levels following the financial crisis and has remained weak during this recovery. Similar to residential investment, much of this weakness can be attributed to a need to work through the overbuilding that occurred during the run up to the financial crisis, as structures share of GDP rose rapidly from 2004 through 2008. There are some indications that this excess supply has diminished materially and that pent up demand for non-residential structures should lead to stronger spending going forward. For example, the vacancy rate for office space nationally has declined steadily over the past four years toward historically more normal levels (Chart 18). In addition, in response to the shale energy boom in the US, investment in energy-related structures has been notably strong. This supports the outlook for a pickup in investment in commercial structures.

IPP: Uptrend should continue
Spending on IPP – composed of spending on software, R&D, and entertainment, literary and artistic originals – has displayed a steady uptrend as a share of GDP over the past several decades, which has been relatively impervious to cyclical factors. Recent strength in IPP spending has been driven primarily by the R&D component. IPP spending may also benefit from a shift away from investment in information processing (IP) equipment.

Equipment: IP equipment has been notably weak
Equipment spending as a share of GDP remains well below historical averages for this point of the recovery. In this section we take a more granular look at equipment’s components to analyze the underlying causes of this weakness. We have already determined that transportation equipment is near longer-term averages. We also find that recent contributions to BFI from industrial equipment and the “other” equipment category appear to be in line with longer-term averages. Conversely, IP equipment appears to be the component driving much of the softness in total equipment spending. Spending on IP equipment has been consistently below its longer-term average contribution to overall fixed investment during this recovery (Chart 19). 

Eoin Treacy's view -

The majority of established technology companies rely on corporate spending to boost earnings. The outperformance of the Nasdaq-100 highlights the fact the corporations have been spending on software and other services. The return to outperformance of the industrial sector in 2012 reflects increased spending on machinery and embedded processors. Generally speaking there is a perception that the US recovery is weaker than one might expect but the fact that companies are embarking on increased spending is a sign of confidence. 



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June 24 2014

Commentary by Eoin Treacy

The Future of Spanish Pensions

Thanks to a subscriber for this report by Javier Diaz-Gimenez and Julian Diaz-Saavedra which may be of interest to subscribers. Here is a section: 

Three recent articles have studied the 2011 Reform of the Spanish pension system. Conde-Ruiz and Gonzalez (2013) and De la Fuente and Domenech (2013) simulate two individual life-cycle models and they conclude that the 2011 Reform will reduce the expenditure in pensions somewhat, but that it is insufficient to solve the middle and long-term sustainability problems faced by the Spanish pension system. And a report published by economists form the Spanish Finance Ministry (MEH, 2011) simulates an aggregate accounting model economy and reaches a similar conclusion.

The 2013 Delay. In 2013, when the 2011 reforms were starting to be implemented, the Spanish government enacted a further gradual delay of the first retirement age. This delay increases the first retirement age from 63 to 65 years, one month per year starting in 2013, for workers who retire voluntarily. 

In the second model economy that we study in this article we simulate the 2011 Reform and the 2013 delay simultaneously and we find that this reform extends in five years —from 2018 to 2023— the duration of the pension reserve fund, that it reduces the total debt that would have been accumulated by the pension system until 2050, from 212 to 124 percent of that year GDP, and that it reduces the consumption tax rate needed to finance the pensions from 45 percent to 39 percent. Consequently, we conclude that this reform is insufficient to solve the sustainability problem of the Spanish pension system.

The 2013 Sustainability Factors. The 2011 Reform made provisions to add a sustainability factor to Spanish pensions. This factor would take into account the expected duration of retirement and would reduce the real value of pensions as needed to ensure the financial sustainability of the system, effectively changing the Spanish pension system from a defined-benefit system to a defined-contribution system.

 

Eoin Treacy's view -

Spain isn’t the only country with a hole in its pension program.  Considering the propensity of politicians to delay painful decisions until they have no other option we can anticipate that the majority of these issues will rumble on for quite some time to come. For the moment fixed income investors are more than willing to give the sovereign debt of countries like Spain and Italy the benefit of the doubt. 



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June 17 2014

Commentary by Eoin Treacy

Treasuries Drop Most in 2 Weeks on Inflation Jump as Fed Meets

This article by Daniel Kruger and Cordell Eddings for Bloomberg may be of interest to subscribers. Here is a section: 

“There is inflation -- you can feel it, you can see it as a consumer -- now it’s starting to creep into the actual numbers,” said Michael Franzese, senior vice president of fixed-income trading at ED&F Man Capital Markets in New York.

The Federal Open Market Committee is “going to see these numbers, and hopefully we’ll get some kind of dialog.”

Traders are pricing in a 63 percent chance policy makers will raise interest rates by July next year.

The Fed is reducing its monthly bond purchases, while keeping the target for overnight lending between banks in the range of zero to 0.25 percent where it has been since 2008.

Officials signaled at their April 29-30 meeting that interest rates will stay low for a “considerable time.”

Treasuries gained yesterday after the International Monetary Fund said it now sees the world’s largest economy growing 2 percent this year, down from an April estimate of 2.8 percent. The IMF left a 2015 prediction unchanged at 3 percent, and said it doesn’t expect the U.S. to see full employment until the end of 2017, amid slow inflation.

 

Eoin Treacy's view -

Consumers have been complaining about inflation for quite some time, not least because the price of anything normal people spend money on has increased. In such cases the hedonics employed by the Fed offer cold comfort. As inflation shows up in official statistics, the Fed’s overt courting of inflation appears to be finally seeing results. While this will put pressure on the Fed to follow tapering with a series of incremental interest rate hikes, it is also worth remembering that the Bank of England has had inflation figures coming in above its target for a number of years and is only now beginning to talk about raising interest rates. The Fed will probably want to see inflation figures remain robust before making an big decision.



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June 12 2014

Commentary by Eoin Treacy

Fed Prepares to Keep Record Balance Sheet for Years: Economy

This article by Craig Torres and Matthew Boesler for Bloomberg may be of interest to subscribers. Here is a section:

Officials worry that such sales would spark an abrupt increase in long-term interest rates, making it more expensive for consumers to buy goods on credit and companies to invest, according to James Bullard, president of the Federal Reserve Bank of St. Louis.

That “is a widespread view in parts of the Fed, I think, and in financial markets,” Bullard said in an interview last week. While he disagrees with that perspective, it “won the day.”

The Fed is testing new tools that would allow it to keep a large balance sheet even after it raises short-term interest rates, a step policy makers anticipate taking next year. They would use these tools to drain excess reserves temporarily from the banking system.

“It is pretty clear they are anticipating operating in a situation with a lot of reserves and a high balance sheet for a long time,” said former Fed governor Laurence Meyer, a co- founder of Macroeconomic Advisers LLC, a St. Louis-based forecasting firm.

 

Eoin Treacy's view -

The US government deficit has shrunk from a credit crisis nadir of 10% to its current 2.9% and continues to improve. This has meant the Treasury is issuing fewer bonds. However, the Federal Reserve’s balance sheet has continued to expand which has been a tailwind for Treasury prices. If the Fed continues to cut is purchase sizes by $10billion a meeting it will cease purchasing Treasuries and mortgage bonds by October. 
 

 



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June 06 2014

Commentary by Eoin Treacy

Email of the day on Eurozone ABS funds

Investment funds indicate 5% entry fee but today most brokers don’t apply them, especially online brokers. Here are the only two ABS fund which I found, and you can buy in Europe, they are open end investment funds:

LU0189453128 Julius Baer ABS
LU0255620626 Nordea Mortgage Backed 

 

Eoin Treacy's view -

Thank you for this informative email contributed in the spirit of Empowerment Through Knowledge. Both the above funds have been added to the Chart Library. 



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June 05 2014

Commentary by Eoin Treacy

Full Text of Mario Draghi speech

Today’s raft of measures from the ECB represent a major surge in global liquidity. Here is a section from the speech

This package includes further reductions in the key ECB interest rates, targeted longer-term refinancing operations, preparatory work related to outright purchases of asset-backed securities and a prolongation of fixed rate, full allotment tender procedures. In addition, we have decided to suspend the weekly fine-tuning operation sterilising the liquidity injected under the Securities Markets Programme.

The decisions are based on our economic analysis, taking into account the latest macroeconomic projections by Eurosystem staff, and the signals coming from the monetary analysis.

Together, the measures will contribute to a return of inflation rates to levels closer to 2%. Inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%. Looking ahead, the Governing Council is strongly determined to safeguard this anchoring. Concerning our forward guidance, the key ECB interest rates will remain at present levels for an extended period of time in view of the current outlook for inflation. This expectation is further underpinned by our decisions today. Moreover, if required, we will act swiftly with further monetary policy easing. The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate should it become necessary to further address risks of too prolonged a period of low inflation.

 

Eoin Treacy's view -

The ECB’s policies have contributed to the deflationary forces which continue to pose a threat to their aim of anchoring inflationary expectations. Most particularly the Bank’s program of sterilising capital infusions to the financial sector, by withdrawing liquidity elsewhere, has been a headwind to the bloc’s domestic economic activity. By allowing its balance sheet to expand once more, the ECB is removing an obstacle to growth.   

 



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May 30 2014

Commentary by Eoin Treacy

Insights in 140 Words for May 29th 2014

Thanks to a subscriber for this edition of Deutsche Bank’s weekly snapshot on topical issues. Here is a section on Treasuries: 

What’s behind the relentless rally in Treasuries this year? Ten year yields have fallen 60 basis points since January and are approaching 12 month lows. Half the spike following the taper tantrum has now been retraced. Explanations abound. Some focus on marginal demand, for example Chinese buying via Belgium (note the falling renminbi), short-covering or a rotation into bonds as equities reach new highs. Others make a relative value argument: widening spreads versus Bunds, a lower terminal Fed funds rate, weak US first quarter data. But few mention falling supply. A shrinking US deficit means less Treasury issuance. Indeed year-to-date net issuance is down 60 per cent from 2013. And at $490bn this year, the deficit is forecast to shrink by another $200bn, nearly matching the reduction in Fed buying. Investors just can’t get enough of US Treasuries - quite literally.

Eoin Treacy's view -

The fact that the US Treasury is issuing less debt is a topic discussed regularly in the Subscriber’s Audio. This chart of the Fed’s balance sheet illustrates how it has continued to increase despite the Fed’s tapering over the last six months. At least part of the reason the Fed has been able to taper is because there are fewer bonds being issued for it to buy. 

Interestingly, the last two weeks are the first time the Fed’s balance sheet contracted on consecutive weeks in more than a year. Two weeks and a mild contraction do not make a trend, but this index is worth watching considering how dependent on liquidity the stock market has become. 

 



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May 28 2014

Commentary by Eoin Treacy

ECB Says Search for Yield May Harm Financial Stability in Europe

This article by Alessandro Speciale for Bloomberg may be of interest to subscribers. Here is a section:

While “legacy” risks from the global financial crisis persist for both banks and sovereigns, new threats are emerging from “a continued global search for yield, which has left the financial system more vulnerable to an abrupt reversal of risk premia,” the ECB said in its semi-annual Financial Stability Review published today. Even so, “financial stress indicators have remained low and stable” over the past half year, it said.

Central banks across the world have kept interest rates at record lows to rekindle growth after the financial crisis, depressing bond yields and leaving investors searching for more attractive assets. At the same time, regulators have tightened rules and the ECB is conducting a bank balance-sheet assessment to identify weaknesses before assuming supervisory powers in November.

Euro-area countries have attracted capital from emerging markets, with U.S. exchange-traded funds recording net inflows to Spain of more than 1.3 billion euros ($1.8 billion) since the beginning of the year.

“Such flows might prove to be fickle, absent prospects of strong absolute returns differentiated by underlying country and bank-specific macroeconomic prospects,” the ECB said.

“Continued action by sovereigns is needed to address public debt sustainability challenges -– notably progress in restoring the soundness of public finances while working to boost macroeconomic growth prospects.

 

Eoin Treacy's view -

The desire to capture yield in an ultralow interest rate environment has driven spreads back to where they were before the financial crisis. This momentum creates a sense of security that the situation will persist indefinitely but any change to underlying interest rate expectations would upset the status quo and result in leveraged positions being pressured. 



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May 19 2014

Commentary by Eoin Treacy

Fears over lowflation serve up bond market surprise

Thanks to a subscriber for this article by Mohamed El-Erian for the Financial Times which may be of interest. Here is a section:

First, persistent concerns about the failure of American and European growth to “lift off” – including last week’s sluggish first quarter eurozone data – have been amplified in recent weeks by spreading worries about “lowflation”. That is, inflation that is too low for too long and, as a result, risks pulling the rug from underneath inflationary expectations.

Perhaps nothing serves to signal such concerns more loudly than indications by the traditionally inflation-paranoid German Bundesbank that it would support the European Central Bank venturing deeper into unconventional monetary policy to counter lowflation.

Deflation threat
Second, central banks have signalled continued willingness to repress interest rates longer in order to stimulate growth and reduce the threat of deflation. The ECB is expected to introduce a new range of stimulus measures when its governing council next meets on June 5. Mark Carney, governor of the Bank of England, reiterated last week that he is in no rush to raise interest rates notwithstanding concerns about a booming housing market.

Meanwhile, across the Atlantic, while the Federal Reserve is phasing out its monthly asset purchases, officials are strengthening their forward policy guidance that seeks to keep interest rates abnormally low for an even longer period.

Third, market positioning has turbocharged economic and policy factors. Few traders were ready for lower interest rates, let alone a flatter yield curve. As such, the recent yield moves have triggered market stops, forcing them to buy bonds to limit their mounting losses. Meanwhile, the lower the interest rates, the harder it has become for some long-term institutional investors to remain underweight bonds given the longer-dated nature of their liabilities. 

 

Eoin Treacy's view -

These represent some plausible answers for why government bond prices have rallied en masse over the last couple of weeks. A number of institutional market participants have voiced the opinion that it will be a very long time indeed before the Fed raises interest rates from the zero bound. That certainly helps to justify recent demand for long-dated bonds buy how sustainable is this? 



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May 14 2014

Commentary by Eoin Treacy

European Bonds Lead Global Rally on Central Bank Stimulus Bets

This article by Lukanyo Mnyanda and Eshe Nelson for Bloomberg may be of interest to subscribers. Here is a section: 

The prospect of more stimulus from the ECB is adding to gains in fixed-income securities around the world this year amid record-low central-bank interest rates and signs growth is converging toward a slower pace. The Bloomberg Global Developed Sovereign Bond Index returned 3.8 percent this year, versus 3.4 percent for the MSCI All Country World Index including reinvested dividends.
     
“We could cut interest rates once again,” Praet said, according to the German newspaper. “Negative interest rates are a possible part of such a combination of measures.”
     
The ECB would only embark on Federal Reserve-style government-bond purchases “if the economy and the inflation in the euro area develop significantly worse than we expect,” Praet said, according to the interview in Die Zeit.

 

Eoin Treacy's view -

Market participants are beginning to price in the potential that the ECB is likely to lower interest rates or engage is some form of additional stimulus at its next meeting. As pointed out last week, the ECB’s balance sheet has turned upwards again, following more than a year of contraction, suggesting there is some reason to lend credibility to the easing hypothesis. 

 



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May 13 2014

Commentary by Eoin Treacy

Email of the day on fixed income markets

This chart is the main reason why rates continue to be so low. The market has simply stopped listening to the Fed’s optimistic forecasts. Investors are not willing to trade rates up before the economy is on a solid growth trajectory with higher inflation. In the meantime the hunt for yield will continue. The risk is that the Fed eventually will be right and inflation starts moving up toward 2%. Once that happens fixed income investors will turn around for real and position themselves for higher rates. But a significant amount of fixed income wanting to re-position and a low primary dealer inventory of spread products could make fixed income markets – and therefore also equity markets – vulnerable to future inflation releases. Including the CPI data that comes out this week on Thursday.

Eoin Treacy's view -

Thank you for this interesting graphic which as you point out depicts just how bad the Fed is at predicting GDP growth. I agree with your assessment that the majority of fixed income investors are waiting for concrete signs of inflation before selling. What choice do they have? The alternatives are not attractive. 



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May 12 2014

Commentary by Eoin Treacy

Gundlach No Normal Means U.S. Yields Defy Market Selloff

This article by Daniel Kruger and Wes Goodman for Bloomberg may be of interest to subscribers. Here is a section: 

“That’s one of the reasons why yields are not just going to explode on the upside,” Gundlach, who oversees $50 billion as the co-founder and chief executive officer of DoubleLine Capital LP, said in a May 7 interview with Tom Keene from Bloomberg’s headquarters in New York. “Part of this equation is the demand for income from the growing number of retirees.”

Eoin Treacy's view -

The fall in labour force participation has been one of the main reasons the Fed has put less focus on unemployment statistics in making monetary policy decisions. The so called “grey tide” of baby boomers retiring has been a news item for years. As more people move to fixed incomes, they will learn how effectively their pensions have been managed and many will quickly come to understand that 10-year yields below 3% do not represent value. This is particularly poignant as the Fed tapers because it has removed the momentum trader from the market in just about every issue with a maturity of less than 30 years. 



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May 09 2014

Commentary by Eoin Treacy

Buybacks: Another Name For Quality

Thanks to a subscriber for this post from Morningstar which may be of interest to subscribers. Here is a section: 

Firms that repurchase shares have tended to outperform, and firms that issue shares have tended to underperform. These effects have been found around the world. Strangely, firms that buy back shares tend to outperform for years after the repurchases are first announced.

Many investors and corporate managers believe repurchases lift share prices by boosting earnings per share--they're "accretive" to earnings, in the turgid parlance of business. The idea is that after a buyback the company's cash flows remain unchanged but are then divided among fewer shares, making each share more valuable. It may very well be that this effect is a self-fulfilling prophecy. However, theory indicates that whether a repurchase boosts earnings per share has no bearing on whether the repurchase actually adds value. The only time buybacks make sense is when a company's shares are trading at below intrinsic value and managers have no better opportunities to invest in.

Of course, the world doesn't work like this. Buybacks usually are greeted with applause by the markets, for good reason. Studies indicate the market assigns less than $1 of value for each $1 of excess cash a company holds, likely because investors think managers tend to destroy value by empire-building. Buybacks (and dividends) signal to the market excess cash on hand as well as future cash flows will be returned to shareholders if high-enough returning investments can't be found.

OK, but this story doesn't explain why companies that repurchase shares go on to experience years of outperformance--shouldn't the market quickly price in the information revealed by the share buyback?

There are lots of theories as to why this is the case, few of them persuasive. I think it's simple: Companies that cannibalize themselves tend to be more profitable and less leveraged. They have moats. Investors seem to underreact to the information revealing long-run profitability.

Eoin Treacy's view -

The Powershares Buyback Achievers ETF (PKW) has been a notable outperformer relative to the wider market since 2009. Investors are happy to see buybacks because the supply of shares decreases so their holdings become more valuable. As shares of the respective companies become collector’s items, they become more appealing and the potential for a momentum move increases. 



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May 07 2014

Commentary by Eoin Treacy

Treasury Yield Curve Steepens as Fed Chief Sees Accommodation

This article by Susanne Walker for Bloomberg may be of interest to subscribers. Here is a section: 

The Treasury market yield curve steepened after Federal Reserve Chair Janet Yellen said a “high degree” of accommodation remains warranted, tempering expectations for an acceleration of interest-rate increases.

The difference in yields between five- and 30-year securities increased to about 175 basis points, or 1.75 percentage points, as investors bet moderate growth will prompt the central bank to stick with forecasts for increases next year. Benchmark 10-year notes were little changed before today’s auction of $24 billion of the securities.

“The Fed is going to remain in the game for now,” said Sean Simko, a money manager who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania. “It keeps Treasuries in the range it’s in. She has alluded to the economy making strides. We still need to remain patient.”

 

Eoin Treacy's view -

The term “high degree” when referring to monetary accommodation is sufficiently opaque to allow the Fed plenty of wiggle room as it tapers quantitative easing while allowing its balance sheet to continue to expand. Against this background, it is worth remembering that one of the reasons the Fed has felt able to taper is because the government’s deficit has been shrinking which has resulted in fewer Treasuries being issued. As a result there have been fewer bonds to buy.



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May 01 2014

Commentary by Eoin Treacy

Email of the day on risks attached to the banking sector

One point to the bullish side I have yet to see discussed is the $2 Trillion in second mortgages resting on bank balance sheets. These are non-recourse loans that are tied to shortest side of the curve and could put the banks at risk should there be a meaningful increase in payment levels: the banks write it all off if the borrower walks. Today's B of A capital debacle showed me a degree of instability remains with the banks. Isn't the Fed appreciating this? If so, I suspect we are in the early stages of a long term policy of using the Fed balance sheet as needs must.

Eoin Treacy's view -

Thank you for this informative email. Just what banks have on their balance sheets is a constant source of concern for investors since there is so little discussion about the quality of the liabilities and how they are leveraged. Thanks also for responding to my question on the extent of adjustable rate loans in the equity release loan market in this follow up email:

Yes, 2nd mortgages of the home equity variety are in many if not most cases tied to LIBOR or T-Bills.  My logic chain tells me that during the crisis meetings of November 2008 Fed officials saw the immediate problems that technical insolvency brought to the banks, but during subsequent rehabilitation periods saw that igniting a potential liability source like those 2nd mortgages would be diametrically opposed to their goal of restoring the banks.  If I am right that problem still exists today although it is diminishing.

 



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May 01 2014

Commentary by Eoin Treacy

Email of the day on the role of banks in money creation

For 12 years I was a member of a Bank Credit Committee later a member of a Fixed Interest Credit Committee for an international Insurance company.  The animal spirits of the members of those credit committees can so easily loose personal impartiality.  They start to buy the gloss not the critical analytics of the deal before them.  

I was hated on Bank Credit Committee because I was voting against real estate deal after real estate deal.  All to build high rise office Towers principally in Melbourne.  Credit Committee meetings became very heated and even bitter.  This was during the credit boom in real estate in the early 1990 here in Australia.  The Banks CEO hated me because we were not writing enough new bank loans like our competitors.  If my Treasury Division had not been making so much money he would have fired me.  The staff in the Bank’s Lending Department avoided me.  

I was eventually proven right because within a couple of years commercial real estate vacancies in Melbourne were 25%.  There was many shiny new office towers and nobody to tenant them.  I know of one company that signed a 10 year tenancy agreement in one of these empty Towers and the first 5 years of that Tenancy agreement was rent free.  Think the Landlord also paid for the fit out.  It was a financial disaster.  Westpac almost went under.  It was also a very ugly time for bank shareholders.

So how did I make money from this situation?  Well one morning I lined all my dealers along the window.  (they still like to remind me of this exercise).  I asked them “what do you see on the Sydney skyline”.  One young dealer said "Cranes".  I responded that is right every third building had a crane on it.  I said this investment boom in commercial real estate will eventually go bust and that will then lead to single digit interest rates.  What a fortunate insight because we made heaps and heaps of money.  After bond rates fell from 14%-15% to 7% I got scared.  The rally in bonds then exceeded anything I could have ever possibly imagined.

Later members of the Bank Credit Committee never spoke about this matter.  It was as if it never happened.  There were no acknowledgements or apologise.  They were friendly again.  It’s uncomfortable place to hold a view the majority so strongly oppose.  The following quote helped me understand my colleagues.  

“All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.” — Arthur Schopenhauer

 

Eoin Treacy's view -

Thank you for sharing your valuable experience which emphasises just how much of a resource the Collective of subscribers to this service represents. You mentioned this episode at our dinner in Sydney earlier this year but this more in-depth explanation serves as a timely reminder of the psychology at work within the financial system not least in reference to the above email. .
 

 



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April 28 2014

Commentary by Eoin Treacy

Email of the day on the persistency of zero interest rates

“That piece I sent you from Koo is really good. It really reinforces my views on rates. Low for as long as we both shall live.”

Eoin Treacy's view -

Thank you for this educative report “Central Banks in Balance Sheet Recessions: A Search for Correct Response” by Richard Koo dated March 31st 2013. While more than a year old, it represents a cogent argument for the persistence of low rates which has gained credence. A link to the full report is posted in the Subscriber's Area but here is a section:

When the effectiveness of monetary policy depends on the size of fiscal stimulus, it should be the responsibility of the central bank to inform the public and policy makers that the government should not move toward fiscal consolidation when the private sector is repairing balance sheets. Such persuasion is essential because the average public is still unaware of the disease called balance sheet recession. They are unaware because the schools have never taught them about the possibility of such recessions.

It is extremely encouraging in this regard that Chairman Bernanke of the Federal Reserve, who once championed the supremacy of monetary policy, is now spearheading the effort to keep the US from falling off the fiscal cliff. His answers to a question in April 25, 2012 press conference where he said “the size of the fiscal cliff is such that there is absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy” attest to the fact that he knows the importance of fiscal stimulus when the private sector is not borrowing money. In particular, his comments indicate that monetary policy cannot substitute for fiscal policy during this type of recessions.

Unfortunately, he is so far the only central banker who is openly warning about the risk of fiscal cliff. President Draghi of ECB and Governor King of Bank of England are still insisting on fiscal consolidation even though their economies are suffering from serious balance sheet recessions. 

 

 



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April 16 2014

Commentary by Eoin Treacy

The Government Debt Iceberg

Thanks to a subscriber for this densely packed report by Jagadeesh Gakhale for the The Institute of Economic Affairs which may be of interest to subscribers. Here is a section from the conclusion: 

Even when countries appear to have prudent fiscal policies according to short-term government borrowing and debt metrics, they are normally building up future commitments that do not appear on the government’s balance sheet and will not involve actual cash payments for decades.

For example, if the government borrows £50,000 to pay the salary of one extra teacher this year, then that additional indebtedness will be clear to taxpayers and securities markets alike. But, if the government makes a commitment to pay future pensions that have a present value of £50,000 and which involve exactly the same future cash flows as servicing the debt issued to finance the additional teacher, there will be no additional borrowing recorded.

However, the commitment to pay the future pension may be just as binding as the commitment to service government debt. Indeed, in some circumstances, such as the case of contractual commitments to pay future pensions to public sector workers, a pension promise may have a higher legal status than government debt.

In this IEA Research Monograph on inter-generational accounting, the author, Jagadeesh Gokhale, points out that existing metrics of government debt are entirely backward looking. If a government has accumulated debt of 85 per cent of national income, that simply tells you something about past cash flows. The figure tells you nothing at all about those commitments the government has made that involve future cash flows. If a private insurance company promised to pay out £3 billion of annuities over the next 30 years and did not include them on its balance sheet, it would be closed down. Yet this is precisely how the government does its accounting.

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

I intentionally juxtaposed this report with the above video expressing an optimistic outlook for the global economy. The challenges represented by government debt are non-trivial to put it mildly and the resolution of this issue will in many respects be dependent on how well we achieve productivity growth over the coming decades. 

 

 



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April 14 2014

Commentary by Eoin Treacy

Notes from the DoubleLine Lunch with Jeffrey Gundlach, Spring 2014

Thanks to a subscriber for this review of a talk by Jeffrey Gundlach from Joshua Brown for his blog The Reformed Broker. Much of the content will be familiar ground for subscribers but this comment on bond ETFs caught my attention. Here is a section: 

Jeff is highly concerned with one particular bond bubble that is still ongoing. Below are all major categories of bond ETFs. The red line that began from nothing and has now zoomed to the top is bank loan ETFs, remarkably. He notes that the typical bank loans trade settles in T-plus 10 (meaning trade date plus ten more days, more than twice as long as a stock trade) and that this will mean an illiquidity catastrophe should demand for these products go the other way. The bank loan complex is not equipped to deal with rapid changes in flows, like the creation-redemption process needed for ETFs as one example. He mentions anecdotally that a hedge fund friend of his is looking to short Eaton Vance, one of the purveyors of these big bank loan investment products.

Eoin Treacy's view -

Investor awareness of the high fees they are paying for investment products has contributed to the explosive growth of the ETF sector. Rather than rely on loadings or commissions such funds primarily rely on assets under management and on low trading costs for their profitability. 

The low cost of listing such funds has resulted in firms supporting large numbers of strategies in the hope that some will capture investor interest and assets under management will increase. The net result is that situations occasionally develop where the ETFs of reasonably illiquid instruments can be more liquid than the instruments themselves. ETFs remain a valuable financial innovation but it is increasingly important to do one’s due diligence in order to ascertain just what one is buying. 



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April 07 2014

Commentary by Eoin Treacy

Legal & General says reform will shrink UK individual annuity market by 75%

This article from Reuters appeared in the Guardian last week and may be of interest to subscribers. Here is a section

The UK market for individual annuities will shrink by some 75% after government measures freeing retirees from having to buy them come into effect next year, one of the biggest annuity providers forecast on Wednesday.

Nigel Wilson, chief executive of life insurance and pensions provider Legal & General Group Plc, said he expected the amount of money going into individual annuities to shrink to around £2.8bn a year from nearly £12bn, though he did not give forecasts for the group's own future business mix.

Wilson's comments at an investor conference in London follow a shake-up of the pensions system announced by Chancellor George Osborne in his budget last week.

 

Eoin Treacy's view -

A number of IFAs attended The Chart Seminar and the Global Strategy Session last week and the question of how changes to the annuities market will affect various asset classes was one of a number of topics discussed. 

The immediate knock-on effect of the announcement was that shares of insurance companies such as Legal & General sold off because it represents the loss of a significant element of their business. However, the realisation that this change only applies to individual pensions and not those of companies has softened the blow for the annuities sector. 

 



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March 21 2014

Commentary by Eoin Treacy

Email of the day on long-term bond yield charts

“I attach a chart from the chart library - to draw your attention to a problem I have noticed today.

“Please observe that on the X-Axis, the distance between =1975 and 1985 is only about 20% of the distance between 1985 and 1995.

“My gut feeling is this is simply a matter of lack of density of data points ... but  the result does not look good ...... and could be easily fixed in a number of ways.”

 

Eoin Treacy's view -

Thank you for sending through the chart and for raising a question which may be of interest to subscribers. The reason the scale is not displaying correctly is because daily data for Australian 10-year yields only became available in 1983. Since you are attempting to draw a daily chart over 40 years, the charting engine is attempting to fit the data into the timeframe you requested. If you move the period of the chart to monthly you will you will see that the scale is correct. However since we only have closing values on a monthly basis before 1983 we cannot draw candles. It is for this reason that we mostly display line charts for very long-term bond yield data. 



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March 18 2014

Commentary by Eoin Treacy

Email of the day on the best way to benefit from a bear market in Treasuries

“Can you please add the iPath 10 year US-T Bear ETN (DTYS) to the library and comment on whether you think it is a good vehicle for investing long term (10 years) in any ending of the US-T bull market and subsequent bear market?”

Eoin Treacy's view -

Thank you for this suggestion which has been added to the Chart Library and for this question which may be of interest to other subscribers. Taking a short position in an instrument that will necessarily have a higher yield as prices decline represents a challenge for when positions need to be rolled forward. This would suggest that the ETFs taking short positions in Treasury futures may fall victim to similar issue commodity ETFs did when they failed to take account of trading costs incurred when instruments trade in contango. 

The present low interest rate environment makes this less of a concern but assuming we are correct in the assumption that the bull market in Treasuries is over, rising yields and short-term interest rates will mean that holding short positions beyond short-term trading opportunities is likely to be expensive. 

In my view the best hedge would be in equities with records of increasing dividends above the rate of inflation. One would also have the potential for capital market appreciation.  

 



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February 27 2014

Commentary by Eoin Treacy

European Bonds Surge as ECB Stimulus Confines Crisis to Memory

This article by Neal Armstrong and Lukanyo Mnyanda  for Bloomberg may be of interest to subscribers. Here is a section: 

At the previous ECB policy meeting on Feb. 6, President Mario Draghi cited the need for “more information” to explain why the central bank hadn’t expanded stimulus. He repeated Feb. 23 that officials are “ready to take any action.”

“Further possibility of easing by the ECB is definitely likely,” said Michael Markovich, head of quantitative analysis at Credit Suisse Group AG in Zurich.

Euro-area sovereign debt returned 2.9 percent this year through yesterday, according to Bloomberg World Bond Indexes, as a quest for yield and signs of economic recovery in the periphery boosted investor demand for those nations’ securities.

Italy auctioned 3 billion euros of five-year notes at an average yield of 2.14 percent today, the lowest on record. It also sold 4 billion euros of bonds maturing in 2024 at an average yield of 3.42 percent, the least since 2005.

Portugal bought back 1.32 billion euros of bonds due this year and next to smooth out debt repayments.

 

Eoin Treacy's view -

While the Fed remains likely to continue to taper its quantitative easing, the ECB is still committed to making as much liquidity available as is required in order to cement the recovery of the region’s banking sectors. 

The ECB balance sheet indicates that they are sanitising their cash infusions, which is contributing to deflationary forces on the periphery. With inflation well below its target of 2%, the potential for additional measures to stimulate activity are more likely than not. One way or the other, the banking sector continues to benefit from access to abundant capital. 



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January 09 2014

Commentary by Eoin Treacy

Pimco Investment Outlook

This edition of Bill Gross' monthly report may be of interest to subscribers. Here is a section: 

First of all the obvious, An investor should own bonds with less duration and shorter maturities when the teeter totter is on the losing end. Admittedly, those with long-term liability structures such as pension funds and insurance companies have to be careful about their underweights but as a rule, less duration should mean more alpha relative to an investor's benchmark as the interest worm turns and the cycle shifts upward. 

But riding the bond market seesaw doesn't always mean negative returns, especially when it comes to other "carry" components inherent in fixed income securities. As I pointed out in my August 2013 Investment Outlook titled "Bond Wars" maturity extension is just one of the ways to produce carry and total return in a fixed income portfolio. In addition there are 1) credit spreads, 2) volatility sales, 3) curve and 4) currency-related characteristics that when combined with maturity can produce returns over and above those microscopic Treasury bill rates, and still keep you from "breaking the buck" under a majority of scenarios. On the "down" side of an interest rate teeter totter these carry components can help a portfolio benchmarked to a 5-year duration bond market index float above water and ever enjoy swimming. 

 

Eoin Treacy's view -

In this edition Bill Gross shares our conviction that the secular bull market in bonds is over. However, this represents a significant challenge for investors who have benefitted enormously from a confluence of reliable yields and outsized capital appreciation over the last 30 years. Therefore, while the Fed Funds Rate remains close to zero short dated bonds are likely to continue to be less volatile than their longer-dated peers. However in a rising yield environment achieving a positive return will be a difficult feat for the majority of fixed income investors and will require the type of flexibility described above. (Also see my additional comments of this subject posted on December 30th). 



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January 07 2014

Commentary by David Fuller

Tim Price: Rate Expectations

My thanks to the author of this ever-interesting investment letter, published by PFP Wealth Management.  

It is posted in the Subscriber’s Area but here is the opening, which quotes Warren Buffett extensively:

  “It is no longer a secret that stocks, like bonds, do poorly in an inflationary environment.”

- Warren Buffett, ‘How inflation swindles the equity investor’, May 1977.

 On December 31st, 1964, the Dow Jones Industrial Average stood at 874. On December 31st, 1981, it stood at 875. In Buffett’s words,

“I’m known as a long term investor and a patient guy, but that is not my idea of a big move.”

 To see in stark black and white how the US stock market could spend 17 years going nowhere – even when the GDP of the US rose by 370% and Fortune 500 company sales went up by a factor of six times during the same period – the price chart for the Dow is shown below. [Ed: subscriber’s can see this in Tim Price’s letter and also recreate it in the Chart Library, should they ever wish to.]

 So the US stock market suffered a Japan-style lost decade, and then some. Back to Buffett, again.

 “To understand why that happened, we need first to look at one of the two important variables that affect investment results: interest rates. These act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That's because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line..

 “In the 1964-81 period, there was a tremendous increase in the rates on long-term government bonds, which moved from just over 4% at year-end 1964 to more than 15% by late 1981. That rise in rates had a huge depressing effect on the value of all investments, but the one we noticed, of course, was the price of equities. So there--in that tripling of the gravitational pull of interest rates- -lies the major explanation of why tremendous growth in the economy was accompanied by a stock market going nowhere.”

David Fuller's view -

That seventeen year period from end December 1964 to end December 1981, marked the valuation contraction cycle which occurred between two secular bull markets.  The first of these lengthy bull trends commenced with the end of the US Depression and also WW2. 

By coincidence, it was in the mid-1960s that I decided to change careers and head for Wall Street.  Why?  Because although I heard about the difficulties of the Depression from my parents, all I subsequently heard about the stock market during my adolescent years and early 20s was that it mostly went up, thanks to a booming economy.  

The mid-1960s through 1981 provided a steep learning curve, as veteran subscribers will have heard me say on occasion during my financial career to date.  Thereafter, the next secular bull market commenced from valuation contraction lows in 1Q 1982, before ending with the 20th century.   

So what do we make of the S&P 500 Index’s historic chart pattern which dates back to the 1960s, not least in the context of Tim Price’s further assessment?

This item continues in the Subscriber’s Area.



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December 30 2013

Commentary by Eoin Treacy

The Bond Question

Eoin Treacy's view -

Convertibles have been one of the best performing types of bond fund in 2013 because they offer a blend of yield and optionality on the equity markets. This helps to emphasise just how much equities have outperformed this year but also highlights an issue many investors now face. What do we do with the bond component of our portfolios?

For the last few years we have highlighted the fact that the Merrill Lynch 10-yr+ Treasury Futures Index is one of the best barometers of the health of the Treasury market The fact that it has evolved from one of the most consistent uptrends in the world to displaying top formation completion characteristics is not something any investor can ignore because what happens in the bond markets tends to have wide ranging implications. 

Pension funds must hold bonds. Investors who wish to lock in a yield with low volatility in the base instrument have tended to favour bonds. The liquidity and size of the market are additional positive considerations for many investors.  

 



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December 27 2013

Commentary by Eoin Treacy

German Bunds Slide With Italian Bonds as Stocks Rally on Growth

This article by Lukanyo Mnyanda for Bloomberg may be of interest to subscribers. Here is a section: 

Demand for the safest fixed-income assets is waning after the euro area returned to growth in the three months through June, having contracted for the previous six quarters. The region's economy will expand 1 percent next year and 1.4 percent in 2015, after shrinking by 0.4 percent this year, according to the median of analyst estimates compiled by Bloomberg.

German securities lost 1.8 percent this year, according to Bloomberg World Bond Indexes. Italy's earned 7.1 percent and Spain's returned 11 percent as the sovereign debt crisis that roiled the region since 2009 started to ease.

Eoin Treacy's view -

Despite the fact that Jens Weidmann continues to express the Bundesbank's reservations about excessive monetary accommodation, the likelihood of the Eurozone tightening policy anytime soon remains low. In fact, the need for low interest rates and abundant liquidity has been of particular benefit to Germany which saw its debt take on safe-haven status. At least part of the logic for this surge in demand was that if the Euro were to break up, Germany's sovereign debt would be redenominated into a strong currency. 



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December 13 2013

Commentary by Eoin Treacy

Three-Decade Treasuries Rally Is Far From Over

This article by A. Gary Shilling for Bloomberg may be of interest to subscribers. Here is a section: 

Meanwhile, I believe Treasury yields are more likely to go down than up. First, persistent slow growth, gridlock in Washington, business uncertainty, and ample supplies of capacity and labor on a global scale mean the U.S. employment situation
will probably remain weak.

The Fed has said it wouldn’t raise its federal funds rate until the unemployment rate -- now 7 percent -- comes down to 6.5 percent. That target is becoming less meaningful, however, because the decline in joblessness has been primarily the result of a falling labor participation rate, not rising employment. If the participation rate hadn’t dropped from its February 2000 peak because of the retirement of members of the baby-boom generation, discouraged job-seekers and youths who have stayed in school during the recession, the unemployment rate now would be 13 percent. As investors increasingly grasp the Fed’s falling unemployment rate target, Treasury yields -- which have anticipated a rise in interest rates -- will probably continue to decline.
     
Inflation is close to zero and deflation is probably only being forestalled by huge fiscal and monetary stimulus efforts. But that stimulus has been replaced by fiscal drag, resulting in the shrinking federal deficit. In addition, the impending Fed tapering of its bond purchases won’t tighten credit by reducing excess bank reserves, but it will reduce the monthly additions to that $2.4 trillion trove.
     
With inflation this close to zero, it won’t take much of a hiccup to rattle the economy. And deflation is distinctly beneficial to Treasuries.

Eoin Treacy's view -

How the US Treasury market performs is perhaps the most important consideration for large investors such as pension funds and has become a contentious issue over the last year. For three decades total return has been flattered by a confluence of yield and capital appreciation, with the latter being far more dominant over the last few years. With interest rates at record lows, a reliance on capital appreciation has transformed the asset class into a large trading vehicle rather than the secure source of income it has classically been known for.



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December 02 2013

Commentary by Eoin Treacy

Citigroup to BofA Spurn Treasuries for Cash on Taper Risk

This article by Cordell Eddings and Daniel Kruger for Bloomberg may be of interest to subscribers. Here is a section: 

Never before have America’s banks been so wary of risking their cash deposits on U.S. government debt.

After holdings of U.S. debt surged to a record $1.89 trillion in 2012, lenders from Citigroup Inc. to Bank of America Corp. and Wells Fargo & Co. are culling for the first time in six years and amassing dollars. Banks’ $1.8 trillion of the bonds now equal less than 70 percent of their cash, the least since the Federal Reserve began compiling the data in 1973.

With net interest margins falling to the lowest since 2006, banks are spurning Treasuries and hoarding unprecedented amounts of cash on prospects that loan demand will revive as a strengthening economy leads the Fed to reduce its own debt purchases. Five years of cheap-money policies also have depressed yields and made it less attractive for banks to buy Treasuries as a way to bolster income.

“Banks reluctant to lend were large holders of Treasuries” Jeffrey Klingelhofer, a money manager at Thornburg Investment Management Inc., which oversees $89 billion, said in a telephone interview from Santa Fe, New Mexico. “Like a lot of

other people who have been moving out of fixed income, it’s largely to avoid the fallout from tapering”

Eoin Treacy's view -

In the futures markets it is not unusual to see a change of direction around contract roll dates since these events force market participants to reassess their positions. An example of this tendency appears to be unfolding in a number of government markets with recent short-term rallies petering out and reversals seen late last week.



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November 03 2013

Commentary by Eoin Treacy

Citigroup to BofA Spurn Treasuries for Cash on Taper Risk �

This article by Cordell Eddings and Daniel Kruger for Bloomberg may be of interest to subscribers. Here is a section: 

Never before have America’s banks been so wary of risking their cash deposits on U.S. government debt.
After holdings of U.S. debt surged to a record $1.89 trillion in 2012, lenders from Citigroup Inc. to Bank of America Corp. and Wells Fargo & Co. are culling for the first time in six years and amassing dollars. Banks’ $1.8 trillion of the bonds now equal less than 70 percent of their cash, the least since the Federal Reserve began compiling the data in 1973.

With net interest margins falling to the lowest since 2006, banks are spurning Treasuries and hoarding unprecedented amounts of cash on prospects that loan demand will revive as a strengthening economy leads the Fed to reduce its own debt purchases. Five years of cheap-money policies also have depressed yields and made it less attractive for banks to buy Treasuries as a way to bolster income.
“Banks reluctant to lend were large holders of Treasuries” Jeffrey Klingelhofer, a money manager at Thornburg Investment Management Inc., which oversees $89 billion, said in a telephone interview from Santa Fe, New Mexico. “Like a lot of
other people who have been moving out of fixed income, it’s largely to avoid the fallout from tapering”

Eoin Treacy's view -

In the futures markets it is not unusual to see a change of direction around contract roll dates since these events force market participants to reassess their positions. An example of this tendency appears to be unfolding in a number of government markets with recent short-term rallies petering out and reversals seen late last week. 



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