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April 29 2016

Commentary by Eoin Treacy

Goldman Sachs Calls Bonds Expensive as Morgan Stanley Is Bullish

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

The firms, which are among the 23 primary dealers that trade with the Fed, are at odds as investors decipher the central bank’s views on the economy in its statement this week. Morgan Stanley called the comment “slightly dovish.” Goldman forecasts rate increases in June, September and December. U.S. consumer spending rose less than forecast in March, Commerce Department figures showed Friday, after data Thursday showed the economy growing at its slowest pace in two years.

Looking for Growth
Central bankers used their statement to indicate growing confidence in the world economy while suggesting they’re still looking for the signs of growth, inflation and global stability to justify a move.

 

Eoin Treacy's view -

This divergence between the opinions of Goldman Sachs and Morgan Stanley with regard to Treasuries has been an open bone of contention for months. There is a lot at stake not least since the bond market has been in a secular bull market for 35 years and has been supported in spectacular fashion by the extraordinary measures employed by central banks to avoid a depression. 



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April 28 2016

Commentary by Eoin Treacy

Japan Stocks Tumble After BOJ Holds Off on Adding to Stimulus

This article by Yuko Takeo, Toshiro Hasegawa and Yuji Nakamura for Bloomberg may be of interest to subscribers. Here is a section:

“We’ve had the knee-jerk reaction to no change as the majority expected some form of action,” said Cameron Duncan, Sydney-based co-head of income strategies at Shaw and Partners, which manages the equivalent of $7.6 billion. “In, hindsight, it’s probably consistent that they haven’t done anything because they eased three months ago.

There’s typically a lag in terms of response to that sort of easing. It’s the Bank of Japan and they’re pretty conservative and they are still waiting to see what the impact of that is.”

Goldman Sachs Group Inc. and HSBC Holdings Plc were among those expecting the central bank to add to ETF buying. Goldman Sachs estimated the BOJ would expand annual purchases to 7 trillion yen, while HSBC predicted an increase to 13 billion yen.

The central bank’s decision to forgo additional easing this time hasn’t deterred some from expecting more stimulus in the future. It’s inevitable that economic growth and inflation will take a downturn and given the outlook for a stronger yen, the BOJ will likely boost stimulus eventually, SMBC Nikko Securities Inc.’s chief market economist Yoshimasa Maruyama said.

Driven to Ease
“The situation the BOJ is in won’t change for the better because of its decision today,” Maruyama wrote in a note to clients. “It’ll be driven into easing further sooner or later.”

The Topix is down 13 percent this year, making it the worst performing developed market in 2016, after starting 2016 tumbling into a bear market on worries over oil prices and slowing global economic growth. The measure has climbed back 12 percent from a Feb. 12 low, bolstered by a recovery in oil prices and signs of stabilization in China’s economy.

 

Eoin Treacy's view -

“If you’re going to go, go big” was something the BoJ appeared to have understood when it adopted the QE program that sent the Yen down more than 50% and ignited a major run in Japanese stocks between late 2012 and early 2015. Since the middle of last year the commitment to doing everything necessary to ignite inflation has waned. The wait and see attitude adopted of late suggests a lukewarm commitment to reform and expansion. 



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April 27 2016

Commentary by Eoin Treacy

Email of the day on inflation expectations and rates

You've drawn attention to the 12 month T-bill rate a couple of times over the past week. Additionally, it is also very instructive to monitor inflation expectations to gauge what is discounted in terms of the future direction of interest rates. The five-year “breakeven” rate, a market measure of inflation expectations derived from comparing the yield of Treasury Inflation protected bonds (Tips) and conventional Treasuries, has climbed from a low of 0.95% in early February, to 1.56% now. It peaked at 2.4% in October 2012 after reaching an unprecedented minus 0.9% in 2008. 

Movements in Tips have tended to reflect investor expectations about future consumer price inflation, and these have been stoked by the recent rise in oil prices and a weaker dollar, which means higher import prices. In fact, the breakeven rate has been rising in tandem with oil prices since February. Interestingly, the “core” US inflation rate, which strips out the impact of volatile components such as energy and food, has also been rising. The current buying of Tips reflects a view that the cycle of dollar strength and commodity weakness has come to an end. 

Like you and David, I also think that commodities have bottomed. However, there are no signs of strong underlying demand and inflationary pressures from the real economy at the moment. Furthermore, Janet Yellen, the Fed chair, has cast doubts on the durability of the recent pick-up in core inflation and inflation expectations, arguing that the case for moving cautiously on interest rates was still strong. It is not surprising that she would say that given that the Fed has reduced the likely number of rate rises this year. 

My view is that the US breakeven rate will rise with commodity prices which will push conventional yields up and stock markets down but I don't believe that oil prices, for example, will get anywhere near the previous peak for the reasons discussed by this Service. Thus bond yields too will peak at a much lower level. The collapse in commodity prices in the last few years has distorted valuations in various markets and there will be a ripple effect across the other asset classes.

 

 

Eoin Treacy's view -

Thank you for this thoughtful email and for highlighting breakeven rates which I have not looked at in a while. I watch the 12-month yield because if gives us a good indication of how the bond market is pricing the risk of the Fed raising rates. 



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April 19 2016

Commentary by Eoin Treacy

Helicopters 101: your guide to monetary financing

Thanks to a subscriber for this report from Deutsche Bank explaining just how many tools are available to central bankers that go beyond conventional thinking. Here is a section:

It is the adoption of modern accounting standards for central banks that perhaps best summarizes the tension between a central bank’s actual abilities and the institutional limits placed by modern practice. Unlike any corporate, government or household, a central bank has no reason to be bound by its balance sheet or income statement. It can simply create money out of thin air (a liability) and buy an asset or give the liability (money) out for free. It can run perpetual losses (negative equity) because it can fund these by printing more money.
Taking this fundamental principle on board leaves us with the following menu of policy options, in ascending order of unorthodoxy. We accompany each option with a discussion on the implications for the CB balance sheet.
1. Quantitative easing combined with fiscal policy expansion: This is the least “unconventional” option and is already happening, albeit with a lack of explicit co-ordination. Central banks purchase interest-bearing government debt with a temporary increase in the monetary base.
This is accompanied by increased fiscal spending (or tax cuts), enacted by the Treasury in reaction to implicit central bank support for bond markets. The Treasury has more room to increase the deficit and the outstanding term of its maturing government bonds, because financing costs are made lower by central banks, but this support can be withdrawn at any time. In this case, the central bank’s assets and liabilities rise in parallel: the rise in central bank government bond holdings shows up as an increase in assets, while the increase in private-sector cash holdings shows up as a rise in central bank liabilities.
2. Cash transfers to governments: Same as option (2) except the government debt is non-redeemable, and hence the increase in the monetary base is permanent. Money can be credited directly to the Treasury account at the central bank, which would keep government debt/GDP ratios stable. The central bank can purchase 0% coupon perpetuities from the Treasury, which because they have no value, should amount to the same thing.3 The precise impact on the balance sheet here will depend on the nature of the transaction with the government. In the case where cash is swapped for a zero-coupon perpetuity, assets and liabilities would rise correspondingly, but the central bank would make a loss because it would not receive a coupon on government debt while eventually having to pay interest on bank reserve balances if interest rates rise.
3. Haircuts on existing CB-held debt: The central bank can unilaterally restructure and/or forgive its government debt holdings, improving government debt sustainability and allowing the Treasury room for future deficit spending. This can happen in a one-off fashion, or according to some graduated rule. For instance, the central bank could commit to write off 5% of government debt holdings until some target is achieved. The Greek OSI and PSI experience offers a precedent for distinguishing between privately and publicly held government bond holdings thus potentially avoiding CDS triggers. Note that central bank purchases of negative-yielding instruments are a form of notional haircuts as the government pays back to the central bank less than it issued. The resulting balance sheet change here is also straightforward: the central bank’s assets would be reduced by the corresponding size of the haircut, and this would be registered as a loss on the central bank’s liability ledger.

4. Cash transfers to households: The most radical option has central banks create and transfer money to individuals directly (through cheques, bank transfers or state pension contribution credits), cutting out the role of the Treasury entirely. In this case, the central bank’s liabilities would rise, as the public’s cash holdings against the central bank would show up as a rising liability. If no asset is purchased by the central bank, the rise in the liability would have to be offset by a corresponding loss on the balance sheet in the form of negative equity.

 

Eoin Treacy's view -

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

Anyone who believes central banks have come close to the end of what can be achieved by monetary accommodation should read this report. When a central bank has the ability to create money out of the nothing there is absolutely no limit to what they can do in an effort to achieve their goals. The results might not be to everyone’s’ liking because items 2, 3 and 4 above would stoke additional asset price inflation but that does not mean they cannot be implemented. 



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April 07 2016

Commentary by Eoin Treacy

Jamie Dimon's Rate-Spike Nightmare

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

3) Investors are piling into medium and longer-term U.S. bonds with increasing conviction that borrowing costs will stay low forever. The biggest exchange-traded funds that focus on such notes have experienced a surge of new money this year, with the volume of short interest on the ETFs' shares falling. This has helped fuel a 4.9 percent surge in Treasuries maturing in seven to 10 years so far this year, according to Bank of America Merrill Lynch index data.
 
4) The demand hasn't only come from ETFs and mutual funds. Big institutions and hedge funds have also bought more U.S. government bonds, particularly those maturing in the next decade, as they seek safe spots to park cash in the face of global economic uncertainty. 

Eoin Treacy's view -

How the Fed measures inflation does not appear to bear a great deal of resemblance to what we experience in our day to day lives. The cost of services such as insurance, education and healthcare have all trended higher and housing prices have recovered in many major cities but inflation measures have not responded. When I look at what I spend on a monthly basis that doesn’t make sense but the other side of the balance sheet also needs to be addressed.

Wages have been static for a long time and that means people have had to pay more for services but have cut back elsewhere to make ends meet. That is probably closer to how the Fed views inflation than any other explanation but it means wages are vital in how they decide to act. 



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March 21 2016

Commentary by Eoin Treacy

When Older People Do Better Than Those of Working Age

This article by Jason Douglas and Jon Sindreu for the Wall Street Journal may be of interest to subscribers. Here is a section:

The average person 65 and older in the U.S. earns 77% of the income of the average citizen, up from 69% in 2008, at the start of the recession. In the U.K. the figure is 89%, up from 78%. In Spain and France, seniors now earn about 103% and 102% of the average worker’s income, respectively, according to an analysis of data from the European Union’s official statistics agency. That’s up from 86% in Spain and 96% in France in 2008.

This divergence between generations is in part a reflection of demographic shifts that have been brewing for years, as populations grow older and the wealthy postwar baby boomers in particular reach their golden years.

But it is also widening as a consequence of forces bearing down on the earnings of the young, creating a growing imbalance that threatens to undermine the promise that market economies will deliver rising living standards for successive generations. Younger workers are grappling with flat or falling pay, decreased job security and less-affordable housing, sapping the spending power that helps fuel the economy. As the elderly population increases, younger workers also face a rising bill for the extra tax dollars needed to fulfill past governments’ promises to retirees.

 

Eoin Treacy's view -

We don’t have to look far for a reason behind the surge in populist rhetoric across Europe and the USA this year. Whether it is the rise of right wing politics in France and Germany, the Eurosceptic referendum in the UK or Donald Trump in the USA there is a general sense that the measures implemented by governments to avoid a calamity in the financial sector have resulted in drops in living standards for many people. 



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March 21 2016

Commentary by Eoin Treacy

Wall Street's Pile of Unwanted Treasuries Exposes Market Cracks

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

There are signs that the dislocations have abated. The gap between prices of new and old securities has fallen closer to its average for the past year, and in the repo market, 10-year Treasuries are no longer what’s known as “on special.” Dealers that lend cash in exchange for the notes in these deals now receive interest, since the repo rate is positive.

Bond bulls can also take heart in how the stress on the system didn’t slow the rush into U.S. government debt this year. Treasuries maturing in greater than a year have earned 1.7 percent in 2016 as stocks slumped to start the year amid concern global economic growth was cooling, Bloomberg Treasury bond index data show. The Treasury 10-year note yield rose four basis points, or 0.04 percentage point, to 1.91 percent as of 1 p.m. New York time.

In a twist, the demand for U.S. debt that drove 10-year yields toward record lows in February may have contributed to the strains, Keeble said. Buyers of Treasuries who typically don’t lend out securities in the repo market may have bought benchmark 10-year securities as a haven, he said.
For George Goncalves, head of rates research at primary dealer Nomura Securities Inc. in New York, dealers already holding so much debt may have less capacity to absorb more rounds of selling in the future.

“If there is another round of bond selloff, the market will need real-money support to keep everything orderly,” he said in a March 17 research note.

 

Eoin Treacy's view -

Quantitative easing has had a massively distorting influence on the bond markets because the Fed is now the largest owner of whole issues which has an influence on the yield curve. Selling pressure from foreign governments and sovereign wealth funds left primary dealers with bloated inventories of Treasuries they had difficulty shifting but the question of what the Fed is going to do with its massive holdings of bonds when they mature remains an open question. 



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March 10 2016

Commentary by Eoin Treacy

Segregating the resilience of EM banks to trying global macro outlook

Thanks to a subscriber for this heavyweight 101-page report from Deutsche Bank focusing on emerging market debt. Here is a section:

The debt stock of the EMs has increased significantly since the global financial crisis. In contrast to advanced economies in which governments are the main borrowers, the main driver of EM indebtedness is the private corporates (while banks and households are leveraged up as well), and the bulk of the financing is FX denominated, making EMs susceptible to financial stress, economic downturns, and capital outflows. We believe a correction has to an extent occurred in the EMs since the taper shock, and our base scenario foresees a slight rebound in economic growth in CEEMEA and LatAm in 2016. Under our central scenario that the Fed will raise rates only gradually, we recommend that investors Buy BZWBK (Poland), Doha Bank (Qatar), Garanti (Turkey), Standard Bank (South Africa), Bradesco (Brazil), and Credicorp (Peru). 

There are two main risks to our base-line projections: 1) more aggressive rate hikes by the Fed than assumed under our base scenario, and hence, more adverse market adjustments to a tightening Fed; and 2) a sharper slowdown in China, which would have obvious knock-on effects on commodities, global trade, and EMs in general. The past few weeks have shown that those two risks are unlikely to materialize together in the near term, and we believe that the risk of a sharp increase in rates is now a very unlikely scenario. We believe, however, that if they materialize, they will weigh on banks via two main channels. The first is margins, as funding costs will climb higher at a much faster pace and may also force banks to put on the brakes in terms of lending. The second one is asset quality. We think EM corporates are likely to face two related but distinct risks associated with their recent rapidly rising leverage under a more bearish scenario: liquidity risk and FX losses.

In the first part of this report, we opt to examine the refinancing risk and the associated deleveraging risk for the banking sectors in CEEMEA and LatAm. We look at the maturity structure of the external debt, as well as the FX liquid assets, and demonstrate the extent of ‘refinancing risk’. We then examine the extent of deleveraging if rollover ratios fall to the levels we witnessed during the global crisis. The second part of the report aims to assess the potential asset quality risks arising from the recent increase in private corporate debt. Accordingly, we stress-test our earnings estimates to a potential increase in risk costs under the assumption that some of the FX corporate debt will default this year. While sustained financial market volatility, slower lending, and weaker growth should inevitably affect other business segments as well, our focus here is on banks’ corporate exposures, which in most cases have increased significantly since the global crisis. 

Under a bearish scenario in which top-line revenues are challenged and corporate loan qualities deteriorate, we see greater risks in Turkey (with Vakifbank and Yapi Kredi relatively more vulnerable), Russia (VTB), Brazil (Santander Brasil), and Chile (Banco de Chile). Conversely, CE3 (with BZWBK, OTP and Komercni relatively less exposed), South Africa (Standard Bank), Mexico (Banorte), and Peru (Credicorp) appear as relatively less exposed to a scenario in which banks have to reduce their lending due to unfavorable external borrowing conditions and the quality FX corporate loan books erodes.

 

Eoin Treacy's view -

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

There are two sides to every argument. There is no doubt that the strength of the US Dollar over the last few years has been a major headache for companies that intended to pay back foreign loans in their own currencies. That is going to act as a headwind for their balance sheets for as long as it takes them to refinance. On the other hand they may be assisted by the boost to productivity and relative competitive advantage that comes from a sharply weaker currency. 



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March 09 2016

Commentary by Eoin Treacy

Fed rate hikes coming

Thanks to a subscriber for this report by Torsten Slok for Deutsche Bank which is packed with interesting charts. 

March 07 2016

Commentary by Eoin Treacy

Email of the day on Treasuries, Wall Street and Australia

I am a retired Debt Capital Markets banker. I think US Treasuries are still an attractive investment. Well at least US Treasuries pay a coupon and the USD is an attractive currency to many global investors. You are right these ridiculous low yields are not sustainable long term. However before reality reappears in global bond markets we need to see the end of the many excessively accommodative global monetary policies. You are rather bullish on equity markets. Looking at the S&P500 I think I can see why you hold that point of view. As you say the S&P 500 seems to be forming a base or consolidation. Regrettably the chart for the local ASX200 to my observation looks awful. Thank you for all your good work.

Eoin Treacy's view -

Thank you for these comments and I agree US Treasuries represent a safe haven for bond investors, when so many other sovereigns have negative yields. The big question we will likely get an answer to over the coming six months is how willing the Fed is to go-it-alone in raising rates.

With the rest of the world moving towards further monetary accommodation the upward pressure on the US Dollar from additional Fed hikes would represent a significant headwind. Meanwhile the US economy is 70% domestic consumer and wage growth has become a focus for those looking at signs for what the Fed will do next. Last week’s decline in wage demands suggest the Fed has time to monitor the situation. 



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March 04 2016

Commentary by Eoin Treacy

Don't panic about high-yield defaults

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

An alternate view is that US high yield, with or without the commodities sector, remains within the trading range we have seen since 2010. The European market is similar. In other words, high yield has been behaving much as it has throughout the post-financial crisis period which has witnessed several episodes of major market stress. These include Greece in 2010, the US rating downgrade in 2011, the eurozone crisis in 2011/12, and the China equity meltdown in August 2015. During these periods, high-yield spreads gapped out as investors feared a re-run of the 2008-09 experience when spreads and defaults soared. 

This time around, things are a bit different in that spreads have widened on account of macro concerns combined with genuinely higher defaults in the energy and materials sectors (Figure 2). Investors must distinguish these two issues. Sure, macro concerns do keep mounting – prominent on the radar recently are US growth slowdown, China devaluation fears, slumping commodity prices, health of emerging market economies, European banks, the shift to negative interest rates and Brexit. But the view on the broader highyield market should have very little to do with the commodity cycle or the longevity of the recovery. Rather, it should have everything to do with whether one believes policymakers will keep muddling through or if they are about to make an error that plunges the global economy into another 2008-09 crash. 

If one believes policymakers will not make a significant blunder then high-yield is probably not on the verge of a default debacle, even if macro risks are on the rise. Even in the event of a major crisis, it is likely defaults will not reach the levels of recent cycles. Looking closely at past credit cycles provides some useful lessons.

Since 1970 there have been four major default cycles and one minor one in the mid-1980s (Figure 3). Note that while the default rate has averaged about four per cent over these 45 years, it is not a mean-reverting relationship – default rates are either low or high. Some have warned that hitting four per cent is an ominous sign beyond which defaults will likely keep rising much higher. However, the four per cent default level was breached thrice in the 1980s and again in 2012 without significant further increases. There is nothing sacrosanct or cataclysmic about hitting four per cent; every cycle has to be evaluated on its merits.

The business and default cycles of the past 45 years have mostly shared two broad characteristics – the Treasury yield curve has flattened and inverted and there has been explosive growth in corporate debt other than bonds. In the past three cycles a third factor has been asset bubble conditions in one or more sectors which caused these cycles to be particularly vicious. None of these three conditions conclusively exists now. 

Eoin Treacy's view -

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

This is one of the most bullish reports on bonds I’ve seen in quite a while and thought subscribers would benefit from a fresh perspective. One argument I have also seen proposed which makes sense is that while low oil prices have been a harbinger of defaults in the energy sector, the rebound will remove some of the pressure so the pace of defaults might be lower that currently priced in. 

 



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February 26 2016

Commentary by Eoin Treacy

New JPMorgan Flash-Rally Theory Sends Message on Today's Market

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

Some big names back JPMorgan’s view that it’s often tougher to trade Treasury securities in the roughly $500 billion-a-day cash market than the derivatives that track them. The Federal Reserve Bank of New York touched on the topic in a recent blog post. Sam Priyadarshi, head of fixed-income derivatives trading at Valley Forge, Pennsylvania-based Vanguard Group Inc., the largest private holder of Treasuries, says the relative ease is encouraging his team to trade more in futures. His team trades Treasuries for some of the firm’s active portfolios.

The JPMorgan analysts looked at measures of trading activity and the depth of the markets’ liquidity to determine the source of the steep drop in yields in October 2014. They found that shortly before the decline, volume in 10-year Treasury notes spiked. In contrast, trading volume in 10-year futures contracts only peaked after the note’s yield had plummeted to its low for that day, they said. They also found that, in futures, average transaction costs were lower, and distribution of market depth across the order book was more stable.

 

Eoin Treacy's view -

Activity in the Treasury market is receiving a great deal of attention at present. The level yields are at right now suggests to some people a recession is imminent, but other economic factors are considerably more benign. That is contributing the sense of dissonance many people feel.

The fact that upwards of $8 trillion in Euro, Yen and Swiss Franc denominated debt is trading with a negative yield has a lot of people on edge. The end of the Federal Reserve’s quantitative easing program has also altered the status quo, while the spike in junk yields raises questions about who is exposed. However there are some additional considerations that are potentially more important for the medium-term outlook. 

 



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February 24 2016

Commentary by Eoin Treacy

Trends & Inflection Points

Thanks to a subscriber for this note by Mark Steele for BMO which may be of interest to subscribers. Here is a section: 

Gold does well when the banking system is at risk.

The banking system is at risk.

Yesterday, we highlighted the CDS curve on Deutsche Bank, which went inverted (Markit pricing) when WTI hit $26. We updated that chart as of 5:30am, only this time with gold overlaid on the DB curve – Figure 3.

 

Eoin Treacy's view -

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

The correlation between the underperformance of the financial sector and the surge in gold prices is not a coincidence. Gold has been in need of a bullish catalyst and it has attracted interest as government bonds yields moved into negative territory. 



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February 16 2016

Commentary by Eoin Treacy

Email of the day on the impact of financial regulation

You write: "The prospect of negative interest rates is particularly bad news.....because not only do they have to hold more capital but they have to pay the ECB for the privilege". This is not particularly clear. Please explain why banks have to hold more capital when rates go negative. Also, how the link with the ECB works. Thank you very much.

Eoin Treacy's view -

Thank you for the opportunity to clarify what is an important point. The regulatory overhaul that has been implemented across markets means banks need to hold more Tier 1 capital. Prior to the financial crisis they could have substituted some Tier 2 capital, (lower quality assets) to fulfil their core capital requirements. If they don’t have enough Tier 1 capital they need to get it somewhere and the easy route is to borrow bonds at the discount window in exchange for Tier 2 and lower quality assets. The result of negative interest rates is that they now have to pay for the privilege rather than picking up the carry on the spread on higher yielding assets. 



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February 11 2016

Commentary by Eoin Treacy

A Dangerous Shift

Thanks to a subscriber for this characteristically bearish report by Gerard Minack which may be of interest. Here is a section:

The second corrosive factor for markets is the downgrading of perceived central bank potency. There are several recent hints of this decline. Mario Draghi’s ‘whatever it takes’ comment in 2012 was, in my view, the single most important central bank action of the past 5 years. However, European bank stocks – a principal beneficiary of ‘whatever it takes’ – have now almost given up all their ‘whatever it takes’ gains, despite recent ‘whatever it takes with steroids’ comments from Mr. Draghi (Exhibit 5).

Likewise, the Bank of Japan’s bazooka now seems to be firing blanks. The yen strengthened and equities fell after the cash rate was cut below zero – the opposite of what was presumably expected.

Most importantly, perceptions of the Federal Reserve also appear to be changing. Markets have never priced the Fed’s dot-plot rate guidance. More tellingly, in my view, the market is now pricing a non-trivial chance that the Fed will have to completely reverse course. Current pricing of Euro-dollar futures and options now implies a reasonable chance of zero or negative rates ahead (Exhibit 6).

Medium-term inflation expectations are my crude measure of central bank credibility. Exhibit 7 shows the 5 year-5 year forward breakeven inflation rates for Europe and the US (an implicit forecast of inflation 6-10 years from now). These measures have been falling for 18 months. Markets are increasingly of the view that central banks will not be able to achieve their key policy aim: returning inflation to normal levels.

My medium-term view is that central banks will not be able to overcome the forces of disinflation. I didn’t expect markets to agree with that until the next recession. However, if that is what is happening now, then this will be a more difficult year than I had been expecting.

 

Eoin Treacy's view -

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

The IMF paper I posted on Tuesday highlighting a mechanism for introducing negative interest rates by reducing the attractiveness of paper money should not be taken lightly. It is perhaps the most relevant example of the lengths to which central banks are willing to go to achieve their goals. Since Janet Yellen refused to rule out the potential for the USA to adopt a negative interest policy in future we can conclude the ECB and BoJ are not the only central banks considering the tool.  



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February 09 2016

Commentary by Eoin Treacy

Breaking Through the Zero Lower Bound

Thanks to a subscriber for this report by Ruchir Agarwal and Miles Kimball for the IMF which may be of interest to subscribers. Here is a section:

We show here how the combination of (a) using electronic money as the unit of account and (b) a time-varying paper currency deposit fee can be used to eliminate the option to circumvent the negative rates by withdrawing, storing and, later, redepositing paper currency. The key idea is that a negative interest rate can be accompanied by a time-varying deposit fee that ensures the value of paper money and the value of funds in electronic accounts will move in tandem. Such a deposit fee only needs to be imposed at the central bank’s cash window—the facility through which the central bank and commercial banks interact to bring cash in to and out of circulation—and not on households, firms, or banks. Levying the paper currency deposit fee on net deposits of paper currency allows the central bank to create an exchange rate at the cash window between electronic currency and paper currency, so that in a negative interest environment, the value of paper currency can be caused to depreciate over time relative to electronic money. The objective is a policy at minimum distance from the current monetary system consistent with eliminating the zero lower bound. In particular, such a policy requires no extra regulations or quantity constraints. Instead, its impact on the economy works entirely through the price system.

Eoin Treacy's view -

This is about the best, though unintentional, argument for owning gold and stocks with reliable dividend growth I’ve seen. One of the primary arguments used by fundamental analysts to disparage gold is that it does not pay a dividend and as a result cannot be valued. That’s does not seem to trouble them when it comes to suggesting that fiat currency should be intentionally debased and eroded by negative interest rates. With $7 Trillion in bonds currently in a negative yield environment, gold has a positive carry just by virtue of not paying anything. 



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February 08 2016

Commentary by Eoin Treacy

Credit Market Risk Surges to Four-Year High Amid Global Selloff

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

Exchange-traded funds that hold U.S. junk bonds slid to their lowest levels in almost seven years. BlackRock’s iShares iBoxx High Yield Corporate Bond exchange-traded fund and SPDR Barclays High Yield Bond ETF both fell to the lowest levels since 2009.

Financials and energy were the two investment-grade sectors that added the most risk in the U.S., Markit CDX North American Indexes show. In high yield, energy, communications and health care fared the worst.

Chesapeake Energy Corp., the U.S. natural gas driller that’s been cutting jobs and investor payouts to conserve dwindling cash flows, lost more than half it stock market value Monday after a report that it hired a restructuring law firm.

The company’s bonds led losses among high-yield debt on Monday. Chesapeake’s notes due March 2016 tumbled to a record to 74.5 cents, from 95 cents last week, while its bonds maturing in 2017 fell to an all-time low at 34 cents.

“Broad oil weakness has now turned into distressed energy cases, which investors view as possibilities of higher risk of restructuring or debt exchanges," Ben Emons, a money manager at Leader Capital Corporation. “Nothing has been announced of that matter but markets move quicker ahead of such possibility happening."

 

Eoin Treacy's view -

Regardless of the answer, when someone asks whether a default is imminent one has to conclude that the situation is troubling. This is as true of Chesapeake today as it was of Greece, Portugal et al a few years ago. 

Chesapeake’s 2017 6.25% Senior UnSecured bullet bond now yields 150% suggesting very few people think it will make its last coupon payment due in July.   

 



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January 29 2016

Commentary by Eoin Treacy

Japan Adopts Negative-Rate Strategy to Aid Weakening Economy

This article by Toru Fujioka and Masahiro Hidaka for Bloomberg may be of interest to subscribers. Here is a section:

Bank of Japan Governor Haruhiko Kuroda sprung another surprise on investors Friday, adopting a negative interest-rate strategy to spur banks to lend in the face of a weakening economy.

The move to penalize a portion of banks’ reserves complements the BOJ’s record asset-purchase program, including 80 trillion yen ($666 billion) a year in government-bond purchases, which was kept unchanged at the board meeting. By a 5-4 vote, Kuroda led his colleagues to introduce a rate of minus 0.1 percent on certain excess holdings of cash.

Long a pioneer in adopting unorthodox policies to tackle deflation and revive economic growth, the BOJ is now taking a page out of European policy makers’ playbooks in the goal of stoking inflation. The yen tumbled after the announcement, which came after Kuroda just last week rejected the idea of negative rates.

“This clearly shows the BOJ wanted to weaken the yen and raise the price of import goods and boost inflation,” said Daisuke Karakama, an economist at Mizuho Bank in Tokyo. “We don’t know this negative rate policy will be good for the economy in the end,” he said, adding that success in Europe doesn’t guarantee the same for Japan.

 

Eoin Treacy's view -

JGB yields plunged on today’s news since a yield of 0.1% is still better than receiving negative 0.1% from deposit. In addition to continued BoJ purchases, in line with its quantitative easing program, this has sent yields to record lows with little prospect for significantly higher levels while the policy persists. 



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January 25 2016

Commentary by Eoin Treacy

Plumbing the depths...

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

We would be biased long gold into Chinese New Year but only up to around $1,140 We expect the current rally to fade after that the metal to post a new low for the current down-cycle in Q3, followed by a sluggish recovery into year end.

Silver remains a derivative of gold. Trading opportunities are tactical and technical, not fundamental. We recommend buying silver volatility when one-month implied dips below 23%. We would rather own puts than calls.

In the short-term we expect platinum to trade below $800 and potentially test the global financial crisis low of $744. The medium-term outlook is improving, however, and we think platinum’s long period of underperformance relative to both gold and palladium will begin to reverse during H2.

Relative to spot prices we are most bearish palladium. That’s counter to consensus and recent history. But the demand outlook has deteriorated, supply is inelastic, inventories are large, and investor conviction is shaky. Palladium is more likely to trade in the $300s than $600s this year

Eoin Treacy's view -

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

This report is representative of a large number that have crossed our desks recently with the abiding message being that there are short-term risks but medium-term upside potential. In any other circumstances investors would pre-empt a medium-term bullish view by buying now and using further weakness as an opportunity to increase positions. One has to ask why this is not more evident within the commodity complex right now?

 



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January 21 2016

Commentary by Eoin Treacy

Even the ECB's Cash Can't Stop Investors Worrying About Portugal

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

Central to the concern over Portugal is whether the government is shifting tack as it prepares to temper the austerity measures that won favor with investors, if not voters.

Prime Minister Antonio Costa’s government, sworn in at the end of November, is due to deliver a draft of its 2016 budget to European authorities this week. Plans include reversing state salary cuts and bolstering family incomes, policies he needs to ensure the support from the Communists and Left Bloc to have a majority in parliament.

The government already increased the minimum wage and plans to reinstate four holidays and reduce the working week for state workers to 35 hours, abandoning some measures introduced during Portugal’s three-year international bailout program that ended in 2014. It also plans to regain control of airline TAP SGPS SA.

Portugal still attracted foreign investors to a sale of 4 billion euros ($4.4 billion) of 10-year government bonds via banks last week. Finance Minister Mario Centeno said maintaining confidence in the country is crucial and it would be reflected in the budget. Bond yields peaked at 18 percent during the debt crisis.

Costa, 54, says he can still keep the budget deficit within the European Union limit of 3 percent of gross domestic product through 2019 as the country tries to deal with its 223 billion- euro debt pile.

 

Eoin Treacy's view -

The ECB has been circumspect about adding new liquidity because the speed of the Euro’s decline was doing their job for them. However with the stability of the Euro, and particularly with sentiment doubting whether the Fed will be able to raise rates four times this year, the need for ECB to take responsibility for its own policy has increased again. 



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January 20 2016

Commentary by Eoin Treacy

Gold and Safe Haven Status

Eoin Treacy's view -

Gold prices are down about 43% in US Dollar terms since the 2011 peak but have been notably quiet over the last few months as volatility has picked up in just about every other asset class. Sometimes just doing nothing is enough to attract attention when the emotionality of the market spikes higher and this has certainly been the case for gold. 



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January 08 2016

Commentary by Eoin Treacy

Bill Gross Says Tough Time for Bonds If Fed Relies on Jobs

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

Bill Gross says bonds will have a tough period ahead if the Federal Reserve relies on job growth as a critical measure for raising interest rates.

After a Labor Department report today showed that payroll growth surged in December to 292,000, Gross said it appears that the Fed is on track to raise rates three or four times this year, based on statements from policy makers. 

"If the Fed continues to believe jobs are a critical element as opposed to aggregate demand and global growth, bonds have a sad period ahead of them," Gross, the lead manager of the $1.3 billion Janus Global Unconstrained Bond Fund, said in a Bloomberg Radio interview.

The Federal Reserve raised interest rates in December for the first time in almost a decade after a strong year of job growth. Payrolls increased by 2.65 million last year compared with 3.1 million in 2014 -- the best back-to-back years for hiring since 1998-99. The central bank is counting on job growth leading to increases in worker pay and inflation.

"The Fed does believe that jobs and the unemployment rate is critical to future inflation over the medium term," Gross said. "So the three or four Fed steps that Stan Fischer and Janet Yellen seem to confirm are probably on track, at least in their verbiage."

Gross said he doesn’t think it’s possible to raise interest rates by 100 basis points in today’s levered global economy, in which the dollar is rising and hurting companies in emerging markets. Bonds will be stable if the Fed only raises interest rates one or two times over next 12 months, said Gross.

 

Eoin Treacy's view -

The first question is whether the Fed will raise rates four times this year the second is do they intend to raise them four times in 2017 as well? 

The bond market is telling us investors do not believe the Fed will be able to raise rates at such an ambitious pace not least because of the influence that will have on the ability of foreign companies to fund repayments of Dollar loans they took out over the last decade of a weak greenback. This has an issue we have been discussing for nearly 18 months now and the low level of commodity prices represents an additional headwind to many debt issuers in emerging markets.  



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January 05 2016

Commentary by Eoin Treacy

How are traditional Safe Haven assets performing?

Eoin Treacy's view -

Following yesterday’s disappointing start to the year and against a background of heightened geopolitical tension, weakening performance in emerging markets and fears about a paucity of earnings growth I thought it would be an interesting time to look at the performance of what have traditionally been viewed as safe haven assets. 



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December 22 2015

Commentary by Eoin Treacy

What the Fed rate hike could mean to mortgage borrowers

This informative article by Kathy Orton at the Washington Post may be of interest to subscribers. Here is a section:

 

It is likely that uncertainty in the global economy will continue to put downward pressure on long-term rates. The Mortgage Bankers Association is predicting the interest rate for 30-year fixed-rate mortgage will be around 4.8 percent at the end of 2016, that's an increase of less than one percent.

"We have a fairly weak global economy right now," said Michael Fratantoni, MBA's chief economist. "You have many global investors parking their money in U.S. Treasury securities or other safe assets and that is keeping our longer term rates lower than they otherwise would be." 

Despite those concerns, Fratantoni is optimistic about next year's real estate market.

"At some point, you could get to a level of rates, 6 to 6 1/2 percent, that would really begin to crimp affordability and then that would be a real negative," he said. "But at this point, it's going to be just a very modest headwind. Most of the other fundamentals are suggesting a very strong housing market in the year ahead."

Waters agrees. Although he demurred when asked what he thought the interest rate on a 30-year fixed-rate mortgage would be at the end of the year, he didn't think it would be significantly higher.

"I tend to think from a 30-year fixed mortgage standpoint there's not going to be an extraordinary change," he said. "I don't think they'll go up or down more than a quarter percent, at least not initially. It's not going to five [percent] and it's not going to three [percent]. We're going to stay in a tight band."

 

Eoin Treacy's view -

30-year Treasury yields moved to a new low in January and spent the rest of the year moving higher in a rangey uptrend characterised by a progression of higher reaction lows. A sustained move below 2.8% would be required to question current scope for continued higher to lateral ranging. 



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December 22 2015

Commentary by Eoin Treacy

Soaring Debt Yields Suggest Oil M&A Could Happen in 2016

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

Mergers haven't taken off in the oil patch this year largely because potential targets have been banking on a rebound and potential buyers have been expecting further falls. The spike in yields for borrowers in the energy sector, along with the growing acceptance that oil and gas prices likely face another year on their back, should mean those opposing views finally converge in 2016, prompting some deals.

What's more, this chart suggests the advantage should lie with large, strategic buyers like the oil majors for two reasons.

First, one way potential targets have been shoring up balance sheets is to sell assets rather than the entire company.

But a thriving asset market requires buyers being able to raise capital at reasonable rates, be they other E&P companies or private equity firms looking to snap up bargains. Asset sales have slowed already this year, with just $29 billion worth in North America, compared with $107 billion in 2014, according to data compiled by Bloomberg.

Second, with the cost of capital rising and cash harder to come by, any deals struck will require at least the promise of synergies and will favor those buyers able to use their own stock as a credible acquisition currency. One reason Anadarko's approach to Apache met with such scorn was that it scattered rather than tightened the company's focus. The majors, diversified anyway, bring the benefit of bigger balance sheets, which both alleviate any credit pressures weighing on the target and provide a clearer path to developing a smaller E&P company's reserves. Paying with shares also means that selling shareholders get to participate to some degree in the eventual recovery in oil and gas prices.

 

Eoin Treacy's view -

Major oil companies have slashed exploration budgets with the result they have more capital to pick up promising assets as prices decline. Private Equity firms have amassed sizable war chests to invest in troubled energy companies but have so far been slow to make large purchases. Meanwhile sellers are hoping for a rebound so they can get a better price. With everyone appearing to bide their time a catalyst is required to encourage deal making. 



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December 21 2015

Commentary by Eoin Treacy

Spanish Yield Rises to 5-Week High on Instability After Election

This article by Anooja Debnath and Lucy Meakin for Bloomberg may be of interest to subscribers. Here is a section:

Spain’s government bonds fell, pushing the 10-year yield to the highest in five weeks, after an indecisive election left Prime Minister Mariano Rajoy with limited options to forge a governing majority, threatening a period of instability.

The yield difference between Spanish and similar-maturity Italian bonds widened to the most since mid-November amid muted declines in the rest of the euro-area’s peripheral debt markets.
While Rajoy’s People’s Party placed first in Sunday’s election, earning the right to try to form government, the results suggest the only party able to form a majority with him in the 350- member parliament would be the Socialists, the PP’s historic rivals.

Even in Spain the losses were limited, with the slide only the largest in a week, as investors focus on European Central Bank bond purchases, lower debt issuance and an improving economic outlook. Monday is the last day of ECB buying until Jan. 4.

“The election outcome failed to provide us a clear picture of who will take power,” said Anders Moller Lumholtz, chief analyst with Danske Bank A/S in Copenhagen. “It is likely to take time before we get clarity, and uncertainty is not a friend of the market. ECB QE buying could cushion some of the knee-jerk reaction, but as Monday is the last day before the QE goes on pause we probably shouldn’t expect much effect from that side. Beyond the political uncertainty, we are positive on Spain.”

 

Eoin Treacy's view -

Spain has been a beneficiary both of relatively stable government and ECB largesse which has allowed the economy recover following a major property market crash. However since Greece represents investors’ most recent experience of government upheaval within the Eurozone nerves are understandably frayed.  This is particularly true when such a large country is involved. 



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December 16 2015

Commentary by Eoin Treacy

Email of the day on the impact of currency market volatility on returns

In your piece today [Ed. Yesterday] on bonds the foreign exchange rate aspect was not mentioned. Several years ago many international investors were tempted by the relatively high yields on Australian bonds. Non-Australian investors have lost out on the fall in the value of the Australian dollar.

Eoin Treacy's view -

Thank you for highlighting this issue which has been a topic covered in the Friday audio commentaries for at least the last 18 months. While the Dollar was trending lower, investors in emerging markets and commodity producers had the luxury of capital and currency market appreciation as well as being able to pick up a competitive yield. 

With a resurgent Dollar the status quo has been shaken up and that is creating both risks and opportunities across a number of assets. Since foreign issuers of US Dollar debt represent significant weightings in bond indices, the strength of the Dollar is a potential headache for investors in bond ETFs. 

 



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December 15 2015

Commentary by Eoin Treacy

Email of the day on bond fund risk:

You have made the following argument on bond funds. 

"In addition a bond fund has to manage duration, even in a falling market, which means bonds often cannot be held to maturity. This means investors in bond funds risk underperforming the bond market in a rising interest rate environment." 

That does not seem correct. If the fund rolls bonds in such an environment, it will take a capital loss but receive higher interest on the remaining capital. I have seen research that suggests that these effects cancel each other out.

 

Eoin Treacy's view -

Thank you for raising this point which allows me to elaborate on yesterday’s piece focusing on bond risk. Yes, of course there is an argument that if prices go down, yield goes up and over the course of a reasonably lengthy maturity the investor will be compensated for the additional risk that has been taken on. However for this to be true in all cases would be to subscribe to the belief that one cannot lose money by investing in bonds. We have plenty of evidence that this is not the case so there must be additional factors affecting value. 



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December 15 2015

Commentary by Eoin Treacy

Summers: Most Plausible Bubbles No Longer Plausible

This short interview with Larry Summers may be of interest to subscribers. 

Eoin Treacy's view -

In this interview Mr Summers goes on to highlight that a lot of bad news has already been priced into markets that were mentioned in the media over the last few years as representing bubble risks. He cites commodities, emerging markets  and high yield debt as examples of markets that have already contracted substantially and therefore have already priced in the effects of a first rate hike. 



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December 14 2015

Commentary by Eoin Treacy

Junk-Bond Fund's Demise Mars Vulture Investor's Storied Career

Thanks to a subscriber for this article by Gregory Zuckerman and Daisy Maxey for the Wall Street Journal which may be of interest. Here is a section: 

Traders said part of the reason the Third Avenue fund ran into deep problems: It allowed daily withdrawals but stuck with investments that have become harder to trade and have been steadily losing value as investors fled energy and other kinds of riskier debt. It has been harder to find investors willing to buy debt the fund holds, including energy company Magnum Hunter Resources Corp. and troubled Spanish gambling company Codere SA, traders said.

As the Third Avenue fund’s holdings began to decline, rival traders at hedge funds shorted, or bet against, some of the mutual fund’s holdings, wagering that Third Avenue would experience investor withdrawals and be forced to sell some of its holdings, according to the company and one trader who made this move.

“It all starts with maybe trying to overreach,” Mr. Tjornehoj  said. “Maybe this is the strategy—focused credit—that should only be available to institutions or accredited investors.”

Now, investors are focused on whether other funds may run into similar investor withdrawals and problems as the year-end approaches. Many investors move to exit losing funds and investments late in the year to generate losses to reduce capital gains taxes, traders said.

 

Eoin Treacy's view -

When I started in Bloomberg in 2000 most of my clients on the Belgium and Luxembourg sales route were fixed income oriented so the first thing my manager had me do was read bond math manuals to get up to speed with what clients were looking at. I remember reading about convexity, how much of a move in price and yield duration can be expected from a move in interest rates, and it made sense to me since interest rates tended to move a lot. Little did anyone expect at the time that trading convexity would become a one-way bet, that would last for the better part of a decade.  



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December 11 2015

Commentary by Eoin Treacy

High Yield and Energy

Eoin Treacy's view -

When interest rates are low there is an incentive to issue debt over equity. The low interest rate environment also contributes to spreads tightening as yield hungry investors move further out the risk curve to capture the return they require. The unexpectedly long length of time that interest rates have been low has created a situation where business models were framed around the situation continuing and now that the Fed is set to change tack an adjustment is underway. 



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December 10 2015

Commentary by Eoin Treacy

Zuma Sparks Outrage in South Africa by Axing Finance Chief

This article by Michael Cohen  Amogelang Mbatha for Bloomberg may be of interest to subscribers. Here is a section:

“The government has crossed a line which it hasn’t crossed for the last 20 years,” Steven Friedman, director of the Center for the Study of Democracy, said by phone from Johannesburg. “This is really, effectively, the first finance minister to be fired since 1994. The accurate perception is that the reason he was fired is that he was doing his job, insisting on fiscal discipline.”

While Zuma announced in February that the government had taken a decision to build new nuclear plants, Nene insisted that South Africa had to be able to afford them. Nene also clashed with the chairwoman of South African Airways, Dudu Myeni, a former schoolteacher who also heads Zuma’s charitable foundation, after he refused the national carrier permission to restructure a plane-leasing deal.

“It is common knowledge that Nhlanhla Nene sought to rein in excessive government spending and was causing too much of a blockage for President Zuma in respect of the nuclear procurement deal and SAA,” Mmusi Maimane, the leader of the main opposition Democratic Alliance, said by e-mail. This is “yet another example of how President Zuma puts himself first and the country second.”

 

Eoin Treacy's view -

Some of the best vacations I’ve had have been to South Africa and with the Rand making historic lows against a host of currencies the Sardine Run in 2016 is sounding increasingly enticing. While the Rand’s decline certainly makes South Africa more attractive as a tourist destination, the slide in standards of governance mean the country will be less attractive for foreign companies seeking manufacturing and services venues.  



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December 08 2015

Commentary by Eoin Treacy

Oaktree's Marks Likens Distressed Conditions to Post-Lehman

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

“Post Lehman there was too much to do and now there is again,” Marks said Tuesday, referring to the financial crisis that followed the collapse of the investment bank in September 2008. “For the credit investor we have our first opportunities in several years. It’s been a long, long time."

After Lehman’s bankruptcy, Oaktree deployed billions of dollars in distressed debt, reaping a handy profit. Its Opportunities Fund VII, which did the bulk of the investing, has so far distributed $22 billion to clients on $13.5 billion of drawn capital, according to its recent third-quarter earnings statement.

Oaktree’s top executives, including Marks and co-Chairman Bruce Karsh, had bemoaned a dearth of distressed-investment opportunities since at least 2013, when the Standard & Poor’s 500 index was still in the middle of a four-year run-up. That changed in August, when investor concern that China’s economic growth was slowing quicker than expected sparked a selloff in stocks and high-yield bonds. Energy companies have been hit particularly hard as oil prices continue to slide.

“What you saw in the third quarter of this year could well be a harbinger of things to come in the next year or two,” Karsh said in October. “We’re in the later stages of this credit cycle. We saw the psychology beginning to really roll over and change and people starting to get fearful. We started to see a lot of cracks.”

 

Eoin Treacy's view -

Private equity firms have had little trouble raising capital for energy sector acquisitions not least because it represents one of the few sectors trading at depressed valuations. With a dearth of truly high yield opportunities, investors have little choice but to look at energy and this is exacerbated by the availability of liquidity in an ultra-low interest rate environment. 



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December 03 2015

Commentary by Eoin Treacy

Draghi Braves QE Hype With Boost That Leaves ECB Room to Do More

This article by Jeff Black and Maria Tadeo may be of interest to subscribers. Here is a section: 

The fresh stimulus coincides with a shift in global monetary policy, with the ECB adding stimulus as the U.S. Federal Reserve prepares to start its process of normalization. Even so, financial markets reacted with skepticism, sending the euro up as much as 2.6 percent and equities and government bonds down in a sign that Draghi’s measures fell short of expectations.

“The expectations were too high, and this was the minimum he could do,” said Marco Valli, chief euro-area economist at UniCredit SpA in Milan. “I think this was a mix of Draghi being held back by the conservatives, but also him wanting to keep some powder dry in case more is needed.”

 

Eoin Treacy's view -

The ECB’s balance sheet is currently in the region of €2.7 trillion. At €60 billion a month until March 2017 they will add an additional €960 billion which will take the total to well in excess of the previous peak in largesse; reached during its previous expansionary program. With the announcement that they will continue to reinvest maturing issues the prospect of the balance sheet contracting is almost zero. Meanwhile they leave the door open to additional easing should the need arise.   



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November 17 2015

Commentary by Eoin Treacy

Email of the day Chinese selling and negative sway spreads

Just a short comment regarding the negative swap spread story Eoin posted: I've heard rumours about the Chinese selling large volumes of US treasuries, more than what the market can absorb. This due to their own domestic policy challenges recently. The heavy selling has depressed bond prices/pushed up yields, to unnatural levels compared to swaps. Just a rumour (I'm in no position to confirm it) but sounds plausible to me. If you have further views on this, I would be very interested.

Eoin Treacy's view -

Thank you for this information and I have also read about Chinese liquidation of Treasuries. At least part of the reason for this is because they are no longer holding back the appreciation of the Yuan but rather selling Dollars to slow its decline. This has removed a potent source of demand for Treasuries. 



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November 16 2015

Commentary by Eoin Treacy

Debt Market Distortions Go Global as Nothing Makes Sense Anymore

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

It’s hard to overstate how illogical it is when swap spreads are inverted. That’s because it suggests that governments are less creditworthy than the very financial institutions they bailed out during the credit crisis just seven years ago. And as the Fed prepares to end its near-zero rate policy, those distortions are coming to the fore.

The rate on 30-year swaps, which allow investors, companies and traders to exchange fixed interest rates for those that fluctuate with the market, and vice versa, has been lower than comparable yields on Treasuries for years now as pension funds and insurers increasingly hedged their long-term liabilities.

But in the past three months, spreads on shorter-dated contracts have also quickly turned negative. Now, five-year swap rates are about 0.05 percentage points lower than similar- maturity Treasuries, while those due in three years are also on the verge of flipping.

 

Eoin Treacy's view -

There are three important charts in the fixed income markets right now. The Swap spread is one of them because at increasingly wide negative levels important questions are being asked about how risk is being priced. 



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October 20 2015

Commentary by Eoin Treacy

Email of the day on the nominal price of the DAX

Can you access the DAXK on Bloomberg? It’s the DAX without dividends reinvested. Then we can compare apples with apples as it were!

Eoin Treacy's view -

Thank you for this suggestion. The DAX is a total return Index so its 2.92% yield helps to flatter total return over the medium-term and makes shorting the Index a rather expensive proposition relative to nominal indices. I’ve added the DAXK to the Chart Library and you will observe that it has a similar chart pattern but I agree it makes sense to compare nominal indices with nominal indices in one’s analysis. 



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October 13 2015

Commentary by Eoin Treacy

Cracks Emerge in Bond Market

This article by Mike Cherney for the Wall Street Journal may be of interest to subscribers. Here is a section: 

U.S. companies have increased borrowing to levels exceeding those just before the financial crisis, as firms pursue big acquisitions and seek to boost stock prices by buying back shares. According to one metric, the ratio of debt to earnings before interest, taxes, depreciation and amortization for companies that carry investment-grade ratings, meaning triple-B-minus or above, was 2.29 times in the second quarter. That’s higher than the 1.91 times in June 2007, just before the crisis, according to figures from Morgan Stanley.

“The metrics that you measure health and credit by have peaked a while ago,” said Sivan Mahadevan, head of credit strategy at Morgan Stanley. “They are beginning to deteriorate.”

Many investors and analysts say the concerns are overdone. They note that the U.S. economy is still expanding and that many large firms continue to raise money at historically low rates. They say the U.S. unemployment rate, which held at 5.1% in September, is the lowest since 2008, despite unease over slowing economic growth overseas.

While “there are some areas of weakness,” Ms. Lurie said, “there are many other points to show positive economic growth.”

Corporate finance chiefs have been willing to absorb downgrades because a stellar rating has become less important, with little price difference between some bonds with ratings a few notches apart. And until recently, companies had little trouble selling debt regardless of their rating.

Eoin Treacy's view -

In an environment of ultra-low interest rates yield hungry investors have little choice but to move further out on the risk curve to achieve the returns they require. Since rates have stayed so low for so long spreads have contracted right across the curve. Issuers have been able to get money for whatever they want and this ample liquidity helped fuel significant momentum rallies. Petrobras’ successful issuance of a 100-year bond in June at spreads only marginally wider than much shorter-dated issues is a good example of trend. 



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October 06 2015

Commentary by Eoin Treacy

Email of the day on the bond market

All the attention is in Peru these days as the World Bank, the IMF etc are meeting here.
.
The problem is serious in EM countries, with the price of commodities going down and probably staying down for many years as the China economy shifts gears.

There is a credit crisis looming for EM in the private sector, since almost all companies have some exposure to the US Dollar in terms of debt. With local currencies devaluating in a fast way the math doesn´t add up so I do not know how things are going to end up. Thank you for the chart, I am very concerned about the spread.

What happened last week with the new bond issue of HP was something that caught my attention and that small event can be the sign of something worse coming.

Eoin Treacy's view -

It was a pleasure to meet this subscriber at the Chicago venue for The Chart Seminar last year. His prescient account of the slowdown in economic activity in Peru owing to the strength of the Dollar helped inform our commentary of the underperformance of commodity focused markets, particularly in Latin America, until recently.  



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October 05 2015

Commentary by Eoin Treacy

Email of the day on BBB/Baa spreads

I am trying to create a chart that shows: the US corporate spread, showing: a) Corporate yields b) UST yields c) the spread between the 2 so far I can´t create it, can you please help me. For this Chart, Baa Seasoned Corp benchmark is closer to 30y duration than 10y, so I will like to compare to 30y UST. Thanks 

Eoin Treacy's view -

I’ve added the Moody’s Baa Corporate Benchmark to the Library not least because its history goes to back to 1986 which offers historical perspective. 

To create a spread choose the Index from the menus or search. The ticker is MOODCBAA or you can use Moody’s in the search.
Click on Charting, 
Click on the green Other Relative button. 
In the popup window search for “30yr” 
Select US 30yr Treasury Bond Yield from the results. 
Select difference from the dropdown menu. 
Hit Apply. 

This is what the resulting spread should look like.

 



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September 29 2015

Commentary by Eoin Treacy

How to Fix the Offshore Drilling Industry

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

The overwhelming consensus view is that “deepwater is dead” or structurally impaired. We strongly disagree. The tried and true path to long-term success in energy investing is to “go where the oil is” and that is in deepwater where reserve additions have outpaced shallow water by 3.2x and onshore by 45% (1.3x excluding oil sands). Our field by field analysis suggests long-term (10 year) demand for 320 floating rigs (vs. 225 currently active and a total fleet – including expected newbuild deliveries - of about 385 today). The bad news is that near-term demand remains weak with a rig-by-rig analysis suggesting demand will bottom at 194 rigs in 2H ‘16. A similar analysis of the jackup market implies trough demand of 328 by YE ‘16 (vs. a fleet of about 570 rigs).

Reality bites: Industry to tackle structural supply issues
Rig attrition has begun to take hold with 43 floaters retired in the current cycle to date and an additional 28 floating units cold-stacked with most of those unlikely to return to the market. Although a significant increase relative to the last several years, these actions have only removed 14% of deepwater capacity (23% including stacked units) even as roughly 75 newbuilds remain on order so the fleet will still see net growth absent more aggressive action. The news is worse on the shallow water front, where only 52 units have been retired and 57 stacked (10% and 20% of the global fleet, respectively). With the oil price testing new lows again recently, backlog dwindling and hopes for a near-term demand recovery fading rapidly, the industry now seems more realistic about the need to take more decisive action on capacity reduction. We see scope for as many as 70 floaters and 110 additional jackups to exit the fleet over the next 12-18 months, although we believe the floater market will come into balance sooner given its better secular demand outlook, higher degree of consolidation and greater differentiation between newbuild and older units.

 

Eoin Treacy's view -

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

The decline in oil prices continues to take a toll on the drilling and services sector with a large number of consistent downtrends in evidence. Inevitably this is putting the most strain on the most highly leveraged operations and rationalisation is a virtual certainty the longer prices remains close to current levels. 



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September 23 2015

Commentary by Eoin Treacy

Rupiah Drops Most in Six Weeks After Indonesia Cuts GDP Estimate

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

The Indonesian parliament’s finance commission agreed late on Tuesday to lower the expansion projection in the 2016 budget to 5.3 percent from 5.5 percent. A preliminary factory gauge released Wednesday in China, Indonesia’s largest trading partner, missed estimates and dropped to the lowest since 2009.

Investors are still waiting to see when the Federal Reserve will raise interest rates, a move that’s expected to sap demand for emerging-market assets.

The rupiah declined 1 percent, the most since Aug. 12, to close at 14,647 a dollar, prices from local banks show. It fell to 14,661 earlier, the weakest level since July 1998, and is down 15 percent this year in Asia’s worst performance after Malaysia’s ringgit.

“The rupiah continues to decline as markets pare their expectations,” said David Sumual, chief economist at PT Bank Central Asia, the nation’s largest lender by market capitalization. “This growth estimate is more realistic. At this stage, with the Fed still clouding the outlook and China continuing to slow, it’s better to be conservative than see another revenue shortfall.” 

 

Eoin Treacy's view -

Indonesia has CPI of more than 7.5% and overnight rates of 5.75%.

The Dollar’s uptrend against the Indonesian Rupiah has picked up pace over the last month and a clear downward dynamic will be required to signal mean reversion is underway. 



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September 21 2015

Commentary by Eoin Treacy

The New Bond Market: Bigger, Riskier and More Fragile Than Ever

This article by Colin Barr for the Wall Street Journal may be of interest to subscribers. Here is a section: 

In the U.S., household, corporate and government debt amounted to 239% of gross domestic product in 2014, the Bank for International Settlements estimates, compared with 218% in 2007.

The U.S. isn’t alone. Dollar credit to nonbank borrowers outside the U.S. hit $9.6 trillion this spring, the BIS said, up 50% from 2009. Repaying those loans and bonds will become costlier in local-currency terms should the dollar rise, as it often does, when the Fed goes ahead with tightening, potentially stressing large borrowers such as emerging-market companies.

Domestically, the rise of large bond funds has created new risks. As the funds have grown, so has cross-ownership of the same bonds, increasing the likelihood of contagion if one manager starts selling, the International Monetary Fund says. Regulators worry that many investors may not know what is in their funds. A market downswing could lead to rising redemptions of fund shares, prompting funds to sell assets to raise cash and amplifying selling pressure across the market.

Since 2007, $1.5 trillion has gone into U.S. bond mutual and exchange-traded funds holding assets from government bonds to corporates and municipal debt, according to the Investment Company Institute. That compares with $829 billion into comparable stock funds.

Bond mutual and exchange-traded funds now own 17% of all corporate bonds, up from 9% in 2008, according to the ICI. In periods of market stress, more-concentrated mutual-fund ownership tends to mean larger price drops, the IMF said last year.

 

Eoin Treacy's view -

Individual bonds do not trade on an exchange but bond ETFs do. As the size of the exchange traded bond fund market has grown so has the risk that they are subject to the same intraday or intraweek volatility as stocks. 



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September 15 2015

Commentary by Eoin Treacy

Email of the day on the upcoming Fed decision

It would appear that the Fed might have a tough decision to make on Sep 16-17 – to hike or not?  Perhaps “not” due to the shaky ground of the current China stock market and the repeated pressure from the IMF & ECB not to raise the rates? 

But hypothetically, let’s assume that the Fed will really decide to hike the rates, even with a clear statement on slow increase of rates. In such a scenario, considering that China is the biggest holder of US Treasuries, would you expect China to start unloading/selling their positions immediately?, especially if they still need to further tighten their money market in order to shore/support their ailing stock market. 

Also in the interest of other subscribers, your view would be appreciated.  

 

Eoin Treacy's view -

Reading the Fed runes has the feeling of sports punditry at present and anything we think or say is not going to sway them one iota. The Fed is going to do what it is going to do. I can only think what I would do if I had bet my career and legacy on ensuring the US economy recovers from the biggest growth scare in a century. I’d be cautious, I’d want incontrovertible evidence and I wouldn’t want to take a risk. These are sober people and the last thing they want is to risk deflation. 



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September 03 2015

Commentary by Eoin Treacy

Sudden Dry Spell for Bond Sales

This blog post on the Wall Street Journal by Cynthia Lin may be of interest to subscribers. Here is a section

Why the sudden stop? Recent market-volatility may to be blame, which often discourages corporation from pricing securities. Some traders also point to more expectations that the Fed may keep its policy rate near zero for a little longer, which gives companies more time to enjoy cheap borrowing costs.

Of course, investment-grade offerings may come back into full swing, analysts say, especially if financial markets stabilize.

“To think August was supposed to have been a massive month, [the lull] suggests there’s an issuance wall waiting in the wings,” says CRT Capital bond strategist David Ader.

Invesco last week said it expects a record-breaking amount of supply to hit the market between Labor Day and the Fed’s Sept. 17 policy announcement. With about $190 billion in the pipeline needed to finance M&A deals, the firm says about $80 billion in investment-grade offerings could hit the market in early-September.

Eoin Treacy's view -

The bond market has been fertile ground for companies seeking to raise capital throughout the era of quantitative easing. Much of this capital has been devoted to buying back shares, paying dividends and refinancing old debt. The strength of the US Dollar and the threat of higher interest rates have acted as a headwind for fixed income funds in particular. 



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September 01 2015

Commentary by Eoin Treacy

Australia as China's Canary Means World Watching RBA's Heartbeat

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

“Of most interest will be any comments regarding recent financial market turbulence in relation to China and emerging-market driven worries and in particular whether this suggests a strengthened easing bias,” said Shane Oliver, head of investment strategy at Sydney-based AMP Capital Investors Ltd. “My view remains that the probabilities are skewed towards the RBA having to cut rates again at some point.”

The stock market rout in China threatens not only Australian exports but also a fresh slump in confidence among consumers and businesses Down Under.

Company profits fell in the second quarter for the fifth time in a row, the longest stretch of declines for at least two decades, according to data released Monday by the Australian Bureau of Statistics. Firms are forecasting a 23 percent drop in investment in the fiscal year that began July 1, little changed from the 25 percent reduction they estimated three months ago, a government report last Thursday showed.

Eoin Treacy's view -

The Australian Dollar is perhaps the greatest arbiter of the effect the decline in commodity prices has had on the economy. The inability of Chinese demand to meet exaggerated expectations has been a headwind for the mining sector as new supply has reached market. So far the major producers have sacrificed profits for market share and there is no sign just yet that this has ended. 



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September 01 2015

Commentary by Eoin Treacy

In strategy shift, CalPERS looks to cut financial risk

This article by for the Los Angeles Times may be of interest to subscribers. Here is a section: 

But even its staff acknowledges in a recent report that despite fast-rising contributions from taxpayers, the pension fund faces "a significant amount of risk."

To reduce that financial risk, CalPERS has been working for months on a plan that could cause government pension funds across the country to rethink their investment strategies.

The plan would increase payments from taxpayers even more in coming years with the goal of mitigating the severe financial pain that would happen with another recession and stock market crash.

Under the proposal, CalPERS would begin slowly moving more money into safer investments such as bonds, which aren't usually subject to the severe losses that stocks face.

Because the more conservative investments are expected to reduce CalPERS' future financial returns, taxpayers would have to pick up even more of the cost of workers' pensions.

Most public workers would be exempt from paying any more. Only those workers hired in 2013 or later would have to contribute more to their retirements under the plan.

The changes would begin moving CalPERS — which provides benefits to 1.7 million employees and retirees of the state, cities and other local governments — toward a strategy used by many corporate pension plans. For years, corporate plans have been reducing their risk by trimming the amount of stocks they hold.

Eoin Treacy's view -

With an unfavourable demographic profile many pension funds are being forced into increasing their weighting in bonds so that they can reduce risk in the distribution phase of retirement programs. This is regardless of the fact that government bond yields are low. This policy ensures additional funds will be required to make up for any shortfalls and/or benefits will be cut. 



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August 27 2015

Commentary by Eoin Treacy

European QE

Eoin Treacy's view -

The ECB has not stopped its QE program. In fact the volatility on stock markets only increases potential it will increase its stimulus. The ECB’s Balance sheet remains on an upward trajectory and still has more than €500 billion to go before it gets back to the stated objective of reaching 2012 peak. 
 



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August 25 2015

Commentary by Eoin Treacy

Bonds Avoid the Chaos of Other Markets

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

The slowdown in China’s economy and tumbling commodities are stoking deflationary concerns, with a measure of euro-area inflation expectations for the next year signaling a potential return to deflation.

The euro-area one-year inflation swap rate, a market gauge of the outlook for consumer-price growth over that period, was at minus 0.012 percent, after falling to minus 0.057 percent, matching the lowest since February, according to data compiled by Bloomberg.

“The extent to which government yields rise is probably less than people once thought because of those lower inflation expectations,” said Nicholas Gartside, London-based chief investment officer for fixed-income at JPMorgan Asset Management. “Bonds have two classic enemies -- higher growth and higher inflation. Both of those are weaker right now.”

Eoin Treacy's view -

Yesterday’s action on global stock markets which saw an early sell-off whose ferocity took traders and investors by surprise was pegged back before the close. In a change of tack today’s bounce was completed retraced today suggesting this is still a very nervous market environment. The majority of bonds futures had rallied in early trading in response to the panicky environment in stock markets but gave up the entire advance by yesterday's close and pulled back sharply today. 



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August 19 2015

Commentary by Eoin Treacy

Germany gained 100bn euros from Greece crisis

Thanks to a subscriber for this article from AFP which may be of interest. Here is a section: 

Germany, which has taken a tough line on Greece, has profited from the country's crisis to the tune of 100 billion euros ($109 billion), according to a new study Monday.

The sum represents money Germany saved through lower interest payments on funds the government borrowed amid investor "flights to safety", the study said.

"These savings exceed the costs of the crisis -- even if Greece were to default on its entire debt," said the private, non-profit Leibniz Institute of Economic Research in its paper.

"Germany has clearly benefited from the Greek crisis."

 

Eoin Treacy's view -

No country has benefitted more from the creation of the Euro than Germany. Not only did it create a massive market centred on its currency but its competitive advantage was cemented by the Euro. Against the current background, the Deutsche Mark would be among the strongest currencies in the world rather than benefitting from the Euro being among the weakest. Its borrowing costs are now lower than even the most bullish analyst could have ever imagined before the crisis. 



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August 11 2015

Commentary by Eoin Treacy

Email of the day on US Dollar denominated debt

Hello, that article on gold by Ambrose-Pritchard for The Daily Telegraph also refers to the $4.5 trillion in US dollars borrowed by emerging countries. With today's devaluation of the Yuan this Bloomberg article identifies the Chinese airline companies that got hammered because of the significant debt they hold in US$ terms. As the trend for rolling over US$ debt plays out in a couple of years perhaps we should trim some of our EM holdings ahead of the curve. If so, what to trim. It may be useful to know which EM sectors/companies hold significant US$ debt.

Eoin Treacy's view -

Thank you for the above article and this question which is sure to be of interest to subscribers. I would welcome some detailed research on emerging market issuers and their US Dollar exposure. Hopefully someone in the Collective has access to this information. 

At The Chart Seminar in Chicago last year a Peruvian delegate highlighted the risk of Dollar strength to the domestic market and the impact it was having on demand for consumer goods. He postulated that it was going to represent a problem for a number of Latin American issuers. This was a common sense point. 

 



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August 03 2015

Commentary by Eoin Treacy

Treasuries Gain as Weak Manufacturing Data Curb Rate-Hike Bets

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

“Data will be very, very much in focus and highly parsed as we near September,” said Christopher Sullivan, who oversees $2.3 billion as chief investment officer at United Nations Federal Credit Union in New York. Manufacturing data for the U.S. “was a tad weaker than expected. It tilted bonds firmer.”

The U.S. 10-year note yield fell one basis point, or 0.01 percentage point, to 2.17 percent at about 10:35 a.m. New York time, according to Bloomberg Bond Trader data. The 2.125 percent security due in May 2025 climbed 2/32, or 63 cents per $1,000 face amount, to 99 19/32. The yield reached the lowest level since June 1.

Fed Chair Janet Yellen said in July she expected the central bank to raise its benchmark rate this year, while emphasizing the pace of increases will probably be gradual.

Policy makers expect inflation to accelerate gradually toward their 2 percent target, the central bank
said in a statement at its July 28-29 meeting.

 

Eoin Treacy's view -

Investors would appear to be voting with their feet and taking a safe haven hedge to the soft performance of stock markets by buying bonds. 

Today’s move in 10-year yields breaks the progression of higher reaction lows and suggests a more volatile environment is unfolding within what continues to look like a developing medium-term base formation. . 



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July 31 2015

Commentary by Eoin Treacy

Email of the day on the Dow Jones Industrials and Treasury yields

I’m a retired, half-baked economist and no technical analyst but the following chart and associated indicators tell me that there is a significant loss of momentum and divergence since the beginning of May.

A five year chart (not attached) is not encouraging.

Your views would be appreciated.

 

Eoin Treacy's view -

Thank you for your observations and your self-deprecatory perspective will stand you in good stead when participating in the markets. When assessing market potential it is generally better to start with a long-term chart before zeroing in on more recent activity. This lends perspective and helps to fend off myopia which is a particular threat with large positions relative to one’s capital. 



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July 15 2015

Commentary by Eoin Treacy

Greece: Will this time be different?

Thanks to a subscriber for this report from Deutsche Bank. Here is a section:

Is this time different?

We are not overly optimistic, but is there are reasons to think that this time could be different? The answer is maybe, because the genie is out of the bottle. First, what the above question really means is whether Greece will manage to implement reforms and finally return to sustainable growth.

Understandably, clients tend to be very skeptical. However, recall that not too long ago several market commentators argued that Ireland and Spain could not remain within the euro area. These two countries are now among the fastest growing economies in the euro area. Before the general elections we were forecasting Greece to grow in line with Ireland and more than Spain in both 2015 and 2016.

The problem is that Greece’s challenges appear more economically, socially and politically entrenched than in the other peripherals. Syriza won the elections with a political programme that was calling for a reversal of reforms – for example in the labour market. There were pledges about reducing tax evasion and corruption – but it appears that tax receipts have fallen materially in past few months. Indeed, since December economic prospects for Greece have deteriorated sharply.

So are we destined to experience a new Greek crisis over the next year or two? While it is difficult to be optimistic, we think something has changed.

Eoin Treacy's view -

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

Greece has little choice but to now toe the line and implement the raft of reforms that has been imposed upon it. If the experience of Ireland and Spain is any measure it is possible to return to a growth trajectory but the intervening period will be very difficult. The big question is to what extent Greece can replicate that performance given the chasm that exists between political parties and the weight of debt the country has accumulated.  



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July 07 2015

Commentary by Eoin Treacy

June 30 2015

Commentary by Eoin Treacy

Puerto Rico Creditors Said Drawing Battle Lines as Default Looms

This article by Laura J. Keller and Michelle Kaske for Bloomberg may be of interest to subscribers. Here is a section:

Garcia Padilla has turned the island’s rescue efforts on their head. In a televised speech Monday, the governor said he will seek to delay payments on the island’s $72 billion in debt for “a number of years,” and he called on officials to come up with a debt restructuring plan by Aug. 30.

His comments sent the prices on some Puerto Rico bonds tumbling to all-time lows, while both Standard & Poor’s and Fitch Ratings cut the commonwealth’s ratings deeper into junk.
With traditional municipal-debt investors shunning its bonds, the island faces a stultifying cash crunch and the government expects its development bank to run out of capital by Sept. 30.

Puerto Rico’s new fiscal year starts July 1 and lawmakers Monday night passed a budget that would enable it to make payments on central-government debt. The U.S. territory of 3.5 million people is grappling with a jobless rate double the national average and a debt load bigger than every U.S. state except California and New York.

The creditors own about $4.5 billion of Puerto Rico’s debt and are led by Fir Tree Partners and Monarch Alternative Capital. They had been proposing terms for the bond deal since at least February, people with knowledge of the matter told Bloomberg last week. It would siphon money to the GDB, which handles the island’s debt transactions and lends to the commonwealth and its agencies, by repaying debt owed by its highway authority.

 

Eoin Treacy's view -

Puerto Rico is in a difficult situation being neither a state nor a city but a commonwealth. It therefore has no recourse to the same bankruptcy protection as a municipal like Detroit, the US government has said it will not bail it out and it does not have the ability to call on the IMF. Just how Puerto Rico anticipates being able to renegotiate the terms of its $73 billion remains to be seen. The market is now pricing in the inevitable budget cuts and tax increases that will be required but have not yet been announced. 



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June 29 2015

Commentary by Eoin Treacy

Treasuries Rise Most in 8 Months as Greek Vote Adds Haven Demand

This article by Susanne Walker Barton and Daniel Kruger for Bloomberg may be of interest. Here is a section:

“The anxiety surrounding the Greek referendum remains at a fairly high pitch,” said Edward Acton, a U.S. government-bond strategist at RBS Securities Inc. in Stamford, Connecticut, one of 22 primary dealers that trade with the Fed. “We may grind lower in yields.”

The Treasury 10-year yield fell 14 basis points, or 0.14 percentage point, to 2.34 percent at 2:18 p.m. New York time, according to Bloomberg Bond Trader data. The yield fell as much as 18 basis points, the most since Oct. 15. The 2.125 percent note due May 2025 climbed 1 5/32, or $11.56 per $1,000 face amount, to 98 1/8.

Fed funds futures show there’s a 30 percent chance the Fed will increase its benchmark rate from near zero in September, down from 38 percent on June 26, and a 67 percent chance by December, down from 73 percent, according to data compiled by Bloomberg.

 

Eoin Treacy's view -

Uncertainty is never welcome in the stock market but bonds tend to attract funds when people have doubts about what else to do with their money. Against a background of zero interest rates, wage growth and agricultural commodity prices that are now rising, there are medium-term risks to owning bonds. However, in the short-term traders are probably concluding that they represent less risk than the impact a potential exit of Greece from the Eurozone could have on stocks. 



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June 26 2015

Commentary by Eoin Treacy

Markets, Mergers & Megadeals

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

By various metrics, M&A affordability is currently very high for most U.S. and European corporates 

Over 75% of U.S. and European corporates have earnings yields above their 10 year cost of debt, while over 60% have free cash flow yields (vs market cap) above their 10 year cost of debt, implying a more affordable M&A financing market 

In fact, the cost of corporate debt is so low that acquisitions financed using low cost debt provide very high purchasing power relative to valuations of targets 

And 

Organic earnings growth in this cyclical recovery has trailed the growth in previous recoveries 

Many companies remain constrained by low organic growth and therefore view M&A as a key strategic differentiator 

To this end, divergent global growth and increased shareholder activism is reshaping corporate strategy 

Eoin Treacy's view -

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

The benign environment that has been characterised by abundant liquidity, low interest rates and a slow and steady recovery has been wonderful for raising capital for buying back shares, increasing dividends and acquiring other companies. 



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June 17 2015

Commentary by Eoin Treacy

Who does Greece owe all its money to?

This article by Evan Bartlett for The Independent may be of interest to subscribers. Here is a most relevant graphic from StatistaCharts. 

Eoin Treacy's view -

The above graphic illustrates the fact that the European Stability Fund and the Greek Loan Facility are on the hook for €141.8 and €52.9 billion respectively, or 60%, of Greece’s debt. The IMF is owed an additional €32 billion and there is another €48 billion outstanding in other bonds.

According to its website, the EFSF has already disbursed the vast majority of the money it had planned to lend to Greece. Little surprise then, the talks on how Greece plans on giving this money back are now breaking down. Greece has less incentive to negotiate when they have already drawn down most of the funds that were available.  



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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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