•  
Tue, 21st November 2017

Anirudh Sethi Report

  •  

Archives of “yield curve” Tag

The Chart That Everyone Is Talking About

Something has changed…

For months high yield bond yields have been compressed alongside rising stock prices as the flood of global liquidity from central banks.

ECB buying has driven European junk bond yields below those of US Treasuries and in turn that has pressured global high yield risk lower – despite a rise in leverage to record highs.

image

However, the last two weeks have seen a big shift in flows as investors have fled high yield funds and pushed into investment grade and Treasuries.

image

FOMC Leaves Policy Unchanged, Upgrades Growth To “Solid” From “Moderate”

In perhaps the least anticipated FOMC statement in months – with expectations of no rate-change and normalization on path – all eyes were on inflation/growth wording. Some feared a more dovish Fed might upset the exuberant growth narrative that is embedded into equity valuations (but not the yield curve), but The Fed seemed slightly more positive (and perhaps hawkish) by upgrading the economy from growth “moderately” to “at a solid rate” even as it cautioned that “Gasoline prices rose in the aftermath of the hurricanes, boosting overall inflation in September; however, inflation for items other than food and energy remained soft.”

As a result of the neutral wording, a December rate hike now appears guaranteed, and the 85% rate hike odds reflect that.

Furthermore, the Fed unanimously voted to leave policy unchanged.

Additional highlights:

  • Fed says economic activity rising at solid rate despite storms
  • Fed: inflation for items other than food, energy remained soft
  • Fed: storms unlikely to alter economy’s medium-term course
  • Fed: labor mkt continued to strengthen, unemployment declined
  • Fed: spending rising at moderate rate, investment picked up
  • Fed repeats mkt-based inflation compensation gauges still low
  • Fed repeats sees inflation stabilizing around 2% medium term

And nothing from Yellen on Trump or Powellbut he reiterated that “Yellen is excellent.”

BOJ Minutes (January) – looks like more of the same …

Bank of Japan January meeting minutes

  • Most members agreed price momentum not firm yet
  • Some members noted speculation that BOJ might raise rates in response to rising treasury yields
  • These members said BOJ should focus solely on 2 pct price target
  • Members shared view that yield curve is formed in smooth manner under YCC
  • One member said shape of yield curve should be a little steeper … this member said BOJ should accommodate a rise in yields due to improvements in Japan’s economy
  • Most members said companies will likely raise prices as consumer spending increases moderately
  • Members shared view that risks to economy, prices are to the downside
  • One member said downward pressure on yields should increase, so BOJ should reduce JGB, T-bill purchases
main points summarised via Reuters        
—-
“Most members agreed price momentum not firm yet” … sounds like another way of saying not even close to the inflation target … the BOJ seems to have an endless well of creativity when it comes to describing missing their target. Arrgghhh …. but maybe I just got outta bed on the wrong side today.
This:
“Most members said companies will likely raise prices as consumer spending increases moderately”
at least sounds like they have some hope for seeing inflation move in the direction they want.

Japan Begins QE Tapering: BOJ Hints It May Purchase 18% Less Bonds Than Planned

With the Fed expected to further tighten financial conditions following its now guaranteed March 15 rate hike, and the ECB recently announcing the tapering of its QE program from €80 to €60 billion monthly having run into a substantial scarcity of eligible collateral, the third big central bank – the BOJ – appears to have also quietly commenced its own monteary tightening because, as Bloomberg calculates looking at the BOJ’s latest bond-purchase plan, the central bank is on track to miss an annual target, by a substantial margin, prompting investor concerns that the BOJ has commenced its own “stealth tapering.”

While in recent weeks cross-asset traders had been focusing on the details and breakdown of the BOJ’s “rinban” operation, or outright buying of Japan’s debt equivalent to the NY Fed’s POMO, for hints about tighter monetary conditions and how the BOJ plans to maintain “yield curve control”, a far less subtle tightening hint from the BOJ emerged in the central bank’s plan released Feb. 28, which suggests a net 66 trillion yen ($572 billion) of purchases if the March pace were to be sustained over the following 11 months. As Bloomberg notes, that’s 18 percent less than the official target of expanding holdings by 80 trillion yen a year.

Some more details: the central bank forecast purchases of 8.9 trillion yen in bonds in March, based on the midpoint of ranges supplied in the operation plan. Maintaining that pace for 12 months will see it accumulate about 107 trillion yen of debt. At the same time, 41 trillion yen of existing holdings will mature, leaving it with a net increase of 66 trillion yen, well below the stated goal of 80 trillion yen.

Overnight US Market :Dow closed +143 points.S&P 500 up 12 points.

Stocks around the world continued to push higher Monday, and U.S. indexes again hit records. Bond yields climbed.

The Standard & Poor’s 500 index rose 12.15 points, or 0.5%, to close at a record 2,328.25 and topped $20 trillion in market value for the first time ever. The Dow Jones industrial average rose 142.79 points, or 0.7%, to an all-time closing high of 20,412.16. The Nasdaq composite gained 29.83 points, or 0.5%, to a record 5,763.96.

Treasury yields also rose as the yield on the 10-year Treasury note rose to 2.43% from 2.41% late Friday. Two-year and 30-year Treasury yields also notched higher.

Roughly five stocks rose for every three that fell on the New York Stock Exchange. Financial stocks helped lead the way, and those in the S&P 500 rose 1.3%. That’s the largest gain among the 11 sectors that make up the index. Raw-material producers and industrial companies were also strong.

Stocks resumed their upward climb last week after stalling for a couple weeks. Strong earnings reports have helped drive the gains. The majority of companies in the S&P 500 that have reported fourth-quarter earnings so far, 69%, have beaten Wall Street’s expectations, according to S&P Global Market Intelligence. It’s mostly come through companies keeping control of costs better than analysts were forecasting.

Overnight US Market :Dow closed -72 points

The Dow Jones industrial average erased its gain for the year on Thursday, part of a pullback for stock indexes as Treasury yields continued their upward march.

The Dow Jones industrial average fell 72 points, or 0.4%, to 19,732.40. That puts the Dow down about 32 points for the year and will makes this the fifth straight day of losses. The Standard & Poor’s 500 index fell 0.4% to 2,263.69. The Nasdaq composite fell 0.3% to 5,540.08.

Four stocks fell for every one that rose on the New York Stock Exchange.

Stocks have slowed in 2017 following an electrifying jump higher since Election Day. Investors are waiting to see what a Donald Trump presidency will really mean for stocks. They’ve already seen the optimistic case, as shown in the nearly 6% jump for the S&P 500 since Donald Trump’s surprise victory of the White House, propelled by expectations for lower taxes and less regulation on businesses.

But on the possible downside, increased tariffs or trade restrictions could mean drops in profits for big U.S. companies.

Bond yields continued their march higher, and the 10-year Treasury yield rose to 2.47% from 2.43% late Wednesday. Yields have generally been climbing since Election Day on expectations that President-elect Donald Trump’s policies will spur more inflation and economic growth. The 10-year yield is still below its perch above 2.60% that it reached in mid-December, but it’s well above the 2.09% yield it was at a year ago.

Reports have shown that the U.S. economy has been improving recently, and the latest on Thursday showed encouraging signs for the housing and labor markets. The fewest number of workers sought unemployment claims last week in 43 years, a sign that corporate layoffs are subsiding.

BIS Warns OF Bouts Of Extreme Volatility, As Market Undergoes “Paradigm Shift”

The Bank of International Settlements is particularly good at two things in its periodic quarterly review update: i) stating the obvious, especially when it comes to summarizing the trader and market participants concerns at any given moment, and ii) having its constituent central bank members – after all the BIS is the “central banks’ central bank” – ignore all of its warnings.

In its just released, latest report, the BIS continues to excel in both, when it lays out what it dubs a “paradigm shift in markets” and points out that unlike previous VaR shock episodes, most notably the 2013 Taper Tantrum, financial markets have been remarkably resilient to rising bond yields and sudden shift in outlook following last month’s shock U.S. election result.

Bank of Japan plays trump card early to shock markets straight

The Bank of Japan last week offered to buy bonds at a fixed yield to curb rising interest rates, playing what was seen as an ultimate trump card far earlier than many expected.

The BOJ announced its first-ever fixed-rate purchase operation on the morning of Nov. 17 to counter mounting fears of an upswing in interest rates. Yields on 10-year Japanese government bonds had climbed steadily since the U.S. presidential election, rising as high as 0.035% the day ahead of the move. The fixed-rated option was introduced only two months ago as part of a monetary policy overhaul in late September that set a target of around zero for long-term yields.

 A call went out for two- and five-year JGBs to address the rapid surge in short- and medium-term bond yields, according to the BOJ’s Financial Markets Department. There were no takers: The offered yields were higher than going market rates, meaning the offered prices were lower, sending wise traders elsewhere. But the conditions of the operation sent a strong signal as to how high the central bank will let rates go before stepping in. Yields slid across all maturities after the move was announced.
 Since then, “interest rates’ upward climb has been weakened somewhat,” Takako Masai, a member of the bank’s policy board, told reporters after a speech Monday. “I get the sense that the purpose of fixed-rate operations has been well conveyed to markets.”

Germany Is About To Sell Zero-Coupon 10 Year Bonds For The First Time Ever

When the financial media says that governments get paid to issue negative yielding debt, that is not exactly true: most sovereign issuers still pay out a cash coupon, a modest as it may be, while they pocket the negative amortization on a bond issued above par for the life of the bond resulting what ultimately ends up being a negative yield for the buyer net of all cashflows at maturity. However, the lower – or more negative – yields get, the less the need for an issuer to actually pay a cash coupon: after all with a negative yield, it is essentially superfluous.

Still, while no sovereign has issued bond with negative cash coupons yet, some are starting to issue zero-coupon ten years: bonds which pay no cash coupons at all.

This is precisely what Germany is about to do in a few hours.

According to Bloomberg, on Wednesday morning Germany will sell 10-year bonds with a zero coupon for the first time, as a rally in fixed-income securities pushes investors to forgo annual interest payments in order to hold the safest assets.

The nation is selling €5 billion of zero percent bonds due in August 2026 on Wednesday, after yields in the secondary market dropped to an all-time low of minus 0.205% last week.

PIMCO Lashes Out At “Flip-Flopping” Fed: ‘Stop Focusing On The Stock Market’

We truly live in interesting times: what was once tinfoil conspiracy theory, namely that the Fed is entirely focused on propping up the stock market, has become not only mainstream thought, but overnight in a scathing essay by prominent PIMCO economists, including Mihir Worah, PIMCO blasted the Fed for constantly “flip-flopping”, and telling Janet Yellen that “the Fed should focus on rising wages, not the stock market.”

Of course, the Fed’s traditional response is a well-rehearsed one: record stock prices will eventually “trickle down” into higher wages. Yes, it has not happened so far in the past 7 years of unorthodox monetary policies, but the Fed is absolutely confident it will eventually… just not yet.

But going back to the punchline, what is most amazing is that we now live in a day and age, when the world’s biggest bond fund managers is telling the Fed to stop reacting to every downtick in the market, and actually regain some of its credibility. To wit:

The Fed’s periodic hinting at possible hikes followed by no hikes (with one exception) has many market observers believing the Fed has become myopically focused on the vagaries of the stock market, almost to the point where it ignores most other indicators of economic health. So with a strong payroll number today and the S&P 500 modestly higher on the year, people fear the Fed will once again start talking up the likelihood of a rate hike. Most bond market participants agree this would be a hawkish mistake; hence short-term Treasury yields have moved higher, while the 30-year is moving lower.

The good news for “market observers” is that they are allowed to do just that: observe. To everyone else who can participate in a centrally-planned economy in which the planner no longer knows how to communicate or has any idea if it is responding to the economy or the market, good luck.

Here is Pimco’s full note: