In the latest tapering chatter:
Tapering talk has already sent 10-year note yields up 120 basis points. Almost the entire increase has been in the real yield, not in inflation expectations. Long-term interest rates aren’t about to retreat if the Fed delays the inevitable until October or December. So if rising long-term rates have policy makers tied in knots, doing nothing buys them time, not yield relief.
The real 10-year yield (from the 10-year inflation-indexed Treasury note) is 0.6 percent. JPMorgan Chase economist Jim Glassman says that before the recession and introduction of the Fed’s unconventional policies, real long-term rates averaged 2 percent to 2.5 percent. The implied five-year forward real rate — the expected real rate five to 10 years from now, which captures the anticipated normalization of monetary policy — is about 1.75 percent, according to Glassman. “That indicates that much of the adjustment in interest-rate markets has been done already,” he says.
Of course, markets tend to overshoot, and there’s no reason to think they won’t this time. But that’s the reaction to any Fed action.
This doesn’t mean “getting it over with” is a good reason to taper; it’s just better than the economic justifications being offered. At the July 30-31 meeting, “almost all members” thought it was too soon to taper. What will have transpired in the six weeks between the July and September meetings? Two more employment reports, that’s what. There is really no quantitative difference between an increase in non-farm payrolls of 162,000 (July) and 199,000 (April). If you don’t believe me, listen to the statisticians at the Bureau of Labor Statistics.
Inflation is below the Fed’s target. The jobless rate, now 7.4 percent, is being driven as much by declining labor-force participation as new hiring. And Fed officials could look at the 13.4 percent decline in new home sales in July as a harbinger and get squeamish about selling some of the central bank’s stockpile of mortgage-backed securities.
Four months of tapering chatter has given wannabe sellers adequate notice. The deed itself seems fully priced into the market, and time isn’t on the Fed’s side.
But it looks like business has cranked up issuance of cheap debt in advance:
Company debt loads in the U.S. are approaching the highest level since the aftermath of the financial crisis as borrowing to finance mergers and shareholder payouts exceeds earnings growth.
Debt levels have increased faster than cash flow for six straight quarters, boosting the obligations of investment-grade companies in the second quarter to 2.09 times earnings before interest, taxes, depreciation and amortization, according to JPMorgan Chase & Co. That’s up from 2.07 times in the first three months of 2013 and compares with 2.13 in the third quarter of 2009, when it peaked after the deepest recession since the Great Depression.
…
While heavier debt burdens have been supported by a Fed policy that pushed average U.S. corporate-bond yields to a record-low 2.65 percent in May, JPMorgan strategists said they expect issuance to slow as interest rates increase. Speculation is mounting that Chairman Ben S. Bernanke will reduce the central bank’s $85 billion in monthly debt purchases as soon as next month.With a greater sense of urgency to tap debt markets before rates climb higher, companies may continue to increase leverage through the end of the year, Bank of America Corp. debt strategist Yuriy Shchuchinov said in an Aug. 26 note.
There’s an interesting allegation about CMHC lending:
A friend who is an economist further went on to say that when lending rules were liberalized to take into account two incomes in a household it in effect imprisoned families to needing two incomes to afford a house. This did not help families, but rather increased the price of housing, with the outcome that young families are hard pressed not to farm out their children to daycare or grandparents. Single-income households need a really high single income or they face very limited housing options. As individuals, families and a society we’re not any better off, and the outcome only has been higher prices.
A recent article by Canso Investment newsletter reported one troubling trend – “gaming” with CMHC’s online automated appraisal system, EMILI. The system was created in 1996 to allow lenders to quickly check if the house price involved in a mortgage transaction was reasonable. According to Canso, while this streamlined the process of mortgage insurance and origination, it also removed any human check and balance.
EMILI uses an algorithm which looks at the address, and particularly the postal code, and metrics of the house to be insured. The key variables are “the square footage of the house and the prior sale prices for the geographic area of the house.”
According to Canso, “there has been extensive ‘gaming’ of this system and excessive prices generated by this system. If a higher price is required for CMHC insurance coverage, the square footage, which is input by the lender and supplied by the mortgage broker, can be increased as required.”
“Gaming” is a polite term. What this really looks like is fraud. Having said that, the impact of this fraud will, for the most part, be limited to excessive lending on a single property, as opposed to the greater problem of excessive money supply for mortgages. This excess money supply has floated the buyers’ market to extraordinary heights with very few real winners. Recent homebuyers may be able to afford their mortgage payments – providing interest rates remain low during the amortization term. But some amortization terms in the past decade have reached 40 years and it’s unreasonable to expect interest rates to remain low three to four decades down the road.
I believe that the CMHC is a major part of the problem: they’re insuring far too many mortgages and Canadian banks now have record amounts of mortgage debts on their books, both in absolute terms and in terms of the proportion of their assets. They can do this because the mortgages are insured – or, at least, they can be counted as insured until they default and CMHC suddenly gets more interested in the house’s square footage!
Eliminate the insurance and – business risks aside – the risk weight will go up. Risk Weight goes up, Risk Adjustjed Assets go up. Risk Adjusted Assets go up, capital requirement goes up. Capital Requirement goes up, banks’ cost of funds goes up. Cost of funds goes up, mortgage rates go up. Mortgage rates go up, mortgage demand goes down.
NASDAQ has provided an explanation for last week’s shutdown:
The malfunction began when NYSE Arca sent more than 20 “connect and disconnect sequences” as well as a stream of quotes for inaccurate stock symbols, according to Nasdaq’s summary. At one point, Nasdaq received over 2 1/2 times more data per second than the system’s tested capacity.
After being inundated with orders, the flaw in the SIP software prevented redundancy that is built into the system from “failing over cleanly” to a backup program, it said.
It was another day of modest advance in the Canadian preferred share market, with PerpetualDiscounts gaining 2bp, FixedResets up 8bp and DeemedRetractibles full steam ahead with a win of 46bp. The Performance Highlights table was heavily weighted towards winners. Volume was high.
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.3423 % | 2,610.7 |
| FixedFloater | 4.18 % | 3.48 % | 36,026 | 18.36 | 1 | 1.7905 % | 3,974.8 |
| Floater | 2.58 % | 2.91 % | 70,768 | 19.90 | 5 | -0.3423 % | 2,818.9 |
| OpRet | 4.64 % | 3.20 % | 69,719 | 0.79 | 3 | 0.3104 % | 2,618.6 |
| SplitShare | 4.73 % | 4.85 % | 55,629 | 3.85 | 6 | 0.1076 % | 2,958.8 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.3104 % | 2,394.4 |
| Perpetual-Premium | 5.78 % | 5.86 % | 115,090 | 14.03 | 12 | 0.0371 % | 2,241.7 |
| Perpetual-Discount | 5.64 % | 5.77 % | 152,448 | 14.19 | 25 | 0.0205 % | 2,286.3 |
| FixedReset | 4.95 % | 3.82 % | 243,411 | 3.87 | 85 | 0.0830 % | 2,448.8 |
| Deemed-Retractible | 5.21 % | 5.11 % | 204,225 | 6.96 | 43 | 0.4614 % | 2,333.8 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| GWO.PR.N | FixedReset | -2.04 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.65 Bid-YTW : 4.85 % |
| BAM.PR.N | Perpetual-Discount | -1.41 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 20.21 Evaluated at bid price : 20.21 Bid-YTW : 5.99 % |
| BNA.PR.C | SplitShare | 1.01 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2019-01-10 Maturity Price : 25.00 Evaluated at bid price : 24.10 Bid-YTW : 5.13 % |
| CM.PR.G | Perpetual-Premium | 1.02 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 24.52 Evaluated at bid price : 24.76 Bid-YTW : 5.51 % |
| CM.PR.K | FixedReset | 1.06 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2014-07-31 Maturity Price : 25.00 Evaluated at bid price : 25.70 Bid-YTW : 2.75 % |
| BNS.PR.Y | FixedReset | 1.09 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.15 Bid-YTW : 4.23 % |
| TD.PR.P | Deemed-Retractible | 1.11 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 25.40 Bid-YTW : 5.11 % |
| CU.PR.F | Perpetual-Discount | 1.14 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 21.25 Evaluated at bid price : 21.25 Bid-YTW : 5.33 % |
| BNS.PR.M | Deemed-Retractible | 1.15 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.70 Bid-YTW : 4.75 % |
| RY.PR.B | Deemed-Retractible | 1.26 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.96 Bid-YTW : 4.76 % |
| BMO.PR.J | Deemed-Retractible | 1.30 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.97 Bid-YTW : 4.55 % |
| BAM.PR.X | FixedReset | 1.73 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 22.66 Evaluated at bid price : 23.56 Bid-YTW : 4.12 % |
| BAM.PR.G | FixedFloater | 1.79 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 22.96 Evaluated at bid price : 22.74 Bid-YTW : 3.48 % |
| MFC.PR.B | Deemed-Retractible | 1.81 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.33 Bid-YTW : 6.49 % |
| BAM.PF.B | FixedReset | 1.87 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 22.74 Evaluated at bid price : 23.99 Bid-YTW : 4.61 % |
| TRP.PR.C | FixedReset | 2.27 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 22.51 Evaluated at bid price : 23.00 Bid-YTW : 3.87 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| TD.PR.C | FixedReset | 76,355 | TD crossed blocks of 30,000 and 40,000, both at 25.33. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-01-31 Maturity Price : 25.00 Evaluated at bid price : 25.36 Bid-YTW : 3.21 % |
| PWF.PR.G | Perpetual-Premium | 64,702 | Scotia bought 19,000 from GMP at 24.90, then crossed 40,000 at the same price. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 24.57 Evaluated at bid price : 24.82 Bid-YTW : 6.01 % |
| BNS.PR.T | FixedReset | 58,699 | TD crossed 50,000 at 25.70. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-04-25 Maturity Price : 25.00 Evaluated at bid price : 25.63 Bid-YTW : 3.06 % |
| PWF.PR.H | Perpetual-Premium | 45,347 | Scotia crossed 39,700 at 24.50. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2043-08-29 Maturity Price : 24.22 Evaluated at bid price : 24.51 Bid-YTW : 5.93 % |
| RY.PR.N | FixedReset | 44,200 | TD crossed 40,000 at 25.40. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-02-24 Maturity Price : 25.00 Evaluated at bid price : 25.40 Bid-YTW : 3.11 % |
| BNS.PR.K | Deemed-Retractible | 43,850 | RBC crossed 37,200 at 25.05. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.95 Bid-YTW : 4.91 % |
| There were 56 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| TRP.PR.B | FixedReset | Quote: 21.43 – 22.22 Spot Rate : 0.7900 Average : 0.5303 YTW SCENARIO |
| BAM.PR.J | OpRet | Quote: 26.35 – 26.78 Spot Rate : 0.4300 Average : 0.2430 YTW SCENARIO |
| TCA.PR.Y | Perpetual-Premium | Quote: 49.10 – 49.60 Spot Rate : 0.5000 Average : 0.3470 YTW SCENARIO |
| ABK.PR.C | SplitShare | Quote: 31.65 – 32.19 Spot Rate : 0.5400 Average : 0.4011 YTW SCENARIO |
| GWO.PR.N | FixedReset | Quote: 21.65 – 22.19 Spot Rate : 0.5400 Average : 0.4081 YTW SCENARIO |
| PWF.PR.I | Perpetual-Premium | Quote: 25.02 – 25.30 Spot Rate : 0.2800 Average : 0.1877 YTW SCENARIO |