The more things change, the more they stay the same:
The U.S. bond market is defying the Federal Reserve again.
The central bank has raised short-term interest rates four times beginning in December 2015 and pushed up the key policy rate by one percentage point. Yet the yield on the benchmark 10-year Treasury note settled at 2.198% on Tuesday, below the 2.269% where it settled before the Fed’s first rate increase since 2006. Yields fall as bond prices rise.
The tension reminds some investors of the “conundrum” described by Alan Greenspan, then Fed chairman, in February 2005. Mr. Greenspan was puzzled by long-term Treasury yields that were ticking lower despite increases in the federal-funds target rate.
It’s nice to see one of my prejudices get support:
Companies with a higher proportion of scientists and engineers are more productive than their peers, even when those workers aren’t directly involved in the research-and-development tasks that drive the most obvious forms of innovation, a new paper from the National Bureau of Economic Research suggests.
…
Mr. Freeman and co-authors Erling Barth, of the Institute for Social Research in Norway, James Davis, of the U.S. Census Bureau, and Andrew Wang, of Harvard Law School’s Labor and Worklife Program, were curious about the influence science and engineering professionals wield outside of R&D. Most previous research has focused on jobs where scientists and engineers were inventing new products.Analyzing employee and production data from manufacturing establishments between 1992 and 2007, the authors found that the value scientists and engineers bring even to non-R&D roles derives from their training, says Mr. Freeman.
When a manufacturer needs to fix the airflow in its factories, for example, “you need someone who knows about the flow of air currents, the right equations to use and other well-established principles,” he says.
The final paragraph quoted above bothers me, because it’s not supported in the actual paper, titled The Effects of Scientists and Engineers on Productivity and Earnings at the Establishment Where They Work. After all, if you know you’ve got to fix the airflow, you don’t get Joe from accounting to fix it because he’s got a Chemistry degree! You hire a firm of airflow engineers, and any establishment can do that. The paper itself concludes in part:
A plausible interpretation of the results is that production establishment-based scientists and engineers help implement the adoption of new technologies and products at workplaces.
It is my view that STEM training promotes the view that there is exactly one right answer to any question and that while we might never actually know that answer, we can always get a little closer; and that people who have this type of world-view at an early age are more likely than others to pursue STEM training in the first place. On the other hand, an archetypal arts graduate will be more inclined to believe there are multiple answers to any question, with a good argument to be made for each.
And it is the archetypal STEM outlook that leads to dissatisfaction with extant processes, with stream of suggested and implemented improvements that eventually result in a measurable increase in productivity.
Obviously, this is a very broad generalization and perhaps not very well put; if I were an arts graduate I would doubtless be able to articulate my idea more clearly!
And Poloz reiterated his hawkish bent:
The Canadian dollar extended gains and investors ramped up bets of a rate increase as early as next month after Bank of Canada Governor Stephen Poloz reiterated the central bank may be considering higher interest rates.
The nation’s currency jumped 0.7 percent to C$1.3103 per U.S. dollar at 8:57 a.m. in Toronto. The loonie traded at 76.3 U.S. cents. Swaps trading suggests investors are placing a 65 percent chance of a rate hike at the bank’s July 12 rate decision, up from 39 percent Tuesday.
…
Poloz used similar language in an interview with CNBC.“Rates are of course extraordinarily low,” Poloz said, adding the bank cut rates by 50 basis points in 2015 to counteract the effects of the oil price shock. “It does look as though those cuts have done their job,” he said, according to a transcript of the interview. “But we’re just approaching a new interest rate decision so I don’t want to prejudge. But certainly we need to be at least considering that whole situation now that the excess capacity is being used up steadily.”
The comments also pushed bond yields higher. The government of Canada two-year note fell for a third day, with the yield rising to 1.01 percent, the highest since January 2015.
The Canada five-year yield was up big-time today, but I’m not convinced that This Is It. Inflation is still quiescent as discussed on June 23 and oil isn’t doing anything special ( BOC Deputy Governor Lynn Patterson says the oil shock that hit Canada in 2014 is no longer acting as a drag on the economy ). However, the volatility in the five-year this month does have me leaning towards the view that when the bond market does normalize, it will do so in a disorderly, abrupt manner, whether it happens next week or in ten years.
This view is bolstered by market reaction to Draghi’s statement in Europe:
Mario Draghi just got evidence that his call for “prudence” in withdrawing European Central Bank stimulus applies to his words too.
The euro and bond yields surged on Tuesday after the ECB president said the reflation of the euro-area economy creates room to pull back unconventional measures without tightening the stance. Policy makers noted the jolt that showed how hypersensitive investors are to statements that can be read as even mildly hawkish, according to three Eurosystem officials familiar with their thinking.
…
A key concern for the central bank is that too-hasty communication that stimulus is on the way out may have an outsized impact on bond yields and bring about an “unwarranted tightening of financial conditions” that would jeopardize the economy’s progress so far. Draghi stressed exactly this point in his Tuesday speech.>“We need prudence. As the economy picks up we will need to be gradual when adjusting our policy parameters, so as to ensure that our stimulus accompanies the recovery amid the lingering uncertainties.”
Yet by avoiding formal discussion of any tapering of quantitative easing until late in the year, the ECB raises the risk of more market volatility when speeches such as Draghi’s hit, especially over the summer months when liquidity is typically thinner. The ECB chief also stressed the need for persistence in maintaining monetary accommodation, but investors focused on his line about the scope for policy tweaks.
“As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments — not in order to tighten the policy stance, but to keep it broadly unchanged.”
There was a nice article on the New York Fed’s blog today titled Low Productivity Growth: The Capital Formation Link, which I don’t find entirely convincing:
Growth of pure technological and managerial knowledge is much harder to observe (in fact, it’s typically interpreted as the portion of productivity growth that can’t be directly credited to improved worker skills or capital formation). It’s difficult to infer what this factor is likely to do: some observers claim that, say, increased application of artificial intelligence will lead to a marked acceleration of productivity, while others assert that there’s little reason to believe that such factors will add as much to productivity as seemingly humbler innovations of the past (such as, say, the adoption of containerization by the transportation sector in the 1960s).
That leaves capital formation as the remaining factor affecting productivity. Workers need tools to do their jobs; the more tools per worker, the more the workers can produce (at least to a point!). As a result, one important factor to examine in assessing productivity trends is the growth of capital per hour worked.
…
Indeed, the chart below shows that relative to depreciation, investment has been weak in this expansion. (Note, a value of one in the following chart means that gross investment equals depreciation, so the net capital stock would be unchanged over time. A value greater than one indicates that gross investment exceeds depreciation and so the net capital stock would grow. Conversely, a value below one indicates that gross investment is less than depreciation and so the capital stock would shrink.)
Click for Big
Far be it from me to claim that all the productivity gains that can be made have been made. However, given the increasing role of services there are limits to the overall impact of manufacturing improvements in the economy. In order to make productivity improvements in manufacturing worthwhile, there must be demand for the goods produced and I’m not convinced that the same opportunities exist today as they did in, say, 1955, when new capital to build a new steel mill was enthusiastically received.
Note that this does not contradict my other views on productivity, as expressed in my periodic rants about the minimum wage. I suggest that while productivity improvements in manufacturing are largely capital-intensive, such improvements in services are process-intensive. It doesn’t cost much money, in the great scheme of things, to develop a new process and write software to implement it; it takes intellectual capital.
Bonds got hammered today, with the Canada five-year up 8bp to 1.28%. We are told that the causes may include spread speculation vs. Treasuries:
An unusual trade across America’s northern border is starting to become a more prominent fixture in the market for sovereign debt.
It’s a straightforward play: simultaneously purchase Ultra 10-year Treasury futures and sell contracts for similar-maturity Canadian debt. It’s a bet that U.S. bonds will outperform as the Federal Reserve slows down its pace of interest-rate increases, while the Bank of Canada appears to be considering a hike as soon as next month.
What’s striking to traders is the size of the wagers. Each leg of Wednesday’s transaction, which sent Canadian bond futures tumbling, represented about $820,000 of risk per basis point. The 9,098-contract Canadian block is the second-largest ever, trailing only a trade in March 2008, according to Shane Quinn, a spokesman for TMX Group.
It’s a poorly written article, but the gist is reasonably clear. The contract size on the Canada 10-year is $100,000 nominal (of a 6% (!) bond, closed today at 142.48). Therefore the Canadian leg of 9,098 contracts had a notional value of about $910-million p.v., $1.3-billion value. The US “Ultra” contract is a relatively new contract:
A main difference between the ultra and regular 10-year T-note is range of maturities of Treasuries buyers would accept.
Regular 10-year T-note holders could take delivery of cash government debt that mature in 6-1/2 years to 10 years. This compare with ultra 10-year owners who could take delivery of cash Treasuries that come in 9 years and five months to 10 years.
I guess people were getting tired of the enormous negative convexity with the ‘regular’ contract!
Anyway … the hit to the bond market was probably behind a good chunk of today’s excellent preferred share market! Assiduous Readers with a fine appreciation of the more awkward things in life will remember that June 13 was also a big day for performance, and had 51/377 issues going ex-dividend. Today, 39/377 issues went ex … so there will be more sad stories!
PerpetualDiscounts now yield 5.08%, equivalent to 6.60% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.65%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 295bp, a slight (and perhaps spurious) narrowing from the 300bp reported June 21.
| 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 | 2.5587 % | 2,173.1 |
| FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 2.5587 % | 3,987.6 |
| Floater | 3.65 % | 3.65 % | 73,738 | 18.18 | 3 | 2.5587 % | 2,298.1 |
| OpRet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.1408 % | 3,062.1 |
| SplitShare | 4.70 % | 4.23 % | 60,285 | 1.48 | 5 | -0.1408 % | 3,656.8 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.1408 % | 2,853.1 |
| Perpetual-Premium | 5.31 % | 4.56 % | 68,052 | 3.42 | 25 | 0.1702 % | 2,789.4 |
| Perpetual-Discount | 5.11 % | 5.08 % | 92,300 | 15.24 | 12 | 0.0213 % | 3,000.8 |
| FixedReset | 4.39 % | 4.03 % | 200,641 | 6.51 | 96 | 0.5283 % | 2,370.5 |
| Deemed-Retractible | 4.99 % | 5.02 % | 124,267 | 6.21 | 30 | 0.1134 % | 2,897.0 |
| FloatingReset | 2.53 % | 2.96 % | 49,288 | 4.33 | 10 | 0.7107 % | 2,578.7 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| BMO.PR.S | FixedReset | 1.01 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 21.66 Evaluated at bid price : 22.10 Bid-YTW : 3.95 % |
| VNR.PR.A | FixedReset | 1.02 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 21.52 Evaluated at bid price : 21.85 Bid-YTW : 4.54 % |
| MFC.PR.I | FixedReset | 1.02 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.71 Bid-YTW : 4.82 % |
| W.PR.J | Perpetual-Premium | 1.03 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2017-07-28 Maturity Price : 25.00 Evaluated at bid price : 25.25 Bid-YTW : -9.46 % |
| SLF.PR.I | FixedReset | 1.07 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.72 Bid-YTW : 4.64 % |
| TRP.PR.E | FixedReset | 1.19 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 22.01 Evaluated at bid price : 22.26 Bid-YTW : 3.95 % |
| NA.PR.W | FixedReset | 1.24 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 21.30 Evaluated at bid price : 21.30 Bid-YTW : 4.07 % |
| BNS.PR.Y | FixedReset | 1.30 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.52 Bid-YTW : 4.41 % |
| MFC.PR.J | FixedReset | 1.35 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.35 Bid-YTW : 4.82 % |
| MFC.PR.K | FixedReset | 1.39 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.19 Bid-YTW : 5.96 % |
| PWF.PR.P | FixedReset | 1.41 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 16.60 Evaluated at bid price : 16.60 Bid-YTW : 4.00 % |
| BIP.PR.A | FixedReset | 1.44 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 22.93 Evaluated at bid price : 23.90 Bid-YTW : 4.81 % |
| GWO.PR.N | FixedReset | 1.57 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 16.77 Bid-YTW : 8.21 % |
| MFC.PR.L | FixedReset | 1.64 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.10 Bid-YTW : 6.08 % |
| BAM.PF.E | FixedReset | 1.70 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 21.88 Evaluated at bid price : 22.15 Bid-YTW : 4.25 % |
| MFC.PR.N | FixedReset | 1.70 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.11 Bid-YTW : 5.47 % |
| SLF.PR.J | FloatingReset | 1.72 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 15.95 Bid-YTW : 8.59 % |
| BAM.PF.B | FixedReset | 1.78 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 21.81 Evaluated at bid price : 22.32 Bid-YTW : 4.21 % |
| BAM.PF.F | FixedReset | 1.82 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 22.86 Evaluated at bid price : 23.53 Bid-YTW : 4.25 % |
| SLF.PR.H | FixedReset | 1.84 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 19.90 Bid-YTW : 6.48 % |
| BAM.PF.G | FixedReset | 1.84 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 22.85 Evaluated at bid price : 23.74 Bid-YTW : 4.20 % |
| TRP.PR.F | FloatingReset | 1.92 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 19.11 Evaluated at bid price : 19.11 Bid-YTW : 3.28 % |
| BAM.PR.K | Floater | 2.37 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 12.95 Evaluated at bid price : 12.95 Bid-YTW : 3.65 % |
| TRP.PR.H | FloatingReset | 2.41 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 14.45 Evaluated at bid price : 14.45 Bid-YTW : 3.23 % |
| BAM.PR.C | Floater | 2.53 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 12.95 Evaluated at bid price : 12.95 Bid-YTW : 3.65 % |
| SLF.PR.G | FixedReset | 2.72 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 17.00 Bid-YTW : 8.16 % |
| BAM.PR.B | Floater | 2.77 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 12.98 Evaluated at bid price : 12.98 Bid-YTW : 3.64 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| CM.PR.R | FixedReset | 314,475 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 23.16 Evaluated at bid price : 25.02 Bid-YTW : 4.38 % |
| TD.PF.C | FixedReset | 184,385 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-28 Maturity Price : 21.45 Evaluated at bid price : 21.45 Bid-YTW : 4.03 % |
| TD.PF.H | FixedReset | 117,864 | YTW SCENARIO Maturity Type : Call Maturity Date : 2021-10-31 Maturity Price : 25.00 Evaluated at bid price : 26.19 Bid-YTW : 3.87 % |
| MFC.PR.R | FixedReset | 65,500 | YTW SCENARIO Maturity Type : Call Maturity Date : 2022-03-19 Maturity Price : 25.00 Evaluated at bid price : 25.81 Bid-YTW : 4.14 % |
| MFC.PR.I | FixedReset | 64,184 | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.71 Bid-YTW : 4.82 % |
| TD.PF.G | FixedReset | 61,064 | YTW SCENARIO Maturity Type : Call Maturity Date : 2021-04-30 Maturity Price : 25.00 Evaluated at bid price : 27.06 Bid-YTW : 3.46 % |
| There were 46 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| BAM.PF.A | FixedReset | Quote: 23.39 – 23.97 Spot Rate : 0.5800 Average : 0.3304 YTW SCENARIO |
| BAM.PF.F | FixedReset | Quote: 23.53 – 23.99 Spot Rate : 0.4600 Average : 0.2664 YTW SCENARIO |
| PWF.PR.T | FixedReset | Quote: 23.12 – 23.50 Spot Rate : 0.3800 Average : 0.2100 YTW SCENARIO |
| CU.PR.C | FixedReset | Quote: 21.81 – 22.24 Spot Rate : 0.4300 Average : 0.2724 YTW SCENARIO |
| MFC.PR.M | FixedReset | Quote: 21.87 – 22.24 Spot Rate : 0.3700 Average : 0.2275 YTW SCENARIO |
| MFC.PR.F | FixedReset | Quote: 16.67 – 17.08 Spot Rate : 0.4100 Average : 0.2915 YTW SCENARIO |
it’s going to be disorderly, these things always are. even though bankers have been warning for months/years that rates will eventually go up, nobody listened. now that they’re finally going to do it, people will wake from their slumber. reminds me of the bond sell off in early 1994 when greenspan hiked and the market was shocked.. shocked..