Category: Market Action

Nerves?

The U.S. Federal Reserve on Tuesday injected billions into the financial system in an effort to calm money markets that have been roiled since Monday, as lending dwindled partly due to huge payments for taxes and bond supply.

The chaos in money markets added to Fed policymakers’ list of concerns that is already heavy on risks from U.S.-China trade tensions, a weakening global economy and sluggish domestic inflation.
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At one point on Tuesday, overnight borrowing costs in the $2.2 trillion repurchase agreement market spiked to as high as 10%.

In the repo market, banks and Wall Street dealers use securities as collateral to obtain cash from money market funds and other cash investors.

Another alarming signal was a jump in the average federal funds rate, which the central bank aims to influence. It reached 2.25% on Monday, which matched the upper end of the Fed’s current target range and was a move not seen since the height of global credit crisis more than a decade ago.

Over the weekend, global markets received another lesson in why market timing doesn’t work:

Oil ended nearly 15 per cent higher on Monday, with Brent logging its biggest jump in over 30 years and a record trading volumes, after an attack on Saudi Arabian crude facilities cut the kingdom’s production in half and intensified concerns of retaliation in the Middle East.

Brent crude futures settled at $69.02 a barrel, rising $8.80, or 14.6 per cent, its largest one-day percentage gain since at least 1988.

U.S. West Texas Intermediate (WTI) futures ended at $62.90 a barrel, soaring $8.05, or 14.7 per cent – the biggest one-day percentage gain since December 2008.

Trades also ramped up, with Brent futures surpassing 2 million lots, an all-time daily volume record, Intercontinental Exchange spokeswoman Rebecca Mitchell said.
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Saudi Arabia is the world’s biggest oil exporter and, with its comparatively large spare capacity, has been the supplier of last resort for decades.

The attack on state-owned producer Saudi Aramco’s crude-processing facilities at Abqaiq and Khurais cut output by 5.7 million barrels per day and threw into question its ability to maintain oil exports.

And now it’s time to start preparing PrefLetter!

It appears that anybody who doesn’t like the idea of negative interest rates is an enemy of the people:

U.S. President Donald Trump on Wednesday called on the “boneheads” at the Federal Reserve to push interest rates down into negative territory, a move reluctantly used by other world central banks to battle weak economic growth that risks punishing savers and banks’ earnings in the process.

Trump, in a pair of Twitter posts, said negative rates would save the government money on its debt, which including Social Security accounts has reached a record $22 trillion on Trump’s watch.

“It is only the naïveté of (Fed Chairman) Jay Powell and the Federal Reserve that doesn’t allow us to do what other countries are already doing,” added Trump, who has repeatedly noted that rates are negative in Germany, Europe’s trading powerhouse.

Pew Research has a nice page on the US federal debt:

Net interest payments on the debt are estimated to total $393.5 billion this fiscal year, or 8.7% of all federal outlays. (The government projects it will pay out a total of $593.1 billion in interest in fiscal 2019, which ends Sept. 30, but that includes interest credited to Social Security and other government trust funds.) By comparison, debt service was more than 15% of federal outlays in the mid-1990s. The share has fallen partly because lower rates have held down interest payments, but also because outlays have risen substantially, up about 29% over the past decade.

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Rent control has come to California! I started reading the article prepared to hate the idea, but they’ve actually done a reasonable job:

California lawmakers approved a statewide rent cap on Wednesday covering millions of tenants, the biggest step yet in a surge of initiatives to address an affordable-housing crunch nationwide.

The bill limits annual rent increases to 5 percent after inflation and offers new barriers to eviction, providing a bit of housing security in a state with the nation’s highest housing prices and a swelling homeless population.
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In February, Oregon lawmakers became the first to pass statewide rent control, limiting increases to 7 percent annually plus inflation.
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Economists from both the left and the right have a well-established aversion to rent control, arguing that such policies ignore the message of rising prices, which is to build more housing. Studies in San Francisco and elsewhere show that price caps often prompt landlords to abandon the rental business by converting their units to owner-occupied homes. And since rent controls typically have no income threshold, they have been faulted for benefiting high-income tenants.
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But many of the same studies show that rent-control policies have been effective at shielding tenants from evictions and sudden rent increases, particularly the lower-income and older tenants who are at a high risk of becoming homeless.

Allowing increases in excess of inflation gives comfort to landlords that they will, eventually, be able to charge the tenant the market rate, while protecting the tenant from ludicrous increases. Avoiding the dislocation inherent in the face of extortionate increases and allowing tenants to plan is a public good that is worth money, even though it is assigned zero value in the disapproving studies.

PerpetualDiscounts now yield 5.63%, equivalent to 7.32% interest at the standard equivalency factor of 1.3x. Long corporates now yield 3.17%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has remains at 415bp (where it was on September 4, close to the post-Credit Crunch record of 420bp set August 28. The latter value is second only to the 445bp recorded November 26, 2008, a day on which

The TXPR index was down 5.94% on the BCE news.

Global bonds took a hit today, sending yields up again:

Bond yields climbed and a gauge of world stock markets recovered from previous lows to trade flat on Tuesday, as uncertainty grew over the mix of stimulus the European Central Bank will add to boost a slumping economy this week amid fresh signs global growth was slowing.

Germany’s 30-year benchmark bond yield briefly broke into positive territory for the first time since Aug. 5, while U.S. Treasury yields climbed to three-week highs.

Benchmark U.S. 10-year notes last fell 1 point in price to yield 1.7333%, from 1.622% late on Monday.

Canada was not immune:

The Canadian dollar strengthened to a near six-week high against the U.S. dollar on Tuesday, supported by improvement in risk appetite and a less dovish Bank of Canada policy announcement last week than some investors had expected.

The Bank of Canada held interest rates steady last Wednesday and made no mention of future cuts despite easing this year by some of its global peers, including the U.S. Federal Reserve.

Chances of a rate cut at the central bank’s next meeting on Oct. 30 have slumped to about 15% from nearly 70% before last week’s rate decision, money market data showed.
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Canadian government bond prices were lower across the yield curve in sympathy with U.S. Treasuries and German Bunds. The 10-year yield touched its highest intraday level since Aug. 1 at 1.435%.

The GOC-5 yield closed at 1.44%, up 6bp.

I see that China has a problem with pork prices:

Things that keep China’s top leaders up at night: a stalling economy, a bruising trade war and, increasingly, pigs.

Specifically, a shortage of pigs, which is fast becoming a national crisis.

The price of pork has been rising for months, and it is now nearly 50 percent higher than it was a year ago, data published on Tuesday showed. Consumers are frustrated, and officials are quietly expressing alarm as they fight the outbreak of a disease that is devastating the country’s pig population and causing the shortage.
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As officials brace for steeper price increases — analysts are estimating that pork prices could end the year at double their level from 2018 — the challenge for Beijing is becoming more serious.

I know where they can get some:

China has suspended pork imports from two Canadian companies, according to an interview with Canada’s agricultural minister and a Chinese customs document, marking the latest irritant in a widening diplomatic dispute.

As world trade becomes more globalized and countries become more interdependent, it’s going to get harder for nations to exert pressure on each other, whether for noble reasons I support or otherwise. If interfering with trade causes an equal and opposite reaction in the sanctioning country – and its allies – that directly affects consumers, we’re going to see a lot fewer sanctions.

Asset-Liability matching is something that is glossed over by many pension funds. I’m pleased to see this insouciance attacked in the Globe:

A company’s employees lend the DB Pension Division money in the form of deferred wages. In return, the company promises to provide a pension to those employees when they retire. Until then, the DB Pension Division invests this money with the goal of being able to pay these promised pensions.

However, many DB Pension Divisions are investing this money in a way that’s mismatched from the bond-like promises they made to employees. They make bets on equity markets and interest rates in the hopes of generating excess returns that will make it cheaper to pay these promised pensions.

Imagine – what do you think would happen if you went to your CFO and told her that you had a great idea for a new business. You want to borrow money and invest it in the equity markets to generate excess returns for shareholders. I suspect you’d find that it would be a pretty short and career-limiting conversation!

So why would this idea work for a DB pension plan? What’s clear is that for the past 20 years, it has not.

HOOPP does this right; I harp on this issue every so often, most recently on July 25, 2017.

I enjoyed a Globe feature about GFL; primarily the bits about the gross inefficiency of municipal operations:

He knew GFL could get its trucks rolling faster, and do the job with fewer vehicles, than the city did. He recalls watching slack-jawed as two long lines of trucks, each 40 vehicles deep, formed to fuel up, since city crews only worked during the daytime. As a result, the last trucks didn’t even leave the lot until after 9 a.m. Likewise, maintenance crews clocked out at 5 p.m., he says, which meant all upkeep and repairs had to be done during the day, requiring the city to keep backup trucks on standby. GFL, on the other hand, carried out all maintenance and refuelling overnight. The upshot was that the city had 110 trucks to do the job, while Dovigi’s analysis revealed GFL could do it with 85.

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DBRS had some interesting Brexit commentary:

DBRS considers that diverging views on Brexit among citizens in the UK could inadvertently lead to the breakup of the Union. DBRS reviews the implications of no-deal scenarios and their potential impact on the unity of the United Kingdom. At one extreme is a “severe” hard Brexit whereby the UK crashes out of the EU permanently with no airbags or restraints on its impact. DBRS concludes that such a Brexit could quickly change the support for Scottish independence and even over time the support for the unification of Ireland, increasing the breakup risk of the UK. These considerations are exacerbated by a weakening economic environment that intensifies divisions within the UK.
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Scottish independence is the most likely cause of a breakup of the UK. The Scottish government has proposed a second referendum on independence. The first referendum in September 2014 was rejected by 55.0% of voters. Reportedly, that outcome was influenced by concerns that Scotland would lose its EU membership. Should the UK leave the EU without an agreement, that consideration would no longer stand in the way. Given that almost two thirds of Scottish voters voted to remain in the Brexit referendum, the issue of Scotland remaining a member of the EU has continued to be an important component in the debate over Scottish independence. In the event that the UK leaves the EU, DBRS expects that calls for Scottish independence would become even louder, especially in a no-deal scenario.

In political developments:

Boris Johnson has faced a double defeat in the Commons after MPs turned down his motion for a general election.

Earlier, MPs backed a bill aimed at blocking a no-deal Brexit if the PM hadn’t agreed a plan with the EU ahead of the 31 October deadline.

Mr Johnson said the bill “scuppered” negotiations and the only way forward now was an election.

But Labour leader Jeremy Corbyn accused the PM of “playing a disingenuous game” to force a no-deal Brexit.

He said his party would back an election after the bill had been passed, but not before.

Both the SNP and the Liberal Democrats also criticised the prime minister’s motion as a plot to make sure the UK left the EU without a deal.

Meanwhile the the BoC stood pat:

The Bank of Canada today maintained its target for the overnight rate at 1 ¾ percent. The Bank Rate is correspondingly 2 percent and the deposit rate is 1 ½ percent.

As the US-China trade conflict has escalated, world trade has contracted and business investment has weakened. This is weighing more heavily on global economic momentum than the Bank had projected in its July Monetary Policy Report (MPR). Meanwhile, growth in the United States has moderated but remains solid, supported by consumer and government spending. Commodity prices have drifted down as concerns about global growth prospects have increased. These concerns, combined with policy responses by some central banks, have pushed bond yields to historic lows and inverted yield curves in a number of economies, including Canada.

In Canada, growth in the second quarter was strong and exceeded the Bank’s July expectation, although some of this strength is expected to be temporary. The rebound was driven by stronger energy production and robust export growth, both recovering from very weak performance in the first quarter. Housing activity has regained strength more quickly than expected as resales and housing starts catch up to underlying demand, supported by lower mortgage rates. This could add to already-high household debt levels, although mortgage underwriting rules should help to contain the buildup of vulnerabilities. Wages have picked up further, boosting labour income, yet consumption spending was unexpectedly soft in the quarter. Business investment contracted sharply after a strong first quarter, amid heightened trade uncertainty. Given this composition of growth, the Bank expects economic activity to slow in the second half of the year.

Inflation is at the 2 percent target. CPI inflation in July was stronger than expected, largely because of temporary factors. These include higher prices for air travel, mobile phones, and some food items, which are offsetting the effects of lower gasoline prices. Measures of core inflation all remain around 2 percent.

In sum, Canada’s economy is operating close to potential and inflation is on target. However, escalating trade conflicts and related uncertainty are taking a toll on the global and Canadian economies. In this context, the current degree of monetary policy stimulus remains appropriate. As the Bank works to update its projection in light of incoming data, Governing Council will pay particular attention to global developments and their impact on the outlook for Canadian growth and inflation.

Sean Kilpatrick comments in the Globe:

Heading into the rate announcement, the bank was expected to keep rates unchanged this month. However, some economists were predicting a rate cut as soon as the bank’s next decision, in late October. The Canadian dollar climbed after the statement’s release, as the bank’s tone dampened market expectations that a rate cut is on the horizon.

… and, by the time the close rolled around:

Separately, data showed Canada posted a bigger-than-expected trade deficit in July, a sign that the boost to the domestic economy from trade in the second quarter may not be repeated.
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The Canadian dollar posted its biggest gain in seven months against the greenback on Wednesday on lowered expectations for a Bank of Canada interest rate cut in October after the central bank’s policy decision made no mention of future moves.

TXPR closed at 586.52, up 0.77% on the day. Volume was 2.36-million, about average in the context of the past thirty days.

CPD closed at 11.74, up 0.95% on the day. Volume of 155,166 was quite high but not extraordinary in the context of the past 30 days.

ZPR closed at 9.39, up 1.29% on the day. Volume of 232,279 was a little above average in the context of the past 30 days.

Five-year Canada yields were up 2bp to 1.15% today.

PerpetualDiscounts now yield 5.64%, equivalent to 7.33% interest at the standard equivalency factor of 1.3x. Long corporates now yield 3.18%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed slightly (and perhaps spuriously) to 415bp, close to the post-Credit Crunch record of 420bp set August 28. The latter value is second only to the 445bp recorded November 26, 2008, a day on which

The TXPR index was down 5.94% on the BCE news.

BoJo’s Brexit plans suffered a setback:

British lawmakers on Tuesday rose up against Prime Minister Boris Johnson, moving to prevent him from taking the country out of the European Union without a formal agreement, in an epic showdown that has the country on the verge of a snap general election.
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The lawmakers forced his hand by voting by 328 to 301 to take control of Parliament away from the government, giving themselves the authority to pass legislation that would stop the prime minister from his threat of a no-deal Brexit.
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The extent of the Tory civil war was on full display as several Mr. Johnson’s Conservative critics, including the former chancellor of the Exchequer, Philip Hammond, lobbed hostile questions at him, making it plain that they had not been brought back into line by threats of expulsion from the party.
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There is so little trust in British politics that Mr. Johnson’s opponents fear that he might request an election for Oct. 14 but then switch the date until after Oct. 31 as part of a move to lock in a no-deal withdrawal.

Which was good news for the GBP, anyway!

The British Pound extended its intraday rebound following the latest Brexit vote results. The Pound Sterling may continue to climb as it mirrors the fall in no-deal Brexit risks.

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Meanwhile, in the Canadian preferred market … well, it’s not rallying any more.