Category: Market Action

The recent US repo-market disruption continues to attract attention:

The Federal Reserve plans to pour cash into the U.S. banking system through early October in a bid to avert another market disruption, but analysts see the need for the central bank to come up with longer-term fixes.
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Repo rates hit 10 per cent on Tuesday, propelling other short-term rates sharply higher.

Analysts blamed huge cash demand to pay for quarterly corporate taxes and the prior week’s US$78-billion worth of coupon-bearing Treasury supply for the market ruction.

They also attributed the decline of excess reserves, to about US$1.4-trillion from US$2.3-trillion in 2017, to the Fed’s reduction of its bond holdings.
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Since Tuesday, the Fed has held four rounds of repo operations, with banks and dealers borrowing from the central banks with their Treasuries and other bonds as collateral.

On Friday, the New York Fed, which implements the central bank’s market actions, said it will conduct more repo operations into October.
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While repo operations are expected to provide a temporary patch, analysts said the Fed needs to offer more permanent solutions.

“The underlying conditions that gave rise to the funding stress are still in place,” said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.

Other analysts said policy-makers should consider launching a standing repo facility and/or increasing purchases of Treasuries.

I don’t think much of the proposed solutions in the final quoted paragraph. Both represent the Fed printing money.

The rationale behind the current bloated balance sheet of the Fed is that we are continuing to recover from the Credit Crunch. There was a huge shock to the system, so the Fed boosted the money supply, fine, I get it. But making this monetary expansion permanent – or even hinting that it could be permanent – looks like an open invitation to galloping inflation.

Look at the stresses that caused the episode! Tax payments and a big Treasury auction! Not at all unusual and totally forseeable. And yet the repo rate spiked to 10%.

Either the Fed screwed up by implementing ‘quantitative tightening’ too rapidly, or the financial system has become addicted to having all that cheap cash around. The first is an easy fix, the second is a little scary …. beating an addiction usually results in pain, as Canadian mortgage borrowers found out in 1981.

And through it all, Canadians are keeping up with the Joneses in the traditional way:

Canadian homeowners who accessed their home equity through a loan or refinancing helped fuel household spending in recent years, according to research by staff at the Bank of Canada.
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In 2017, the researchers found Canadian homeowners extracted $89-billion in home equity through these two methods, with more money – $49-billion – coming through HELOCs.

Borrowers used that money to pay for big-ticket items, such as cars and furniture, or to fund renovations, among other things, according to the research, which suggests this “has likely contributed materially” to this kind of spending in Canada in recent years.

The researchers found that by the end of 2017, this equity extraction could have added two per cent to consumer spending on durables and semidurables (goods that include cars and furniture), as well as 11 per cent to renovation spending.

The report found that translated into a 0.5-per-cent impact on the GDP level.

The source paper is titled Home Equity Extraction and Household Spending in Canada, by Anson T. Y. Ho, Mikael Khan, Monica Mow and Brian Peterson.

Update, 2019-9-25, referred to in comments: From the report Combatting Money Laundering in BC Real Estate:

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… and from a blog (I couldn’t find an actual Bank of Canada chart with this information, but this chart looks right):

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So, the Fed cut by a quarter:

Information received since the Federal Open Market Committee met in July indicates that the labor market remains strong and that economic activity has been rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although household spending has been rising at a strong pace, business fixed investment and exports have weakened. On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 1-3/4 to 2 percent. This action supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain. As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair, John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Charles L. Evans; and Randal K. Quarles. Voting against the action were James Bullard, who preferred at this meeting to lower the target range for the federal funds rate to 1-1/2 to 1-3/4 percent; and Esther L. George and Eric S. Rosengren, who preferred to maintain the target range at 2 percent to 2-1/4 percent.

The voting was interesting, with two hawks and one dove dissenting, which underscores the uncertainty that prevails globally. Of course, there’s there’s one guy who’s never uncertain:

“Jay Powell and the Federal Reserve Fail Again. No “guts,” no sense, no vision! A terrible communicator!,” Mr. Trump said in a tweet shortly after the Fed’s announcement, referring to Jerome H. Powell, the Fed Chair.

Equities fell initially, and then:

But stocks reversed their slide during Powell’s news conference following the policy decision, during which he said the Fed is closely monitoring economic data, trade and global growth risks, but did not see imminent recession, or think the central bank would cut rates to negative territory.
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U.S. Treasury yields dipped following Powell’s remarks.

Benchmark 10-year notes last rose 7/32 in price to yield 1.7909%, from 1.814% late on Tuesday. The 30-year bond last rose 23/32 in price to yield 2.2471%, from 2.28% late on Tuesday.

The dollar strengthened following the Fed’s rate cut. The dollar index rose 0.28%, with the euro down 0.36% to $1.1031.

And in the frozen north:

The Canadian dollar weakened to a two-week low against its U.S. counterpart on Wednesday as oil prices fell and after the U.S. Federal Reserve was less dovish than some investors had anticipated.
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Canadian government bond prices were higher across a flatter
yield curve. The two-year rose 2.5 Canadian cents to yield 1.598% and the 10-year was up 15 Canadian cents to yield 1.433%.

The 10-year yield touched its lowest intraday since Sept. 12 at 1.409%.

PerpetualDiscounts now yield 5.57%, equivalent to 7.24% interest at the standard equivalency factor of 1.3x. Long corporates now yield 3.48%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has plunged to 375bp from the 415bp reported September 11.

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.