PrefBlog

The Fed is very excited about a new extension to regulatory power:

The Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation welcome the announcement today by the International Swaps and Derivatives Association (ISDA) of the agreement of a new resolution stay protocol.
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This initiative is an important step toward mitigating the financial stability risks associated with the early termination of bilateral, OTC derivatives contracts triggered by the failure of a global banking firm with significant cross-border derivatives activities. Initially, 18 large banking organizations have agreed to sign onto the protocol. The protocol provides for temporary stays on certain default and early termination rights within standard ISDA derivatives contracts in the event one of the large banking organizations is subject to an insolvency or resolution proceeding in its home jurisdiction.

The resolution stay amendments of the protocol are intended to facilitate an orderly resolution of a major global banking firm and reduce the potential negative impact of the resolution on financial stability by giving the bankruptcy court or resolution authority the ability to prevent early termination of financial contracts of the firm’s global subsidiaries. The Federal Reserve and the FDIC are encouraged by this effort and look forward to the continuation of this important work.

ISDA adds:

The Protocol essentially enables adhering counterparties to opt into certain overseas resolution regimes via a change to their derivatives contracts. While many existing national resolution frameworks impose stays on early termination rights following the start of resolution proceedings, these stays might only apply to domestic counterparties trading under domestic law agreements, and so might not capture cross-border trades.

Regulators have committed to develop new regulations in their jurisdictions in 2015 that will promote broader adoption of the stay provisions beyond the G-18 banks. Banks have also committed through the Protocol to expand coverage once such regulations are enacted to include a stay that could be used when a US financial holding company becomes subject to proceedings under the US Bankruptcy Code. Those regulations will be made under the rule-making process in each jurisdiction.

The contractual approach is meant to support current statutory regimes and ensure wider, more consistent application. By adhering to the Protocol, the G-18 banks will extend the coverage of stays to more than 90% of their outstanding derivatives notional, and that proportion will increase as other firms sign the Protocol.

The backgrounder (available via a link on the ISDA release) gleefully celebrates the coming extension of regulatory power over investors:

Buy-side firms are not included in the first phase. These institutions are unable to voluntarily adopt the protocol due to fiduciary responsibilities to their clients. By voluntarily giving up advantageous contractual rights, they potentially leave themselves open to lawsuits. The FSB has recognised this issue, and FSB members have committed to encourage broader adoption of the protocol by imposing new regulations in their jurisdictions throughout 2015.

Hyperinflation has been rescheduled:

Federal Reserve Vice Chairman Stanley Fischer said weaker-than-expected global growth could prompt the U.S. central bank to slow the pace of eventual interest-rate increases.

“If foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise,” Fischer said in speech today in Washington.

Fischer, 70, said the Fed won’t raise rates until the U.S. expansion “has advanced far enough,” and most emerging markets should be able to weather the increase.

Fischer’s remarks highlight growing concern among U.S. central bank officials about the impact of a global slowdown and a strengthening dollar. He spoke to central bankers and finance ministers gathered in Washington for the annual meetings of the World Bank and International Monetary Fund.

The Fed’s policy making body last month expressed concern that weak demand, particularly in Europe, could add to the dollar’s appreciation, hurting U.S. exporters and damping inflation, according to minutes released Oct. 8.

I’m a big fan of transparency at the top of central banks – even, or perhaps especially, when it gets ugly:

Mario Draghi and Jens Weidmann are clashing anew over how much more stimulus the ailing euro-area economy needs from the European Central Bank.

As Europe’s woes again proved the chief concern at weekend meetings of the International Monetary Fund in Washington, President Draghi repeated he’s ready to expand the ECB’s balance sheet by as much as 1 trillion euros ($1.3 trillion) to beat back the threat of deflation. Bundesbank head Weidmann responded by saying that a target value isn’t set in stone.

The differences at the heart of policy making risk leaving the ECB hamstrung as the region’s economy stalls and inflation fades further from the central bank’s target of just below 2 percent. History suggests Draghi will ultimately prevail over his German colleague.

The public nature of the dispute will force Draghi to disclose more of his thinking than might otherwise be the case – and this is a Good Thing.

But I’m wondering about the ‘set in stone’ metaphor. Is it mixed? You can carve something in stone, which means the same thing as casting it in iron, but can you actually set something in stone to make it permanent? You can set it in concrete, if you like, and you can set a stone in a ring or a driveway, for instance, but I’m not fully convinced that “set in stone” means much. The intending meaning doesn’t match any of the standard dictionary definitions of “set”, nor does this standard dictionary list “set in stone” as an idiom. It’s all very curious.

Anyway, there is considerable controversy regarding Germany’s approach:

In Washington, Mr. Schaeuble not only endured lectures from longtime critics such as Larry Summers, the former U.S. Treasury Secretary who in an unusually frank panel discussion accused Germany of leading Europe down a path of Japanese-style deflation with a misguided focus on budget consolidation.

He also had to listen to advice from traditional allies such as Finland’s Jyrki Katainen, a future vice president of the European Commission, who warned that Germany could not remain strong forever if it failed to invest more in its own infrastructure and education system.
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In its lead editorial on Sunday, conservative newspaper Die Welt argued that a weakening German economy should force a policy rethink and warned that Schaeuble’s push to achieve a “schwarze Null” – a federal budget that is in the black – in 2015 should not turn into a mindless “fetish.”

The Sueddeutsche Zeitung suggested Chancellor Angela Merkel’s Christian Democrats (CDU) risked turning into the “Tea Party of Europe” with their single-minded focus on deficit reduction.

Meanwhile, it appears that hyperinflation has been rescheduled again:

When it comes to spurring inflation in the U.S. economy, the bond market is becoming convinced that the Federal Reserve has almost no chance of achieving its 2 percent target before the end of the decade.

Inflation expectations have plummeted in the past three months, with yields of Treasuries (BUSY) implying consumer prices will rise an average 1.5 percent annually through the third quarter of 2019. In the past decade, those predictions have come within 0.1 percentage point of the actual rate of price increases in the following five years, data compiled by Bloomberg show.
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Based on the gap between yields of government notes and TIPS, traders have scaled back estimates for average inflation through 2019 by a half-percentage point since June to 1.52 percent, Fed data compiled by Bloomberg show.

That decline has significance for policy makers because yields have historically been accurate in predicting the future pace of annual cost-of-living increases.

The market’s five-year forecast has understated actual inflation based on the U.S. consumer price index by a median of just 0.04 percentage point since the data began in 2003.

… and nominals had a good day:

Treasuries climbed, with two-year note yields dropping the most in more than a year, as signs of economic weakness in Germany fueled speculation that slowing global growth will delay Federal Reserve interest-rate increases.

Thirty-year bond yields dropped below 3 percent for the first time since May 2013 as reports showed U.K. inflation dropped to a five-year low in September and German investor confidence eroded. A gauge of inflation expectations measured by the difference between yields on 10-year notes and similar-maturity inflation-index debt traded close to the lowest in more than a year. Volatility reached the highest level since January.
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The two-year note yield dropped five basis points, or 0.05 percentage point, to 0.38 percent at 3:02 p.m. New York time, according to Bloomberg Bond Trader prices. The 0.5 percent securities maturing in September 2016 added 3/32, or 94 cents per $1,000 face amount, to 100 7/32. The yield fell as much as six basis points, the largest decline since September 2013.

The 30-year (USGG30YR) bond fell five basis points to 2.96 percent and touched 2.94 percent, the lowest since May 3, 2013. The benchmark 10-year yield dropped seven basis points to 2.21 percent. It earlier reached 2.19 percent, a level not seen since June 2013.

And equities – particularly energies – got thumped:

U.S. stocks may have perked up today but the commodity-sensitive Toronto market slipped into correction mode.

Equities in Toronto moved into that zone this morning, though pulled back later, only to drop further again in the afternoon, closing down more than 190 points, or 1.3 per cent, at 14,036.68. That marked a drop of some 10 per cent from its peak in early September, thus meeting the definition of a correction.

But is it a plot?

The decline in oil prices may be depriving Russian President Vladimir Putin of his biggest ally.

Oil has been the key to Putin’s grip on power since he took over from Boris Yeltsin in 2000, fueling a booming economy that grew 7 percent on average from 2000 to 2008.
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Brent crude is down more than 20 percent from its June high, cutting billions of dollars in tax revenue from Russia’s most valuable export. The budget will fall into deficit next year if oil is less than $104 a barrel, according to investment bank Sberbank CIB. At $90, close to the current level, Russia will have a shortfall of 1.2 percent of gross domestic product.
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Top Kremlin officials said after the annexation of Crimea that they expected the U.S. to artificially push oil prices down in collaboration with Saudi Arabia in order to damage Russia, according to Khryshtanovskaya. Putin’s spokesman, Dmitry Peskov, didn’t respond to a request for comment on this issue, nor did he respond over four days of calls requesting comment about oil’s importance to Putin.

“Prices are being manipulated,” state-run Rosneft’s spokesman Mikhail Leontyev said Oct. 12 in an interview with Russkaya Sluzhba Novostei radio. “Saudi Arabia has started offering big discounts on oil. This is political manipulation, manipulation by Saudi Arabia, which can end badly for it.”

The reason Saudi Arabia cut its crude prices earlier this month was to boost margins for refinery clients and the move didn’t signal rising competition for market share, a person familiar with the nation’s oil policy said last week.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 9bp, FixedResets down 4bp and DeemedRetractibles off 3bp. Volatility was average, with some of the usual stupidity in recorded figures brought to you courtesy of the twerps at the Toronto Stock Exchange. Volume was extremely low.

CU Inc. has announced:

it will issue $200,000,000 of 4.094% Debentures maturing on October 19, 2054, at a price of $100.00 to yield 4.094%. This issue was sold by RBC Dominion Securities Inc., BMO Nesbitt Burns Inc., TD Securities Inc., Scotia Capital Inc. and CIBC World Markets Inc. Proceeds from the issue will be used to finance capital expenditures, to repay existing indebtedness, and for other general corporate purposes of ATCO Electric Ltd. and ATCO Gas and Pipelines Ltd.

CIU.PR.A is trading in-line with the CU PerpetualDiscounts at about 5.12%, which is an interest-equivalent 6.66%, meaning that the Seniority Spread for CIU is about 256bp, in line with the index averages. Which is always nice to confirm on an individual company basis!

I think Parakeet Poloz has been told to stop providing forward guidance. He’s listed as the author of a BoC Discussion Paper, Integrating Uncertainty and Monetary Policy-Making: A Practitioner’s Perspective:

This paper discusses how central banking is evolving in light of recent experience, with particular emphasis on the incorporation of uncertainty into policy decision-making. The sort of post-crisis uncertainty that central banks are dealing with today is more profound than that which is typically subjected to rigorous analysis and does not lend itself easily to formal modelling. As a practical matter, the policy-maker is dependent on macro models to develop a coherent monetary policy plan, and this burden of coherence means that fundamental uncertainty must be incorporated explicitly into the policy formulation process. As suggested here, doing so transforms policy formulation from an exercise in reverse engineering to one of risk management, one consequence of which is to inject a little more realism about uncertainty into the policy narrative, while trusting markets to wrestle with the data flow and deliver two-way trading. The evolution is likely to be a long one—researchers are encouraged to keep focusing on developing a practical understanding of how the economy works, one that admits that rules around economic behaviour are not cast in stone, but are almost certainly subject to variation through time and events.
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Helping people to appreciate the underlying reality and the limitations of our craft without invalidating our core value proposition is a challenging task. More importantly, the business of central banking is being reinvented in real time in reaction to these realities. At the Bank of Canada, some of the key manifestations of this evolution, as I have tried to motivate above, are:
(i) explicitly building forecast ranges or scenario modelling around key assumption variables, such as potential output, the neutral interest rate and the world price of oil, into our public policy dialogue;
(ii) pointing to key elements of fundamental uncertainty, analyzing the associated policy risks carefully and openly, and laying out complementary research as we learn more about those risks;
(iii) investing more in consultations with Canadian business people and financial market participants, both in the form of surveys and in frank, face-to-face conversations around alternative interpretations of the macroeconomic data;
(iv) bringing a more fulsome narrative to the policy decision-making process, based on a risk-management framework rather than the more conventional policy engineering model; and,
(v) bringing to the table more research on real-financial linkages and financial stability risks to generate a richer set of considerations that influence day-to-day policy thinking.

If the Parakeet and his masters want to emphasize the uncertainty of forecasting, they would be much better advised to appoint strong, independently minded people to the rate-setting committee, publicizing the dissenting votes with a brief rationale, and encouraging members of the committee to make speeches giving their views. Just like the FOMC. And, as I’ve noted before, I feel quite certain that a lot of these dissenting speeches are orchestrated … ‘Bob, I don’t think you’re right on this one, but you might be! Why not highlight that in a speech so the possibility gets some discussion?’

There were good Canadian jobs numbers:

Canada’s jobs numbers have followed a perfect pattern this year, with gains one month followed by losses the next.

September was no different. The country added a better-than-expected 74,100 jobs last month and – in a complete reversal of the prior month – most of the gains were in full-time positions, and in the private sector.

To put things in a longer-term perspective, employment has grown by a still-muted average of 13,000 jobs per month in the past year. But last month’s increase was an improvement in the jobs picture.

David Parkinson snipes in the Globe:

Statscan reports the “standard error” for the overall survey at 28,500. That means that statistically speaking, 68 per cent of the time the actual monthly job-change figure will be within a range of 28,500 plus or minus the figure Statscan reports; the other 32 per cent of the time, it will be a figure outside that range.

The standard error on the private-sector employment figure is 38,200, while for self-employment it’s 25,900.

What this means is that big numbers in the survey need to be taken with a grain of salt.

But anyway … jobs? Schmobs!:

Now, as longer-run inflation expectations erode in financial markets, the Federal Open Market Committee is shifting its focus toward prices after putting its main emphasis on jobs for months. Several officials worried that “inflation might persist below” the committee’s target for “quite some time,” minutes from the Sept. 16-17 meeting said.

Too-low inflation “is getting to be a real issue again,” said former Fed Governor Laurence Meyer. With inflation at 1.5 percent according to the Fed’s preferred index, Meyer said FOMC policy makers aren’t likely to raise interest rates, even if the economy approaches full employment, defined as a jobless rate of 5.2 percent to 5.5 percent. Unemployment was 5.9 percent last month.
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Policy makers including regional Fed Presidents William Dudley of New York, Charles Evans of Chicago and Narayana Kocherlakota of Minneapolis have in recent days all mentioned below-target inflation as a risk that weighs against raising interest rates too soon.

And the stock market blew us another raspberry:

The Standard & Poor’s 500 Index (SPX) posted the biggest weekly drop in two years as concern about chipmaker earnings fueled a rout across the technology industry.

The Dow Jones Industrial Average (INDU) erased gains for the year as Intel Corp., Microsoft Corp. and Cisco Systems Inc. fell more than 3.5 percent. Microchip Technology Inc. tumbled 12 percent said quarterly revenue was crimped by a decline in China sales and warned of an industry correction. Juniper Networks Inc. sank 9.1 percent after reporting preliminary results that missed its own forecast.

The S&P 500 lost 1.2 percent to 1,906.09 as of 4 p.m. in New York. The index fell 3.1 percent for the week, the biggest drop since May 2012.
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European Central Bank President Mario Draghi clashed with Germany’s finance minister yesterday over the steps needed to revive growth in the euro area, while Federal Reserve officials have said the U.S. economy may be at risk from a global slowdown.

The S&P 500 has fallen for the past three weeks, the longest run since January. It’s down 5.2 percent from a record on Sept. 18, trimming its gain for the year to 3 percent.

The Canadian preferred market declined today, with PerpetualDiscounts down 5bp, FixedResets losing 9bp and DeemedRetractibles off 3bp. Losing FixedResets dominated the Performance Highlights table. Volume was very low.

The equity jocks are off their meds:

After plunging 1.5 percent on Oct. 7 and rallying almost 1.8 percent yesterday, the Standard & Poor’s 500 Index dropped 2.1 percent at 4 p.m. in New York today, the biggest turnaround in almost three years. As investors weigh the prospect of slower economic growth overseas against the benefit of U.S. interest rates staying near zero, a measure of 10-day volatility has risen to the highest level since April, data compiled by Bloomberg show.

The only phrase that generates more comments on this site than “real estate” is “trailer fees”. So it is with some glee that I report that the trailer fee wars are heating up:

“Trailer fees – the meteor is closer than you think” was the title of a recent note put out by Mr. Sedran and Mr. Holden [of CIBC]. The meteor in question is a ban on trailer fees.

“Regulators are studying the impact of these fees, with the results of those studies and a recommendation expected early 2015. A ban on trailer fees would follow a global trend and would address the regulators’ conflict of interest concerns. We think such a ban is coming, and sooner than many think.”

The story is marred by an inaccuracy:

The big knock against trailer fees is that despite the advisor having a fiduciary duty to put the client in the product that best serves their needs, there is a financial incentive for the advisor to sell the client the fund with the highest trailer fee – a glaring conflict of interest.

… but we may see a lot of “portfolio managers” without track records:

Mr. Sedran and Mr. Holden say the industry will likely transition to a model where advisors would be paid for managing a client’s entire portfolio, similar to how financial planners are paid today. Furthermore, under such a model, the advisor’s compensation would be tied to whether their client’s portfolio appreciates in value. The implication is that it will also be in the advisor’s interest to put clients into the funds they believe will perform the best over time.

The so-called implication is laughable – it will continue to be a lot easier for salesmen to get a fresh $1,000 into the account from the client than it is to outperform by 1% on a $100,000 portfolio. But people like to dream.

There’s a laugh line:

The bigger players, such as the Canadian banks who already have vast mutual fund sales forces in branches, should be able to manage the transition just fine, according to Mr. Sedran and Mr. Holden.

Well, of course. If it hurt the banks, their future employees at the regulatory agencies wouldn’t dream of the idea. I remain interested in the regulatory agencies views on new issue commissions and proxy solicitation fees – which are functionally equivalent to trailer fees – but the silence continues.

I have often remarked at the superiority of US institutions over their Canadian counterparts with respect to transparency. It is very useful to gain insight into the policy-setting process by reviewing the countervailing arguments within the various committees – but, of course, there are always some who would prefer a two-line press release:

Joseph LaVorgna, chief U.S. economist at Deutsche Bank AG in New York, said officials risk sowing confusion.

“It’s hard to have a unifying message when you have this many people who feel it’s incumbent on them to tell you what the Fed is thinking,” he said.

“I wish the Fed would answer generalities with generalities,” he said. “When they try to quantify, that’s when the problems come up.”

There’s some more information from Pew Research regarding stagnant wages:

Following the better-than-expected September jobs report, several economic analyses have pointed out the continuing lack of meaningful wage growth, even as tens of thousands of people head back to work. Economic theory, after all, predicts that as labor markets tighten, employers will offer higher wages to entice workers their way.

But a look at five decades’ worth of government wage data suggests that the better question might be, why should now be any different? For most U.S. workers, real wages — that is, after inflation is taken into account — have been flat or even falling for decades, regardless of whether the economy has been adding or subtracting jobs.

Cash money isn’t the only way workers are compensated, of course — health insurance, retirement-account contributions, education and transit subsidies and other benefits all can be part of the package. But wages and salaries are the biggest (about 70%, according to the Bureau of Labor Statistics) and most visible component of employee compensation.
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But after adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms the average wage peaked more than 40 years ago: The $4.03-an-hour rate recorded in January 1973 has the same purchasing power as $22.41 would today.

A similar measure, “usual weekly earnings” of employed, full-time, wage and salary workers, tells much the same story, albeit over a shorter time period. In seasonally adjusted current dollars, median usual weekly earnings rose from $232 in the first quarter 0f 1979 (when the series began) to $782 in the second quarter of this year (the most recent data available). But in real terms, the median has barely budged over that period.

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But amidst all the gloom and doom, there’s some good news:

Prince Edward Island has joined Ottawa’s move to create a national securities regulator, bringing the total to five provinces who have signed onto the plan.

The federal Finance Department said Thursday the province has signed a memorandum of agreement to join the Co-operative Capital Markets Regulatory System.

The addition of P.E.I. follows a decision in July by Saskatchewan and New Brunswick to join B.C., Ontario and the federal government in establishing a national regulator.

I have said for a long, long time that piecemeal cooperation is better than none and much more attainable than the single-regulator pipedream. Mind you, I think the commentary we occasionally see regarding the wonderfulness of a national-mostly regulator is highly overwrought. All that will happen is that some unnecessarily duplicated paperwork will be eliminated. But that’s good reason enough.

It was a poor day for the Canadian preferred share market, with PerpetualDiscounts down 12bp, FixedResets losing 13bp and DeemedRetractibles off 8bp. Volatility was average and balanced, but comprised entirely of FixedResets. Volume was on the low side of average.