PrefBlog

Mr Joseph S Tracy, Executive Vice President of the Federal Reserve Bank of New York, gave a speech titled A strategy for the 2011 economic recovery:

The Great Recession distinguished itself from earlier recessions in terms of its severity rather than its length. There was a decline in real output relative to trend of $1.1 trillion or 8 percent (Chart 1). This contraction brought the level of real output back to its level in 2006. In most recessions, consumption growth slows but remains positive. In this recession, there was an actual decline in consumption rather than just a slowdown (Chart 2). When households need to cut back on their consumption, they typically do so first with durable goods – for example, by delaying the decision to replace a car or to trade up to a nicer house. It is no surprise then that auto sales dropped significantly (Chart 3). Housing starts had been declining since late 2005, and the decline continued during the recession (Chart 4). Producers reacted quickly to the sharp decline in consumer demand, but inventories still rose sharply relative to sales (Chart 5).

Click for Big

How many more stories like the following must we read before the current craze for paid government informants dies down?

An immigration officer tried to rid himself of his wife by adding her name to a list of terrorist suspects.

He used his access to security databases to include his wife on a watch list of people banned from boarding flights into Britain because their presence in the country is ‘not conducive to the public good’.

As a result the woman was unable for three years to return from Pakistan after travelling to the county to visit family.

The tampering went undetected until the immigration officer was selected for promotion and his wife name was found on the suspects’ list during a vetting inquiry.

Interesting opinion on the Canadian bond market:

In order to maximize value in their bond portfolios, investors should limit exposure to Canada’s corporate bond market, one of the most expensive and least diversified of its kind in the world, says Ed Devlin, executive vice president and portfolio manager at PIMCO Canada Corp.

“The fundamental problem with the Canadian corporate bond market is that there is are too many investors chasing too few issuers,” Mr. Devlin said in a recent note to clients.

He noted that 59% of Canada’s main corporate bond benchmark is concentrated in just 10 issuers. By comparison the percentage of the index concentrated in 10 issuers is 20% in the U.S., 26% in Great Britain and 35% in the Eurozone.

Just another reason to start marketting Maple bonds to Canadians … it will never happen. Maple issuers don’t make a point of hiring Canadian ex-regulators.

It was a good day on the Canadian preferred share market as PerpetualDiscounts were up 18bp while FixedResets gained 4bp. The Bozo Spread (Current Yield PerpetualDiscounts less Current Yield FixedResets) is now zero!

The market was well-behaved, with no entries at all in the Performance Highlights.

Moody’s has downgraded Egypt:

Moody’s Investors Service cut its rating on Egypt’s debt on Monday on concern about its public finances, becoming the second credit agency to turn negative since the country was plunged into political crisis.

Moody’s … said the one-notch downgrade, to Ba2 from Ba1 with a negative outlook, was prompted by a significant rise in political risk and concern that the government’s response to mounting unrest could undermine Egypt’s already weak public finances.
…
Moody’s joined peer Fitch Ratings, which cut the outlook on its BB+ country ceiling to negative on Friday, in saying the political turmoil would likely undermine Egypt’s economic reform programme.

There was a demonstration at Dumbass Square. I liked this guy’s sign:

Click for Big

You don’t make a currency global by joining the UN and passing resolutions. You make a currency global by using it to settle international transactions:

HSBC Bank Canada said Wednesday it has completed the first Canadian trade using the yuan exclusively, as the Chinese currency continues to gain traction as an international reserve alongside the U.S. dollar. The deal was conducted for B.C.-based industrial auctioneer Maynards Industries.

Fabrice de Dongo, a spokesman for HSBC Canada, said HSBC made a direct payment in the yuan currency on behalf of Maynards to a company in China. Previously, the payment would have first been converted into U.S. dollars, used for the majority of global trade.
…
China has only recently begun allowing international trade using its currency, beginning with a pilot program in 2009 involving five Chinese cities and member countries of the Association of Southeast Asian Nations. The program was expanded to include all foreign countries, including Canada, in June 2010.

Interest rate modifications don’t work too well with underwater mortgages:

The re-default rate for the Making Home Affordable Program averaged 20.4 percent after 12 months, 15.9 percent after nine months, 10.7 percent after six months and 4.6 percent after three months, according to a report released today by the Treasury Department.
…
In December, 30,030 homeowners newly qualified for permanent modifications that reduce home payments to 31 percent of gross income, the department said today. A total of 58,020 permanent loan modifications have been canceled since 2009.
…
The median loan balance was just over $232,196 after a modification and the median mark-to-market loan-to-value was 118 percent, meaning most homeowners had negative equity or were “underwater.” The median monthly payment reduction was more than $520 or about 40 percent.

It was a mixed and volatile day on the Canadian preferred share market as PerpetualDiscounts gained 17bp and FixedResets lost 4bp. Volume ticked up a bit to above average.

PerpetualDiscounts now yield 5.28%, equivalent to 7.39% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.5%, so the pre-tax interest-equivalent spread is now about 190bp, a slight and perhaps spurious increase from the 185bp recorded on January 26.

ZLC, the BMO Long Corporate ETF, was not particularly exciting this month:

Click for big

Grecian-based multinationals being higher rated than the sovereign is old hat. Japan is another matter:

Toyota Motor Corp. and Canon Inc. are among 13 Japanese companies that will have higher ratings than their home country at Standard & Poor’s after the nation was downgraded.

Japan’s credit rating was cut for the first time in nine years as the world’s most indebted nation staggers under 943 trillion yen ($11 trillion) of borrowings, with the grade lowered one step to AA-. Toyota, the world’s biggest carmaker, and Canon, the largest camera maker, along with companies including mobile phone operator NTT Docomo Inc. and Nippon Telegraph & Telephone Corp., are rated a grade higher.

A nation’s rating doesn’t constitute a ceiling for a corporate rating, which instead depends on analysts’ judgment of inherent creditworthiness, according to S&P’s policy. Exporters that have significant overseas earnings and don’t rely on public authorities may be graded higher than the sovereign, the ratings firm said in a 2002 report.

The Bank of Canada has released a working paper by Garima Vasishtha and Philipp Maier titled The Impact of the Global Business Cycle on Small Open Economies: A FAVAR Approach for Canada:

Building on the growing evidence on the importance of large data sets for empirical macroeconomic modeling, we use a factor-augmented VAR (FAVAR) model with more than 260 series for 20 OECD countries to analyze how global developments affect the Canadian economy. We focus on several sources of shocks, including commodity prices, foreign economic activity, and foreign interest rates. We evaluate the impact of each shock on key Canadian macroeconomic variables to provide a comprehensive picture of the effect of international shocks on the Canadian economy. Our findings indicate that Canada is primarily exposed to shocks to foreign activity and to commodity prices. In contrast, the impact of shocks to global interest rates or global inflation is substantially lower. Our findings also expose the different channels through which higher commodity prices impact the Canadian economy: Canada benefits from higher commodity prices through a positive terms of trade shock, but at the same time, higher commodity prices tend to lower global economic activity, hurting demand for Canadian exports.

There were mixed results on the Canadian preferred share market today, as PerpetualDiscounts gained 25bp while FixedResets lost 4bp. Volume returned to average levels.

Towers Perrin has released its December 2010 Pension Finance Watch:

Strong equity returns dominated pension financial results in December, as the Towers Watson Pension Index moved up 3.5% to 70.7. The index was still down 1.3% for the full year, however, as positive equity returns were more than offset by the growth in liabilities resulting from falling interest rates.

They also released a report on Treasury Infl ation-Protected Securities (TIPS): A primer on infl ation-linked bonds and their relative value as an inflation hedge:

Inflation derivatives are another option when constructing an infl ation hedge. Recent academic research has shown that TIPS have historically been underpriced relative to a synthetic TIPS portfolio of nominal Treasuries and inflation swaps.** Beyond costs, these are also very complex markets with different risks and liquidity features than the cash/physical market. While there are some managers who are capable of handling such a mandate, because of cost, liquidity and counterparty risk, inflation derivatives are likely to be most suitable for clients
who have an explicit infl ation-linked liability they want to immunize in a highly customized manner.

** Why Does The Treasury Issue TIPS? The TIPS–Treasury Bond Puzzle, Matthias Fleckenstein, Francis A. Longstaff, Hanno Lustig September 2010

BIS has released its Core Principles for Effective Deposit Insurance Systems.

The Federal Crisis Inquiry Commission has released the Financial Crisis Inquiry Report. It’s all the Fed’s fault:

Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner.

The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not. The record of our examination is replete with evidence of other failures: financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk. What else could one expect on a highway where there were neither speed limits nor neatly painted lines?

Jonathan Ratner of the Financial Post reports an interesting fact in Canadian investment-grade bond market shines:

The total return of 6.92% was primarily a result of an average shift of 55 basis points in the yield curve. That was the biggest curve shift of any broad investment-grade index tracked by Bank of America Merrill Lynch, although the United States (-48 bps), Europe (-48 bps) and U.K. (-43 bps) were close behind.

The Canadian market also had fairly long duration on its side in 2010, BofAML analyst Preston Peacock said in a note to clients. At 6.78 years, the Canadian Broad Market Index is about two years longer than the United States and roughly 1.5 years longer than the Euro market. Only the Sterling market at 8.49 years has a longer duration than Canada and was the only outperformer with a 7.95% return in 2010.
…
While all sectors of the Canada Corporate Index saw healthy excess returns in 2010, banking (+0.81%) and insurance (+0.88%) had the lowest relative performances. Together, the account for about half the index.

The banking sector, which has a weighting of roughly 40% in the index, didn’t exactly have a bad showing, so its hard to say it dragged down overall index performance. However, the group did lag the 1.31% return of the global bank sector.

Mr. Peacock explained this is due to the 46% allocation to subordinated debt in the Canadian Dollar Bank Index compared to 32% globally. The Canadian group did not sell off as much as its global peers previously and therefore saw less of a bounce-back.

Sub-debt as currently constituted is a bond, since holders can petition into bankruptcy – they will not be bonds under the new regime.

It was a positive day on the Canadian preferred share market amidst continued heavy volume as PerpetualDiscounts gained 9bp and FixedResets were up 7bp.