PrefBlog

Tapering? Schmapering!

Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.

The editors at Bloomberg make some good points before tapering off into an absurd conclusion:

Together with the exuberant market reaction, though, the Fed’s move demonstrates a problem: Investors still don’t make a distinction between its plans for bond purchases and its pledge to keep short-term interest rates low until after the economy recovers. In futures markets, for example, the expected date of the Fed’s first increase in its interest-rate target immediately moved out by about a month, even though there was no major change in interest-rate policy.

The perception of tapering as a proxy for the Fed’s overall stance on stimulus is unfortunate, because there may be good reasons to taper that are not related to the outlook for the economy. The Fed, for example, might become concerned that the size of its holdings will leave it too exposed to losses or hamper the functioning of markets. As a result, perfectly sensible moves to cut back on bond purchases can send the wrong signal. Alternatively, the desire to manage perceptions can push the Fed into maintaining quantitative easing against its better judgment.

Dan Hallett writes an excellent piece in the Globe titled Investing in floating rate notes? Here’s what the industry isn’t telling you emphasizing the fact that interest rate risk is not the same as credit risk:

While FRNs offer protection against rising rates, the largely-corporate profile of FRN issuers (including a good proportion of below-investment grade companies) means that FRN fund investors are assuming a good deal of credit risk. A significant but less concerning risk is the decreasing returns that would result in a falling interest rate environment.
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Trimark Floating Rate Income fund lost 27 per cent of its value during the financial crisis – significant but not insurmountable. The fund has fully recovered, having long surpassed its previous peak. But BMO Floating Rate Income fund is different story.

BMO’s fund lost nearly half of its value – more than many stock funds – and remains under water as of August 31. Its previous peak is more than seven years into the past. It’s no surprise that BMO Floating Rate Income sports the highest risk rating of its peers.

The Canadian preferred share market roared ahead on the non-tapering news, with PerpetualDiscounts winning 69bp, FixedResets gaining 24bp and DeemedRetractibles up 36bp. The Performance Highlights table is suitably enormous, heavily weighted towards winning Straight Perpetuals. Volume was quite high.

PerpetualDiscounts now yield 5.65%, equivalent to 7.34% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 5.0%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 235bp, a sharp decline from the 250bp reported September 11.

Nothing happened today, but I’m sure there was more tapering chatter.

It was another fine day for the Canadian preferred share market, with PerpetualDiscounts up 22bp, FixedResets gaining 18bp and DeemedRetractibles winning 37bp. The Performance Highlights table is short by current standards, skewed heavily towards winners. Volume was heavy, with the Volume Highlights table comprised entirely of relatively low-coupon FixedResets.

The Yellen – Summers race is over:

Summers said that the storm around his possible nomination pointed to a difficult confirmation process that could hurt the President’s economic agenda and the institution, and decided to pull back.

“I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interest of the Federal Reserve, the administration or, ultimately, the interests of the nation’s ongoing economic recovery,” Summers said in a letter to Obama.

Initial reaction was positive:

Treasury futures rose the most in six weeks after former Treasury Secretary Lawrence Summers dropped out of contention to head the Federal Reserve, ending speculation his ascendancy to the post would lead to a faster exit from the central bank’s bond-buying policy.

Mohamed El-Erian, the chief executive and co-chief investment officer at Pacific Investment Management Co., said the decision increases the probability of policy continuity at the Fed. “This would be seen as being particularly supportive for the front end of the Treasury curve,” El-Erian wrote in a commentary posted on the Business Insider website.

The next governor – whoever it is – might have to rebuild Fed credibility:

Bond investors are losing confidence in the Federal Reserve’s pledge to keep benchmark interest rates at about zero into 2015 as the U.S. economy accelerates.

Concern the Fed will increase its target rate for overnight loans between banks next year is showing up in wider price swings for shorter-term securities. Volatility in five-year Treasuries rose above 10-year (USGG10YR) notes for the first time since 2011 and yields on two-year notes more than doubled in the past four months. Bill Gross, who manages the world’s biggest bond fund at Pacific Investment Management Co., reiterated today his recommendation to buy debt with short maturities.

While speculation the Fed will reduce its $85 billion of monthly bond purchases as soon as this week has left bond investors with the worst losses since 1994, JPMorgan Chase & Co. financial models show the end to the central bank’s zero-rate policy would have an even bigger impact.

I am pleased to see that at least one person agrees with me that settlements without admission of guilt are counterproductive:

SEC Chairman Mary Jo White, a former prosecutor, can demand only civil reparations, yet she holds a trump card: She can refuse to let JPMorgan settle cases without admitting or denying guilt. Then private litigants can piggyback off any SEC settlement, adding to the penalties.

Another example of single point failure in centralized systems:

Some U.S. options exchanges shut after reporting a malfunction with the industry data feed for disseminating prices, days after securities regulators told market operators to find ways to improve systems.

CBOE Holdings Inc. (CBOE), NYSE Euronext (NYX), Nasdaq OMX Group Inc. and Bats Global Markets Inc. all reported shutdowns on their websites. Exchanges said they were experiencing issues with the OPRA data feed. CBOE later said it had resumed transactions.
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The Options Price Reporting Authority, or OPRA, administers the dissemination of trade and quote information to brokers, investors and market-data vendors such as Thomson Reuters Corp. and Bloomberg LP, the parent of Bloomberg News. It’s managed by U.S. options exchanges and charges users for its data.

Shared responsibility means no responsibility!

It was a very good day for the Canadian preferred share market, with PerpetualDiscounts up 35bp, FixedResets gaining 18bp and DeemedRetractibles winning 40bp. The Performance Highlights table is suitably lengthy. Volume was extremely high.

There is a continuous stream of tapering chatter!

U.S. stocks rose, with the Dow Jones Industrial Average capping its best week since January, as disappointing economic data fueled bets that any Federal Reserve stimulus cuts this month would be moderate.
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Fifty-seven percent of those surveyed say they don’t expect a sudden change in the markets because investors already anticipate tapering action.

A Commerce Department report today showed retail sales in the U.S. rose 0.2 percent, the smallest increase in four months and below the 0.5 percent advance seen in Bloomberg survey. Wholesale prices in the U.S. rose more than forecast in August, adding 0.3 percent on higher costs for food and some fuels.

A separate report showed inventories at companies increased more than forecast in July, trailing a gain in sales that signals a pickup in factory orders. The Thomson Reuters/University of Michigan preliminary September index of consumer sentiment fell to 76.8 from 82.1 last month, which was the lowest since April.

It was another mixed day for the Canadian preferred share market, with PerpetualDiscounts up 34bp, FixedResets off 1bp and DeemedRetractibles down 3bp. A fairly lengthy Performance Highlights table is heavily skewed towards winners, led by TCA.PR.X, which got called today. Volume was average.

In the latest installment of Fed Governorship chatter, Bloomberg has released a poll of its subscribers, which can be taken as a reasonable proxy for ‘the market’:

Thirty-five percent of investors, analysts and traders who are Bloomberg subscribers say Summers may provide less stimulus than Bernanke, whose chairmanship ends in January, compared with 13 percent who see Summers with looser policy and 22 percent saying it’d be the same. Forty-seven percent see Yellen presiding over the same policy, with 17 percent saying it’d be looser and 8 percent saying tighter. The rest said they don’t know how it would change.
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The poll, conducted Sept. 10, showed 40 percent of respondents see Summers getting the job, compared with 33 percent for Yellen, the Fed’s vice chairman. Three percent see Obama opting for former Fed Vice Chairman Donald Kohn, while the remainder said they didn’t know or expected Obama to pick someone else.

In a May 14 poll of investors, Yellen was seen as the most likely selection by 34 percent of investors, more than any other candidate. Twenty-seven percent of investors thought that Bernanke would be reappointed. Summers was seen as a long-shot, with only 4 percent of investors saying he was likely to be Obama’s pick.

It was a mixed day for the Canadian preferred share market today, with PerpetualDiscounts up 12bp, FixedResets off 1bp and DeemedRetractibles gaining 7bp. Volatility was much lower than current standards imply, but still above the average of the first five months of this year. Volume was a little above average.