PrefBlog

So the big news of the day was the US jobs number:

Payrolls pushed past their U.S. pre-recession peak for the first time in May, a milestone that’s been five years in the making.

The 217,000 advance in hiring followed a 282,000 gain in April, figures from the Labor Department showed today in Washington. It marked the fourth consecutive month employment increased by more than 200,000, the first time that’s happened since early 2000. The jobless rate unexpectedly held at an almost six-year low of 6.3 percent.
…
The report also showed incomes climbed, the ranks of the long-term unemployed decreased and businesses took on more full-time help, evidence of the type of economic progress that will keep the Federal Reserve paring record monetary stimulus.
…
The so-called participation rate, which indicates the share of working-age people in the labor force, held at 62.8 percent, matching the lowest since March 1978.

Drew DeSilver of Pew Research points out:

But while the country may have climbed out of the deepest jobs hole since the Depression, that hardly means everything is peachy. There are about 15 million more working-age people now than there were in January 2008, but essentially the same number of jobs. Only 58.9% of the adult population is employed, four percentage points below the level in January 2008.

As the above chart from the Economic Policy Institute (prepared before today’s jobs report) shows, the economy is still some 7 million jobs short of what it would need for the employment-to-population ratio to reach its pre-recession level. EPI economist Heidi Shierholz commented, “We are far, far from healthy labor market conditions.”

The morally pure among us will be thrilled that Christian Bittar has been fined megabucks for a back-dated crime:

Britain’s markets regulator is seeking to fine former Deutsche Bank AG (DBK) trader Christian Bittar about 10 million pounds ($17 million) for trying to rig benchmark interest rates, its largest ever penalty against an individual, said a person with knowledge of the situation.
…
The penalty would dwarf the $9.6 million imposed on Rameshkumar Goenka, a Dubai-based investor, for manipulating stocks in London, the regulator’s biggest to date. The FCA has said it’s preparing to fine at least seven other traders it didn’t identify for their roles in trying to rig the London interbank offered rate or similar benchmarks. At least two may be fined more than one million pounds each, according to people with knowledge of the talks.

Well, Zero Hedge will be happy, anyway:

So to summarize:

1.Deutsche tells an internal prop trader to invest billions in the Libor market,but tells him: “do everything legally and by the book or else.”
2.Bittar colludes with virtually everyone else under the sun (for a full roster of names all of which point to one place: Switzerland, and secondly Singapore, see here), to generate billions in profits;
3.Bittar makes tens if not hundreds of millions of bonuses for himself;
4.Finally, DB no longer can hide the deception and claws back a portion of Bittar’s bonuses, while washing its hands of the full affair;
5.Scapegoat punished, life goes on.
And then what happened to Bittar?

He now works for Bluecrest Capital Management LLP, Europe’s third- biggest hedge fund with $30 billion under management.

I.e., nothing changes.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts off 4bp, FixedResets up 15bp and DeemedRetractibles gaining 5bp. Volatility was minimal. Volume was extremely low.

DBRS commented on the Quebec budget:

Following disappointing real GDP growth of just 1.1% in 2013, the new budget assumes accelerating growth of 1.8% in 2014 and 2.0% in 2015, supported by an improvement in domestic demand and the external environment. This is consistent with the private sector consensus tracked by DBRS. Despite a difficult first quarter, the outlook for the U.S. economy is encouraging and a lower Canadian dollar will add further support to Québec exports.

At the time of last year’s rating review, DBRS anticipated that the debt-to-GDP ratio had peaked around 61% in 2012-13 and would begin to decline in 2013-14. As a result of the deterioration in fiscal performance, the latest estimates again point to a debt burden of approximately 61% in 2013-14, with another modest increase projected in 2014-15. After which, the debt burden is forecast to gradually decline to roughly 56% by 2018-19, provided that the fiscal recovery remains on target and capital spending moderates as planned.

Assiduous Reader BC wrote in and said:

One other thing I was curious about and thought you might well be the best source to ask.

Years ago, in 2006, the government outlawed income trusts and in the aftermath, a lot of companies began paying eligible dividends that qualify for the dividend tax credit

What possibility might there be that in the future, a revenue hungry government might decide to take similar action in connection with the dividend tax credit.

Thanks very much for any input you can provide

Well, nothing’s guaranteed. For all I know, the Trotskyists will form the next federal government and then I’ll be harvesting potatoes for a living.

That being said, the dividend tax credit seems politically safe to me; none of the three major parties is making it an issue and the major influence on it since it was introduced in 1972 (over the past ten years, anyway) has been changes in corporate tax rates.

However, it should be noted that the explicit purpose of the DTC is to encourage equity investment:

There will be a major increase in the dividend tax credit. Starting January 1, 1978, the amount of dividends received from taxable Canadian corporations will be grossed-up by one-half, as opposed to the current one-third, and taxpayers will be allowed to claim against tax a credit equal to this higher amount.

This measure will provide benefits in a progressive manner in that the net tax on each dollar of cash dividend received will decline by a larger dollar amount the lower the income of the taxpayer. This is shown in the table included in the Supplementary Information. The table also illustrates how this measure will improve the return on equity investments. The proposed increase in the dividend tax credit should thus make it more attractive for investors in all income brackets to return to the equity market. The federal revenue loss from this measure is estimated to be $120 million in the first full year of operation and the measure will also affect provincial tax revenues.

Geez, those were the days, eh? When a tax expenditure of $120-million wasn’t just a rounding error?

However, there are rising concerns about income inequality and its cause:

More than a quarter (26%) of self-identified Democrats and those who lean Democratic cited the tax system as a main reason for the gap. Just 14% of self-identified Republicans and those who lean Republican said the same.

This is particularly evident at the very top of the tree:

But Mr. Zucman and Mr. Saez show a dramatic increase in wealth inequality at the very top of the distribution, among households with more than $20 million in wealth – and especially among those with more than $100 million.

… and we all remember Warren Buffet’s secretary:

Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent.

Buffett said that was despite the fact that he was not trying to avoid paying higher taxes. “I don’t have a tax shelter,” he said. And he challenged Congress and his audience to see what the people who “clean our offices” are taxed, to loud applause.

And why does this happen:

You might wonder how Mr Buffett managed such a low tax rate. Most likely, it arose because corporate dividends and capital gains are taxed at only 15 percent. But the corporate income that funded those returns was already taxed at the corporate level, where the tax rate is 35 percent. Mr Buffett seems to be ignoring the first round of taxation. Is it possible that the world’s most successful has failed to pierce the corporate veil? (If you want to more reliable data on the progressivity of the tax code, see this old post for numbers from the CBO.)

Even more striking to me is a fact that Mr Buffett did not emphasize: how low his taxable income is. His income of $46 million represents a mere 0.1 percent of his reported net worth of over $50 billion. That is not an impressive rate of return!

Why is it so low? I can think of at least four possible ways investors like Mr Buffet can keep their taxable income, as opposed to their true income, low:
1.They hold stocks that pay minimal dividends.
2.They avoid realizing capital gains.
3.They hold some of their portfolios in tax-free municipal bonds.
4.They give appreciated assets to charity, getting a deduction for the current market value without ever having to realize and pay tax on the capital gain

… and at least some of the super-rich are indulging in conspicuous consumption:

Money managers may resent Prof. Piketty’s book but they appear to love its takeaway notion, especially the implication that the market for expensive goods is just going to keep on getting bigger.

Further evidence for that viewpoint came this week when McLaren Automotive reported that it had made a profit in only its third year of operation. The British auto maker, which was spun out of McLaren Group, the Formula One racer, sells high-performance but road-legal cars that go for about $1.8-million.

This is a company that considers Ferrari and Porsche to be downmarket. Yet it has had no trouble selling out production of its P1 supercar.

Call it the 0.01 per cent market. Before Prof. Piketty and colleagues such as Emmanuel Saez at the University of California in Berkeley came on the scene, economists tended to pooh-pooh concerns about wealth distribution, since the middle class was clearly getting richer and at a pace not wildly different from that of the top 10 per cent of society.

It’s the old story, one that particularly impressed me when I visited Russia a few times and saw the glorious architecture in Moscow and St. Petersburg and the awesome craftsmanship of the relics in the Hermitage. I was so overwhelmed in the Hermitage that I decided I needed to concentrate my attention on one thing and just wandered from room to room looking at tables. How do you get such awesome craftsmanship? Well, first you spend ten years training a guy to make tables of superb quality. And then you tell him to spend the next five years to make a table for you. You can only afford to do this in conditions of extreme income inequality.

So, given all the above, I think that at some point the Dividend Tax Credit and Gross Up will attract some populist political criticism, as will the capital gains inclusion rate. It might well be that people will decide that double-taxation of distributed corporate profits is a Good Thing, particularly if snooty rich folks on Bay Street are getting the benefit of the tax breaks instead of hard-working ordinary Canadians on Main Street.

On the other hand, perhaps one of the biggest macro-economic problems facing governments nowadays is that hard-working ordinary Canadians on Main Street are showing an increasing preference for personal real-estate as an investment rather than productive investment. So my political prediction is that eventually the DTC and the lower inclusion rate capital gains will be capped at some figure that is extremely high as far as the man in the street is concerned (say, income of $150,000) but is mere pocket change to the about-to-be-soaked rich. And remember: with one of my political predictions and $2.00, you can get a coffee at Timmy’s. After all, I didn’t expect the The Pickton-ization of Communities and Exploited Persons Act.

On a less philosophical note, Draghi has earned himself a chapter in future histories of monetary policy:

Mario Draghi unveiled an unprecedented round of measures to help the European Central Bank’s record-low interest rates feed through to an economy threatened by deflation.

The ECB today cut its deposit rate to minus 0.1 percent, becoming the first major central bank to take one of its main rates negative. In a bid to get credit flowing to parts of the economy that need it, the ECB also opened a 400-billion-euro ($542 billion) liquidity channel tied to bank lending and officials will start work on an asset-purchase plan. While conceding that rates are at the lower bound “for all practical purposes,” the ECB president signaled policy makers are willing to act again.
…
Draghi announced a new liquidity program designed to encourage lending. Financial institutions will be allowed to borrow money from the ECB equivalent to as much as 7 percent of their outstanding loans to non-financial corporations and households, excluding mortgages.
…
The negative deposit rate, which means charging banks that want to deposit excess funds with the ECB, has been heralded by Draghi as a way to stem unwarranted increases in money-market rates, as well as to curb euro strength that has contributed to slower inflation.

The measure has been used by a handful of smaller central banks in recent years, including Sweden’s, which conducted a 14-month experiment in 2009-2010. Denmark moved below zero in July 2012 — though the cut was aimed more at protecting its currency than stimulating growth — and ended the policy in April.

“It’s another whatever-it-takes moment in the life of the ECB and the euro zone,” said Carsten Brzeski, chief economist at ING-DiBa AG in Brussels “He threw in all he had.”

Excluding mortgages, mind you. Don’t spend no more damned money on your damned houses, people! Use it to collateralize your carry trades:

The policy divergences will widen even further over the next three years as the Fed and then the BOE raise rates, putting them on a course counter to the ECB and the BOJ, according to Andrew Kenningham, an economist at Capital Economics Ltd. in London. By 2017, he estimates, the gap between the U.S. benchmark and those of the euro area and Japan could be nearing four percentage points.

Such divides, he says, are unusual although not unprecedented. The split between U.S. and Japanese rates has often exceeded four percentage points in recent decades and between the U.S. and Germany it topped three percentage points for much of the 1980s.

There are some very interesting musings about solar power:

Deregulated electricity generators make most of their profits on hot summer afternoons, when air conditioners and offices force grid operators to call up their most expensive electricity: natural gas “peaker” plants. Cheap to build but expensive to operate, these plants are essentially jet engines, producing power on demand for a few hours at a time. However, the entire industry benefits when peaker plants kick in, because every other generator, including the cheapest hydropower operator, receives the same top dollar during those peak hours.

Solar panels — whether utility scale or residential rooftop — generate maximum power on exactly those hot afternoons when demand peaks. What’s more, they do so at no marginal cost; the sun is free. This reduces reliance on peakers, causing prices to fall across the board, including for customers without solar power.

This is what terrifies power companies. In California, the afternoon peak has effectively collapsed. CAISO, the state’s grid manager, projects that the peak will become an afternoon chasm, so low that even power plants designed to operate 24 hours a day as “baseload power” (nuclear energy is a good example) may face difficult decisions about when to operate.

The first victims among utilities will be generators that sell electricity from peakers and other plants in the open market. Soon, their plants will be needed only for the few hours around dusk when the sun is weak but demand is still relatively high.

Arizona has net metering, but is considering changes:

The future of solar net metering in Arizona is under attack, with the state’s largest utility Arizona Public Service (APS) proposing changes that undermine cost benefits for residential solar installations.

Under a plan submitted in July with the state’s public utility commission, APS proposes two options for future residential solar customers – both of which will reduce potential financial returns homeowners would receive on their investment.

One alternative would model net-metering contracts much the same as today but require residential customers to pay what APS calls a “convenience fee” – a monthly charge for sending power to the grid. The other option would give homeowners a small ongoing bill reduction, based on market rates APS pays to other power generators.

Seems to me a two-part electricity bill is what’s required – one part for actual electricity use, one part for access to the grid. This would be similar to Toronto Hydro’s charges, but ideally the grid access charge will be based on capacity rather that usage.

TransCanada, proud issuer of TRP.PR.A, TRP.PR.B, TRP.PR.C, TRP.PR.D and TRP.PR.E, was confirmed at Pfd-2(low) by DBRS:

DBRS has today confirmed the ratings of TransCanada Corporation (TCC or the Company) and its wholly owned subsidiary, TransCanada PipeLines Limited (TCPL), both with Stable trends. The ratings primarily reflect (1) expected improvement in TCC’s overall business risk profile over the medium term, (2) potential medium term pressure on its credit metrics and (3) environmental, regulatory and political risks with respect to its natural gas and liquids pipelines segments.

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts gaining 3bp, FixedResets winning 19bp and DeemedRetractibles up 9bp. The longer-than-usual Performance Highlights table, still reflecting the dislocations of the past two weeks, is dominated by winning FixedResets. Volume was quite low and dominated by recent new issues.

It’s nice to see a statistic about how many CLOs lost money in the Credit Crunch:

Issuance of CLOs, which helped finance some of the biggest leveraged buyouts in history during the last credit boom, has picked up following an early 2014 slump brought on by the publication of the Volcker Rule designed to limit risk-taking by banks — major buyers of the funds. CLOs are investors in speculative-grade loans, an asset class in which U.S. banking regulators have said underwriting standards have become too lax.
…
CLOs pool high-yield corporate loans and slice them into securities of varying risk and return, typically from AAA ratings down to BB. The lowest portion, known as the equity tranche, offers the highest potential returns and the greatest risk because investors are the first to see their interest payouts reduced when loans backing the CLO default.

CLO managers may also be trying to issue deals ahead of risk-retention rules proposed by the Dodd-Frank Act in order to increase assets under management and income, said Kroszner. The regulation may require CLO managers to hold 5 percent of the debt they package or sell.
…
Out of 719 U.S. CLOs that purchased widely syndicated loans and were rated by Moody’s Investors Service between January 1996 and May 2012, only 14 funds lost any of their principal at maturity, according to a July 2012 report from the ratings firm.
…
The growth in riskier corporate lending led the Federal Reserve and the Office of the Comptroller of the Currency to warn lenders last year to improve lax underwriting practices. Todd Vermilyea, a Fed official, said May 13 that standards “have continued to deteriorate in 2014” and that “stronger supervisory action” may be needed.

While the Volcker Rule hasn’t led to fewer CLOs it has kept the cost to raise the funds elevated.

The average rate paid on CLO portions ranked AAA was about 150 basis points more than the London interbank offered rate in May, according to Wells Fargo. That’s up from a spread as low as 110 basis points on AAA slices last year.

As I have often complained, regulators and politicians are always careful to talk about downgrades of engineered products, rather than actual defaults.

Watch out for falling house prices!

In May, new home prices in 62 Chinese cities edged downward from the month before, dragging down the Chinese average for the first time in nearly two years. The biggest decline came in Shantou, where prices fell 3.64 per cent from April, according to China Index Academy, a research arm of SouFun, which operates the country’s largest real estate portal.

China’s real estate market is the bedrock of its economy. Residential housing is worth some 12.5 per cent of GDP, and homes contain some two-thirds of Chinese household wealth. A fracture in Chinese housing, in other words, is a fracture in China’s financial well-being.

And the slowdown has come with remarkable speed. Last December, Chinese housing prices rose 12 per cent year-on-year, the biggest gain of 2013. By May, sales were down more than 50 per cent from April at Shantou’s Jiacheng Real Estate Agency.

Assiduous Readers will know of my fondness for mocking CalPERS – the politicized fund that doesn’t do credit analysis. I’ve acquired another target – The Norwegian Government Pension Fund, an $853.9 billion pension fund with no trading expertise:

Norway’s $880 billion sovereign wealth fund, the world’s largest, is throwing its support behind Brad Katsuyama’s new exchange.

Katsuyama’s IEX Group Inc., made famous in Michael Lewis’s best-selling book “Flash Boys,” could shield investors from the predatory habits of high-frequency traders, said the fund, which holds $521.2 billion in stocks globally and is Europe’s biggest equity investor.

“IEX is a trading venue where all players participate on the same terms,” oil fund spokesman Thomas Sevang said in an e-mailed response to questions. “We support this.”

The BoC kept overnight rates steady:

Total CPI inflation has moved up to around the 2 per cent target, sooner than anticipated in the Bank’s April Monetary Policy Report (MPR), largely due to the temporary effects of higher energy prices and exchange rate pass-through. Core inflation remains significantly below 2 per cent although it has drifted up slightly, partly owing to past exchange rate movements.
…
The Canadian economy grew at a modest rate in the first quarter, held back by severe weather and supply constraints. The ingredients for a pickup in exports remain in place, including the lower Canadian dollar and an anticipated strengthening of foreign demand. Improved corporate profits, especially in exchange rate-sensitive sectors, should also support higher business investment in the coming quarters. There are continued signs of a soft landing in the housing market and a constructive evolution of household imbalances. We still expect excess supply to be absorbed gradually as the fundamental drivers of growth and inflation in Canada strengthen.

Weighing recent higher inflation readings against slightly increased risks to economic growth leaves the downside risks to the inflation outlook as important as before. At the same time, the risks associated with household imbalances remain elevated. The Bank judges that the balance of risks remains within the zone for which the current stance of monetary policy is appropriate and therefore has decided to maintain the target for the overnight rate at 1 per cent. The timing and direction of the next change to the policy rate will depend on how new information influences the balance of risks.

There was some chatter about the effect on the dollar:

The loonie had been as high as about 91.7 cents, but began to slip in anticipation of the announcement, to 91.5 cents. In the wake of the statement, it dipped further to 91.3 cents, and by midday stood at 91.4 cents.

Before today, the currency had been hovering around the 92-cent level, having moved up recently.
…
“It could have been expected that downside interest rates moves were taken off the table but this is not the case,” said Rahim Madhavji of Knightsbridge Foreign Exchange.

“The Canadian dollar fell lower on the Bank of Canada continuing to harp a tone of we’re still nowhere close to raising interest rates,” he added in a research note titled “Bank of Canada slaps loonie lower.”

“It seems that the Bank of Canada is quite content with the lower Canadian dollar boosting exports and assisting with inflation. Today’s BoC statement removes any catalyst for loonie bulls in the near term.”

… and some criticism of the dovish language:

“Comes a point the central bank will have to drop the dovish language, although it’s clear that it will try to delay as long as possible,” said Krishen Rangasamy, senior economist the National Bank of Canada.

The bank’s insistence that disinflation remains a threat could prove tough to defend as as the summer and fall wear on, Bank of Nova Scotia economists Derek Holt and Dov Zigler said in a research note. “The Bank of Canada faces a greater sales job to explain why the ‘downside risks to the inflation outlook [are] as important as before,’” they said.

… though mind you, the dollar isn’t helping exports much:

For months, Mr. Poloz and other bank officials have stressed the importance of exports and business investment to putting the economy back on track.

But so far, exports continue to underperform – a reality underscored by Statistics Canada’s report Wednesday that exports dropped 1.8 per cent in April, tilting the trade balance back into deficit.

I think it’s unclear as to where all this hyperinflation and wheelbarrowfulls of cash are going to come from. Not Europe!

Euro zone price inflation fell unexpectedly in May, increasing the risks of deflation in the currency area and sealing the case for the European Central Bank to act this week.

Annual consumer inflation in the 18 countries sharing the euro fell to 0.5 per cent in May from 0.7 per cent in April, the EU’s statistics office Eurostat said on Tuesday.

… not with negative interest rates in Europe, it won’t:

Mario Draghi’s experiment with negative interest rates is unlikely to stop investors from seeking something stronger.

The European Central Bank president will herald a new era today by taking the deposit rate below zero, according to economists in a Bloomberg News survey. That probably won’t quell calls for more radical measures such as quantitative easing to stop the euro area from sliding into deflation.
…
In the Bloomberg survey, 44 of 50 economists said the ECB will cut its deposit rate to negative from zero, with the median estimate for a level of minus 0.1 percent. The survey also predicts that the benchmark main refinancing rate will be reduced by 15 basis points to a record-low 0.1 percent.

The decision will be announced at 1:45 p.m. in Frankfurt. Draghi will hold a press conference 45 minutes later, where he’ll also release revised ECB forecasts on inflation and economic growth.

… which may help a mouthpiece for the UK government carry out his instructions:

Mark Carney has a new ally in his battle to keep Bank of England policy loose: Mario Draghi.

As the BOE’s nine-person Monetary Policy Committee divides between Carney’s view that low rates are still needed and a faction leaning toward higher borrowing costs, events in Frankfurt may favor the governor by weakening the euro against the pound, helping to curb U.K. inflation pressure. The MPC meets in London today and will announce its decision at noon.

It was a mixed day of adjustment for the Canadian preferred share market today, following yesterday’s fireworks, with PerpetualDiscounts down 26bp, FixedResets up 23bp and DeemedRetractibles gaining 4bp. The Performance Highlights table is longer than usual and dominated by winning FixedResets. Volume was on the high side of average.

PerpetualDiscounts now yield 5.30%, equivalent to 6.89% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.35%, so the pre-tax interest-equivalent spread (in this context the “Seniority Spread”) is now about 255bp, a slight (and perhaps spurious) widening from the 250bp reported May 28.