PrefBlog

I’m pleased to see that the fed’s are asking Bombardier questions before cutting the inevitable cheque:

Prime Minister Justin Trudeau will have a hard time saying no to Bombardier Inc.’s request for aid to complete the troubled C Series aircraft because of the company’s deep political and economic roots in Canada.
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Here are six things former officials and analysts say Trudeau is looking at:1. Viability Does the C Series have a bright future?
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2. Efficacy Why hasn’t past aid worked?
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3. Impact Bombardier now has Canada’s top corporate research budget at C$2 billion, more than double that of struggling smartphone-maker BlackBerry Ltd., according to Research Infosource Inc.
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4. Competition Aerospace is supported by state funding elsewhere. Officials briefing Trudeau said it “is often seen as a ‘pay to play’ industry,” and the C Series will compete with aircraft made by Airbus Group SE, Boeing and Embraer SA. Sergio Marchi, a former Liberal trade minister and Canadian ambassador to the World Trade Organization, cited a past dispute with Brazil’s support for Embraer as an example of the risks to Canada of not backing Bombardier. “We need to find creative ways to sustain our global players, because other governments did,” he said in an interview last week.

5. Governance There are concerns with the way the company is run. Bombardier is controlled by its namesake family through shares with extra voting rights, and officials familiar with the government’s plans have said the company’s current governance structure is a barrier to federal aid.
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6. Politics

Trudeau is from Bombardier’s hometown and 40 of his 184 Liberal lawmakers are from Quebec, Canada’s second-most populous province. Spurning Bombardier means the prime minister would have to explain why one of Quebec’s biggest employers can’t have a fraction of the C$9.15 billion bailout offered to Ontario’s General Motors Co. and Chrysler factories in 2009.

The cheque will inevitably come. The last time a Canadian Prime Minister told the Gee-Whiz boys that the Federal Money Fountain was being turned off, the political liability lasted over fifty years.

Dudley was dovish on rates today and nonplussed at premature talk of negative US policy rates:

The U.S. economy has the momentum to help weather stormy global financial markets and policy makers have many other options before they would consider driving borrowing costs below zero if they need to protect growth, Federal Reserve Bank of New York President William Dudley said.

“I just find that an extraordinarily premature conversation to be having,” Dudley said at a press briefing Friday in New York. “There are a lot of things that we would do long before we would really think about moving to negative interest rates.”

Financial markets have been routed in recent weeks by concerns over the global economic outlook. Dudley said the Fed was “definitely aware of what’s going on internationally” and would take that into account when the policy-setting Federal Open Market Committee meets on March 15-16.

In a remark that will probably reinforce views among investors that the Fed will not hike interest rates next month, Dudley said that the outlook for how quickly inflation would rise has been dimmed by recent financial-market developments.

“Inflation is probably going to take a little bit longer to get back to our 2 percent objective, everything equal, than maybe what you thought a few months ago,” he said.

But it’s not stopping the NYT from musing over possible consequences:

So what are some of the weird things that could happen in a world in which negative rates become routine?

The policies in Europe and Japan are still relatively new and involve rates only slightly below zero. But if the policies become long-lasting, or negative rates go much lower, there are a lot of mind-bending ways it could affect routine transactions.

For example, would people start prepaying years’ worth of cable bills to avoid having money tied up in a money-losing bank account? How about property taxes? Would companies and governments put in place new policies prohibiting people from paying their bills too early?

Or consider this: Many commercial transactions now take place with some short-term credit attached — for example, a company that gets a 60-day grace period to pay bills from its suppliers. Would that flip, and suddenly suppliers would prohibit upfront payment and insist that their customers wait 60 days to pay?

Might new businesses sprout up that allow people to securely store thousands of dollars in bundles of $100 bills, or could people buy physical objects as stores of value that the banks can’t charge a negative interest rate on?

“Negative interest rates in Japan is blowing my mind,” said Jose Canseco, the provocative retired baseball player not normally known for his economic musings, on Twitter. And the truth is, he’s not the only one.

And it’s not stopping the bond market worrying!

As worries about European banks’ credit pushed global stocks into a bear market, demand for U.S. debt heated up, driving benchmark 10-year yields toward record lows.

During the Treasuries rally, investors discounted the risk of any surprise jump in interest rates or inflation by the most since January 2015, according to a gauge known as the term premium. The measure of how much extra return investors demand against unexpected developments over the life of the security approached the 45-year low set during last year’s global deflation scare, going by the Federal Reserve Bank of New York’s favored formula.
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By the close of trading Friday, the market-implied chances of a rate cut by the end of 2016 had fallen to about one percent. Traders assign a 30 percent chance of a quarter-point increase by the end of 2016, down from a 93 percent probability seen at the end of last year.

Signs of distress were also evident in the Treasuries yield curve. It has yet to flash the traditional recession signal — short-term yields climbing above long-term yields. But that difference has shriveled. The gap between three-month and 10-year yields, which the Cleveland Fed uses as a growth indicator, narrowed to the smallest since 2012. The spread between two- and 10-year yields shrank to the slimmest since 2007.

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It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 15bp, FixedResets off 72bp and DeemedRetractibles up 36bp. The Performance Highlights table was produced on schedule. Volume was average.

For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

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TRP.PR.E, which resets 2019-10-30 at +235, is bid at 16.55 to be $1.42 rich, while TRP.PR.G, resetting 2020-11-30 at +296, is $0.94 cheap at its bid price of 16.90.

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Most expensive is MFC.PR.N, resetting at +230bp on 2020-3-19, bid at 16.50 to be 0.99 rich, while MFC.PR.G, resetting at +290bp on 2016-12-19, is bid at 16.70 to be 1.05 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 12.32 to be $1.57 cheap. BAM.PF.H, resetting at +417M500bp on 2020-12-31 is bid at 25.04 and appears to be $1.00 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 14.35, looks $0.55 expensive and resets 2019-3-1. FTS.PR.G, with a spread of +213bp and resetting 2018-9-1, is bid at 13.80 and is $0.35 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.53%, with one outlier above 0.50% and one below -1.50%. Note that the range of the y-axis has been changed. There are two junk outliers above 0.50% and three below -1.50%.

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Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?

Assiduous Reader prefobsessed sent me a link to a Barry Critchley piece titled Behind RioCan’s decision to redeem its first-of-its-kind rate reset preferreds. I have updated the post that reported REI.PR.A to be Redeemed.

Meanwhile, Sweden’s gone more deeply negative:

Sweden’s central bank lowered its key interest rate even further below zero and said it’s prepared to use its full toolbox of measures as it battles to revive inflation and keep the krona from appreciating.

The repo rate was reduced to minus 0.50 percent from minus 0.35 percent, the Stockholm-based bank said. A cut was predicted by 10 of the 18 analysts surveyed by Bloomberg, though only three had anticipated this magnitude. The bank said government bond purchases will continue as planned for the first six months of 2016 and that it “will reinvest maturities and coupons from the government bond portfolio until further notice.”

“Uncertainty regarding global developments is still high, with low inflation and several central banks pursuing more expansionary monetary policy,” the Riksbank said. “Swedish monetary policy must relate to this. Otherwise the krona exchange rate is at risk of strengthening at a faster rate than in the forecast, which would make it harder to push up inflation and stabilize it around 2 percent.”

There are fears that this policy will inflate a housing bubble:

HSBC economist James Pomeroy wrote in a recent note:

We’ve long argued that the Swedish economy does not warrant further stimulus, but that the Riksbank would continue to ease given the low inflation rate. The economy is the fastest growing in the developed world (3.9% y-o-y in Q3) and house prices continue to accelerate and are now up 18% y-o-y across the country. Under normal circumstances, one might expect the Riksbank to be hiking rates but – given ultra-loose ECB policy – rates are being kept much lower.

As positive as the story appears for early 2016, there are plenty of reasons to be concerned about the medium term. The pace of acceleration in the housing market points to a bubble.
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… The housing market continues to pose significant risks for the Swedish economy. With prices now up 18% on the year and no sign of macroprudential measures coming into force, we worry that this is not sustainable. Should the housing market roll over at any point in 2016 (or 2017) the impact on the economy would be severe. Estimates from the National Institute of Economic Research suggest that a 20% fall in house prices would lead to a recession-like impact on consumption and unemployment, with a smaller fall still having severe economic consequences.

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And Michael Babad of the Globe supplies another chart:

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The Swedish action has been fingered as one of the triggers for today’s debacle:

The latest culprits picked out of the police lineup: The Swedish central bank’s bigger bet on negative interest rates; Fed chief Janet Yellen’s testimony before largely clueless U.S. legislators; and bearish hedge-fund manager Kyle Bass’s assertion that Chinese banks are facing huge losses that dwarf those of the U.S. financial system in the 2008 crash.

All are fanning fears that another U.S. and global recession looms, that central banks have run out of ammunition to fight it the way they did during the previous financial crisis and that more than a few of the world’s major banks aren’t in good enough shape to withstand the ensuing fallout.

… and what a debacle it was!

Fearful investors have turned to the health of the global banking system as the latest fixation in a market frenzy that continues to escalate.

Bank equities were trounced worldwide on Thursday, leading the way for an all-consuming stock market selloff that spared no major benchmark.

An overwhelming demand for safety dominated investor attitudes, as the ability of central banks to fend off economic threats seems increasingly doubtful.

While crude oil has been at the crux of the recent outburst of market volatility, bank valuations have now begun to reflect a grim assessment of the global economy.
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Withering risk appetite gripped equities on Thursday, as major Asian and European indexes fell by between 2 per cent and 6 per cent, adding to global equity losses in excess of $15-trillion (U.S.) this year.

In North America, the S&P 500 index dipped to a new two-year low before a late afternoon rally pared back the losses to end the day down by 1.2 per cent. The Nasdaq composite index meanwhile flirted with a 20-per-cent decline conventionally signifying bear market territory. That’s where the S&P/TSX composite index already resides, with Thursday’s 100-point drop adding to a total decline of 23 per cent since September, 2014.

Overnight markets, at time of writing, seem to be getting worse:

The global equity bear market deepened in Asian trading, with Japanese stocks headed for their worst week since 2008 amid anxiety over central banks’ ability to revive the world economy. U.S. crude rose from a 12-year low.

The Topix index slumped 4.1 percent in Tokyo as traders returned from holiday, pushing the regional Asian benchmark toward its steepest weekly drop since gyrations in Chinese assets at the start of the year. The index pared some of its losses as the yen weakened for the first time this week. U.S. index futures indicated gains after losses there helped the MSCI All-Country Index cap a 20 percent slide from its May record.

…and in Korea:

Trading in South Korea’s Kosdaq exchange for smaller stocks was temporarily halted after the benchmark gauge plunged more than 8 percent on concern valuations were excessive relative to earnings prospects.

Trading was suspended for 20 minutes at 11:55 a.m. in Seoul after the measure dropped 8.2 percent. The index pared declines to 6.1 percent at the close. Celltrion Inc. was the biggest drag on the small-cap measure after the stock almost tripled in the past 12 months. The Kospi gauge of larger companies closed at its lowest level since August.

The Kosdaq index of more than 1,100 companies jumped 26 percent to outperform the large-cap gauge last year as investors piled into biotech shares and other smaller companies in search of earnings growth as smokestack industries stagnated. Celltrion, which developed an arthritis medicine, trades at 42 times projected 12 month profits, four times the Kospi’s 10.5 times.

And there are, as I always like to point out … unintended consequences:

It seemed like a good idea at the time: Cut interest rates below zero to revive growth.

But as policy makers from Tokyo to Stockholm embrace the notion, investors are close to panic mode. Far from buoying financial markets this year, negative rates have helped to put global stocks on the brink of a bear market, sent the cost of protection against corporate defaults soaring and driven investors to havens such as U.S. Treasury bonds and gold.

Fueling the turmoil is fear that negative rates will slam the world’s banks. In theory, negative rates could be the panacea to cure sluggish global growth: by charging lenders fees for parking money at central banks, policy makers hope banks will use that cash to make loans, jump-starting their economies. In practice, investors worry it may squeeze bank profits and rattle money markets.

“We’re here in an environment where central banks have to learn one message, and that is that negative interest rates are not desirable and they are not workable,” Hans Redeker, head of global foreign-exchange strategy at Morgan Stanley in London, said in a Bloomberg Television interview. “When you cut into negative interest rates you have to think about the profitability of the banking sector.”

About a quarter of the world economy is now in negative-rate territory with more than $7 trillion of government debt offering yields less than zero.

Last October, BIS published a working paper by Claudio Borio, Leonardo Gambacorta and Boris Hofmann titled The influence of monetary policy on bank profitability:

This paper investigates how monetary policy affects bank profitability. We use data for 109 large international banks headquartered in 14 major advanced economies for the period 1995–2012. Overall, we find a positive relationship between the level of short-term rates and the slope of the yield curve (the “interest rate structure”, for short), on the one hand, and bank profitability – return on assets – on the other. This suggests that the positive impact of the interest rate structure on net interest income dominates the negative one on loan loss provisions and on non-interest income. We also find that the effect is stronger when the interest rate level is lower and the slope less steep, ie that non-linearities are present. All this suggests that, over time, unusually low interest rates and an unusually flat term structure erode bank profitability.
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Abstracting from macroeconomic effects, our findings help shed light on the impact of monetary policy on bank profitability after the crisis. Taking our results at face value, we find that the impact, on balance, was positive in the first two years post-crisis (2009–10) but turned negative in the following four years (2011–14). In the first two years, ROA was boosted by an estimated cumulative 0.3 percentage points: the negative effect on bank profitability linked to the decrease in the short-term rate was more than compensated for by the positive one deriving from the increase in the yield curve slope. In contrast, in the following four years, the further decrease in short-term rates and flattening of the yield curve cut ROA by an estimated cumulative 0.6 percentage points. With an average annual ROA of 0.64 over the sample period (1995-2012, Table 1), this means that over 2011–14, the average bank in the sample lost one year of profits as a consequence of low interest rates and compressed yield spreads.

Anybody who finds all this depressing should relax; read a nice book instead:

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It was a horrible day for the Canadian preferred share market, horribler for some sectors than for others, with PerpetualDiscounts off 25bp, FixedResets losing 234bp and DeemedRetractibles down 65bp. Floaters got destroyed. Volume was high.

For those keeping track of Floaters, the all-time low closing bid for BAM.PR.B was 5.90 on 2008-12-19; for BAM.PR.C it was 6.06 on 2008-12-22; and for BAM.PR.K, 6.40 ON 2018-12-18. So we’re still a way off from my positive comments during the Credit Crunch. But some people, I’m sure, are just discovering the answer to the question: Are Floating Prefs Money Market Vehicles?.

For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

Click for Big

TRP.PR.E, which resets 2019-10-30 at +235, is bid at 16.50 to be $1.34 rich, while TRP.PR.G, resetting 2020-11-30 at +296, is $0.80 cheap at its bid price of 17.11.

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Most expensive is MFC.PR.L, resetting at +216bp on 2019-6-19, bid at 15.95 to be 0.70 rich, while MFC.PR.G, resetting at +290bp on 2016-12-19, is bid at 16.80 to be 1.33 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 12.15 to be $1.58 cheap. BAM.PF.E, resetting at +255bp on 2020-3-31 is bid at 15.95 and appears to be $1.00 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 14.80, looks $0.49 expensive and resets 2019-3-1. FTS.PR.G, with a spread of +213bp and resetting 2018-9-1, is bid at 14.25 and is $0.43 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.56%, with two outliers above 0.00%. There are four junk outliers above 0.00% and one below -2.00%.

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Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?

Treasuries continued to climb today:

Treasury 10-year notes gained, pushing yields near a one-year low, as Federal Reserve Chair Janet Yellen stuck to her call for gradual interest-rate increases.

Government bonds are surging this year as turmoil in equity and commodity markets boosts demand for fixed-income assets amid concern that global growth is slowing. Declining inflation expectations have supported longer-dated Treasuries, with the gap between yields on two-year notes and 10-year securities falling to the lowest in more than eight years. An auction of 10-year notes drew the lowest yield since 2012.

Yellen emphasized the Fed’s intent to hike rates; the schedule is up in the air:

In presenting the Fed’s semi-annual economic report to Congress, Yellen said the turbulence had “significantly” tightened financial conditions by pushing down stock prices, pushing up the dollar and raising some borrowing costs.

“These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market,” she told the House Financial Services Committee.

Yellen though made clear that the policy-setting Federal Open Market Committee remains committed to gradually raising rates, after increasing them in December for the first time in nine years.

“I do not expect the FOMC is going to be soon in a situation where it’s necessary to cut rates,” she added.

… and she suggested laws need to be clarified to allow for negative rates:

The Federal Reserve has not yet determined whether it would be able to legally implement negative interest rates in the U.S., Chair Janet Yellen said.

“I would say that remains a question that we still would need to investigate more thoroughly,” Yellen said Wednesday in response to questions from the House Financial Services Committee in Washington. “I am not aware of anything that would prevent us from doing it, but I’m saying we have not fully investigated the legal issues — that still needs to be done.”

A 2010 staff memo posted on the central bank’s website late last month cast doubt on whether the law that authorized the Fed to pay interest on excess reserves, or IOER, also would grant it the authority to charge interest.

DBRS put Algonquin Power & Utilities Corp. on Review-Developing; I have updated the post regarding S&P’s negative outlook.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 16bp, FixedResets off 79bp and DeemedRetractibles up 38bp. The Performance Highlights table highlights very poor performance from the FTS issues, presumably as a result of worries regarding their credit quality. Volume was slightly below average.

PerpetualDiscounts now yield 5.85%, equivalent to 7.60% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.1% (maybe a little more) so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 350bp, a significant increase from the 335bp reported February 3.

For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

Click for Big

TRP.PR.E, which resets 2019-10-30 at +235, is bid at 16.90 to be $1.28 rich, while TRP.PR.G, resetting 2020-11-30 at +296, is $0.87 cheap at its bid price of 17.50.

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Most expensive is MFC.PR.L, resetting at +216bp on 2019-6-19, bid at 16.55 to be 0.69 rich, while MFC.PR.G, resetting at +290bp on 2016-12-19, is bid at 17.56 to be 1.18 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 12.33 to be $1.77 cheap. BAM.PF.F, resetting at +286bp on 2019-9-30 is bid at 18.10 and appears to be $1.16 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 15.21, looks $0.34 expensive and resets 2019-3-1. FTS.PR.G, with a spread of +213bp and resetting 2018-9-1, is bid at 14.65 and is $0.61 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -1.01%, with one outlier below -2.00% and one above 0.00%. Note that the range of the y-axis has changed. There are two junk outliers above 0.00%.

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Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?