PrefBlog

And that’s it for another month!

The Bank of Canada has published a useful analytical note by Rohan Arora, Nadeem Merali, Guillaume Ouellet Leblanc titled Did Canadian Corporate Bond Funds Increase their Exposures to Risks?:

Canadian fixed-income mutual funds have grown rapidly over the past 10 years—15 per cent annually compared with 2.6 per cent for equity funds. These investment vehicles direct a growing share of funds from savers to borrowers and now are a large component of the Canadian shadow banking sector (Young Chang et al. 2016). This note focuses on open-ended mutual funds with large holdings of Canadian corporate bonds, a subset of Canadian fixed-income mutual funds.

Canadian corporate bond mutual funds (CCBFs) are more vulnerable than other funds because of the liquidity mismatch between their assets and liabilities: the funds offer daily redemption to investors yet they invest in relatively less-liquid assets (corporate bonds). This mismatch raises concerns that CCBFs may face large redemption requests during periods of stress (Goldstein, Jiang and Ng 2017). Indeed, in 2017, the Financial Stability Board issued policy recommendations to reduce this vulnerability (FSB 2017).
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In this note, we show that CCBFs have more than doubled in number and size since 2007. We also find that CCBFs have increased their exposure to interest rate risk, credit risk and liquidity risk. These results suggest an increase in the likelihood of large investor redemptions with higher potential impact on Canadian fixed-income markets.

At the same time, CCBFs still hold, on average, enough cash and liquid assets to meet redemption requests equivalent to the worst outflows observed since 2007. Overall, we assess that the vulnerability of CCBFs for the Canadian financial system appears to be rising—which warrants close monitoring—but remains low.

Arora (forthcoming) analyzes how Canadian mutual fund performance influences redemptions by investors, while Arora and Ouellet Leblanc (forthcoming) document how CCBFs meet redemption requests. Together, these papers lay the foundation to build stress tests quantifying the likelihood and potential impact of CCBFs’ asset sales on the financial system.

PerpetualDiscounts now yield 5.46%, equivalent to 7.10% interest at the standard equivalency factor of 1.3x. Long corporates now yield a little over 3.85%, so the pre-tax interest-equivalent spread is now about 325bp, a slight (and perhaps spurious) widening from the 320bp reported March 21.

Which way is the wind blowing? It looks like the world’s about to end again:

A selloff in technology shares sent U.S. equity benchmarks lower, with losses accelerating late in the day. Bonds surged on demand for safe havens, pushing the yield on 10-year Treasuries below a key level.

Trade angst weighed on leading tech companies with the Nasdaq 100 Index erasing most of Monday’s gain after a report the Trump administration is considering a crackdown on Chinese investments in technologies the U.S. considers sensitive. Facebook’s woes mounted and Nvidia Corp. spooked investors in chipmakers. The Chicago Board Options Exchange Volatility Index — Wall Street’s fear gauge — spiked.

The equity selling bled into the Treasury market, sending the 10-year yield below 2.8 percent as investors sought havens.
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•The S&P 500 slumped 1.7 percent as of the close of trading in New York.
•The Nasdaq 100 Index fell 3.3 percent, while the Dow Jones Industrial Average slipped 1.4 percent.

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•The yield on 10-year Treasuries declined eight basis points to 2.77 percent.

I hadn’t realized that some US public employee pension funds were so grossly underfunded:

The state hasn’t done a particularly good job running public pensions. According to S&P Global Ratings, New Jersey’s pension funding ratio is the worst in the nation, having saved enough to cover about 31 percent of the benefits that have been promised. The police and fire system is relatively strong by comparison, with about 65 cents for every dollar it’s on the hook for down the road, according to NJ.com.
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States and municipalities from coast to coast are now living with the consequences of the 1990s tech boom, which brought public pension funding levels to 100 percent and allowed politicians to sweeten the pot for union members.

The subsequent bust — and the Great Recession a few years after that — took its toll on the funds backing those promised benefits. The aggregate state and local government pension funding ratio is now 73 percent, up from 67 percent at year-end 2016, according to Patrick Luby of CreditSights, who cites Federal Reserve data.

Some people think the world might not end after all:

U.S. equities surged back from the biggest weekly rout in two years, with major benchmarks climbing more than 2.7 percent on signs that an escalation of trade tensions was beginning to ease.
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The optimism toward U.S. stocks emerged after the limits of the Trump administration’s willingness to embrace protectionism came into view over the weekend. Treasury Secretary Steven Mnuchin told Fox News that he’s “cautiously hopeful” that China will reach a deal to avoid tariffs on $50 billion of U.S. exports, while European leaders demanded a permanent exclusion at the threat of retaliation and a deal was struck with South Korea.
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The yield on 10-year Treasuries climbed four basis points to 2.85 percent.

How about that Canadian inflation, eh?:

Canadian inflation picked up more than analysts expected in February to the fastest in more than three years as signs point to price pressures continuing to build.

Consumer prices accelerated to an annual pace of 2.2 percent in February, the most since 2014, from 1.7 percent a month earlier. Economists had anticipated a 1.9 percent increase. Core prices — which exclude more volatile items like energy and are considered a gauge of inflation pressures — inched higher for a fifth month to 2.03 percent, which is the fastest since 2012.

The budding inflation could add pressure on the Bank of Canada — which has kept the expansion going with low interest rates — to keep hiking borrowing costs to more normal levels.

All this is happening during renewed NAFTA huffing and puffing:

U.S. President Donald Trump has put new pressure on Nafta negotiations with an order saying he’ll impose steel and aluminum tariffs on Canada and Mexico on May 1 if he’s not satisfied with talks.

Trump’s presidential proclamation Thursday sets tariffs for some countries as of Friday while excluding others such as Canada and Mexico. The document specifies for the first time when those exclusions will run out, adding to pressure for a deal to be reached on the North American Free Trade Agreement around the same time.

A White House statement said Trump will decide by May 1 “whether to continue to exempt these countries from tariffs, based on the status of discussions.” Mexico has said it needs a deal by the end of April, or that talks might as well stretch past the country’s summer election, and then U.S. midterm elections this fall.

All this Trumpism is having an effect:

Spring has sprung — just not in U.S. stocks, where a harrowing week has walloped traders with echoes of February’s correction.

In the past five years, there have been only two other stretches with losses of this magnitude. The S&P 500 Index is down 6 percent. And the picture looks just as bad for the Dow Jones Industrial Average, which sank to a four-month low by the Friday close. Both indexes suffered their steepest weekly drop in more than two years.

Equities are now teetering near — and for blue chips, below — levels seen at the worst point in February’s volatility-fueled meltdown. At the epicenter this time is U.S. President Donald Trump, with his China tariffs driving Boeing Co. down more than 5 percent in a single session on Thursday and losses rippling across industries from technology to banks.