PrefBlog

TXPR closed at 524.69, up 0.53% on the day. Volume today was 1.02-million, fifth-highest of the past 21 trading days. This didn’t help the month much: the TXPR price index (reported here) is down 4.09% from April 28. The total return index (used for benchmarking) will be somewhat better, but not enough to make May anything other than a bad month.

CPD closed at 10.42, up 0.29% on the day. Volume was 50,340, fifth-highest of the past 21 trading days.

ZPR closed at 8.57, up 0.47% on the day. Volume was 594,180, second-highest of the past 21 trading days and miles ahead of #3.

Five-year Canada yields down to 3.47% today.

So the big news today was economic growth:

The Canadian economy grew at an annualized rate of 3.1 per cent in the first quarter of 2023, Statistics Canada reported Wednesday.

The latest data shows growth beat out the federal agency’s own forecast of 2.5 per cent for the quarter. A preliminary estimate suggests the economy grew by 0.2 per cent in April, after remaining flat in March.
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The federal agency says growth in exports and household spending helped spur growth in the first quarter.

Meanwhile, slower inventory accumulations as well as declines in household investment and business investment in machinery and equipment weighed on growth.

The Canadian economy has managed to continue outperforming expectations, despite the Bank of Canada hoping high interest rates would cause a more profound pullback by consumers and businesses.

The household spending figures show spending up on both goods and services in the first three months of the year, after minimal growth in the previous two quarters.

However, the report notes disposable income fell for the first time since the fourth quarter of 2021. The federal agency says disposable income declined by one per cent, largely due to the expiration of government measures aimed at helping people cope with inflation.

This had an immediate effect on rate forecasts:
Pre-announcement

Post-announcement

Oddly, the GOC-5 was down today to 3.47%, despite yield increases in T-bills out to six months.

And the US job market seems to be holding up:

After three consecutive months of declines, job openings jumped in April, reaching 10.1 million, the Labor Department reported on Wednesday.

The surge signals that job opportunities are withstanding the economic pressures that have led many to believe that the American economy may soon enter a recession.

At the same time, the report — known as JOLTS, or the Job Openings and Labor Turnover Survey — showed that the labor market was far less feverish than it was a year earlier.

The quits rate — viewed as an indicator of how confident workers are in leaving a job and finding employment elsewhere — was 3 percent, seasonally adjusted, in April 2022. Since then, it has retreated to 2.4 percent, just above its prepandemic peak. And the hiring rate was unchanged from March, which was the lowest since December 2020.

Layoffs, however, decreased again, showing that employers are hesitant to let go of employees brought on board during this recovery.

While at the same time:

The House of Representatives is expected to vote in the evening on a bill to lift the $31.4 trillion debt limit, a critical step to avoid a destabilizing default that could come early next week without congressional approval.

House passage would send the bill to the Senate, where debate could stretch to the weekend, just before the June 5 date when the government could start to run out of money.
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Fed Governor and vice chair nominee Philip Jefferson said skipping a rate hike in two weeks would provide policymakers time to see more data before making a decision. Philadelphia Fed President Patrick Harker also said on Wednesday that for now he is inclined to support a “skip” in rate hikes.

Market timing? You can have it!

Great-West has swallowed the medicine on Putnam:

Canadian insurer Great-West Lifeco Inc. GWO-T -0.62%decrease
is offloading U.S. wealth manager Putnam Investments to investment giant Franklin Templeton in a deal valued at US$1.8-billion, a fraction of what the insurer initially paid for the operation.

The two asset managers announced Wednesday that Franklin Templeton will initially pay Great-West Life US$950-million to US$1-billion in a combination of cash and stock. Franklin Templeton will issue 33.33 million shares to Great-West at closing and $100-million in cash six months after closing.

Great-West’s shares will represent a 6.2-per-cent ownership stake in parent Franklin Resources Inc., and it has agreed to hold at least 4.9 per cent of Franklin Resources for at least five years.
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Great-West Lifeco purchased Putnam for US$3.9-billion in 2007 to expand its U.S presence. The deal also included a US$900-million deferred tax benefit. In 2007, Putnam managed about US$192-billion in assets but struggled with performance and investor redemption in the years following the financial crisis. Now, the company manages about US$170-billion in assets. That includes about $33-billion of assets in Putnam subsidiary PanAgora, a quantitative asset manager that Great-West Lifeco will keep its controlling interest in.

It’s springtime, and in spring a young man’s fancy lightly turns to thoughts of fraud:

A panel of the Ontario Securities Commission has ordered the principals of Paramount Equity Financial Corp., which sold pooled mortgage products until it was shut down in 2017, to pay $47.2-million, after they were found to have defrauded investors.

But one of the defendants, the company’s chief executive, has gone missing, and another defendant is collecting employment insurance, raising questions as to how much of the judgment will be paid.

Paramount and several affiliate companies, which were placed under the control of a receiver at the request of the OSC in 2017, promoted themselves as a vehicle for investing in second mortgages on residential homes. They raised about $78-million from 500 investors for their two funds.

About $50-million was instead directed to higher-risk mortgages for undeveloped land, or the redevelopment of existing buildings. The OSC panel, called the Capital Markets Tribunal, also found in April, 2022, that the principals of Paramount – CEO Marc Ruttenberg, senior vice-president Brad Burdon and director of sales Matthew Laverty – had undisclosed, indirect ownership interests in these riskier development projects.
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The OSC said it was unable to locate Mr. Ruttenberg when it started its enforcement proceeding, and that the most up-to-date address it had for him is a post-office box in a Toronto UPS store. In its order, the panel said Mr. Ruttenberg did not appear, provide evidence, make submissions or participate in any other way in the proceeding.

… and …

An Ontario builder of so-called “tiny homes” has been charged with fraud and police say 11 victims have now come forward, with more than $800,000 of deposit money unaccounted for.
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Halton Police Regional Services said on May 3 that Philip Bradley, 58, was arrested and charged with nine counts of fraud over $5,000. He has since been released on bail and is expected back in court on June 19. Since his arrest, more victims have come forward according to Det. Constable Kevin Harvey of the Halton Regional fraud unit.

I mentioned CI Financial on May 11 with an update on May 15. Now, DBRS has weighed in:

DBRS Limited (DBRS Morningstar) changed the trend to Negative from Stable and confirmed the ratings of CI Financial Corp. (CI or the Company) and its principal subsidiary, CI Investments Inc. (CII), including CI’s Senior Unsecured Debentures rating and CII’s Issuer Rating, at BBB.

KEY RATING CONSIDERATIONS
The change in the trend to Negative reflects the deterioration in CI’s credit fundamentals, including weaker earnings, still very high leverage, even with paying down some debt recently, and a lower fixed charge coverage ratio. DBRS Morningstar had previously anticipated that CI would have completed the initial public offering (IPO) of its U.S. wealth management business (CI US) to deleverage, but this was postponed due to market conditions with CI instead agreeing to a pre-IPO investment with a group of global institutional investors (Investors).

While the proceeds of the recently closed $1.34 billion pre- IPO investment will help lower debt levels by approximately $1 billion in Q2 2023, and decrease the extraordinarily high debt-to-EBITDA ratio of 7.3 times (x) (as of Q1 2023, per DBRS Morningstar calculations), CI’s leverage will continue to be elevated and its fixed charge ratio low because the Company redeemed mostly its lower-cost debt. In order to retain a majority interest in CI US, the Company will have to grow at a pace that is comparable to the past two years, which would be much more challenging under the current market conditions, and may lead to additional borrowing. Furthermore, the terms of the investment deal stipulate a 14.5% compounding annual return for the Investors that will be materialized at the time of the IPO, within the next six years. The uncertainty with respect to CI’s ultimate ownership in CI US may therefore remain high for some time. As such, DBRS Morningstar does not expect a significant and sustained reduction in debt over the medium term as would have been expected with an IPO.

DBRS is also hosting a webinar that some may find of interest:

Join DBRS Morningstar on Wednesday, June 7, at 10:30 a.m. EDT for a Frontline Perspectives webinar, “The Future of LRCN Issuances in Canada.” Since mid-2020, Canadian insurers and banks have been issuing deeply subordinated capital instruments targeted to institutional investors, which are known as Limited Recourse Capital Notes and Non-Viability Contingent Capital Additional Tier 1 (AT1) Limited Recourse Capital Notes (together, LRCNs). Recent global market developments, including the banking failures in the U.S. and the wipe out of Credit Suisse’s AT1 notes, have adversely affected the market for new issuances.

In this Frontline Perspectives webinar, Nadja Dreff, Senior Vice President, Head of Canadian Insurance, will be joined by Kris Somers, Managing Director, BMO Capital Markets. They will review and discuss the recent LRCN market developments and provide an outlook for LRCN issuances in Canada.

WEBINAR DETAILS:
Date: June 7, 2023
Time: 10:30 a.m. EDT

The New York Fed has updated its Corporate Bond Market Distress Index:

Corporate bond market functioning remained close to historical norms over the month of May, with the end-of-month market-level CMDI above its historical median.

Market functioning in both the high-yield and investment-grade sectors remained roughly flat over the course of the month.

Snippets from the Credit Crunch are still coming out – most recently price-fixing in the UK bond market:

Traders at five major banks colluded in chatrooms to swap sensitive information on UK bonds in the wake of the 2008 financial crisis, Britain’s antitrust agency said in a move that could pave the way for fines for some of the lenders involved.

Citigroup Inc., Deutsche Bank AG, HSBC Holdings Plc, Morgan Stanley and Royal Bank of Canada each unlawfully shared details on pricing and trading strategies in chatrooms between 2009 and 2013, the Competition and Markets Authority said on Wednesday in its provisional findings.
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Antitrust watchdogs across Europe have taken a closer look at bond market collusion in a series of probes targeting some of the biggest banks in the region. The European Commission issued a formal complaint to Deutsche Bank last year for its alleged role in a cartel linked to euro-denominated bonds.

That was the third EU investigation involving cartels affecting the market for bonds trading and comes after the EU spent more than a decade probing how bank traders swapped information in chatrooms.

The UK watchdog has been investigating the allegations since it first opened the probe in November 2018, but has publicly revealed little details about what area of financial services or banks were involved. A separate CMA cartel probe saw 10 construction firms fined £60 million ($74.5 million).

PerpetualDiscounts now yield 6.59%, equivalent to 8.57% interest at the standard equivalency factor of 1.3x. Long corporates yielded 5.23% on 2023-5-26 and since then the closing price has changed from 14.82 to 15.05, an increase of 155bp in price, with a Duration of 12.21 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies a decrease in yield of about 13bp since 5/26 to 5.10%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has widened dramatically to about 345bp from the 320bp reported May 24.

The New York Fed has released a Staff Report by Natalia Emanuel and Emma Harrington titled Working Remotely? Selection, Treatment, and the Market for Remote Work:

How does remote work affect productivity and how productive are workers who choose remote jobs? We estimate both effects in a U.S. Fortune 500 firm’s call centers that employed both remote and on-site workers in the same jobs. Prior to COVID-19, remote workers answered 12 percent fewer calls per hour than on-site workers. When the call centers closed due to COVID-19, the productivity of formerly on-site workers declined by 4 percent relative to already-remote workers, indicating that a third of the initial gap was due to a negative treatment effect of remote work. Yet an 8 percent productivity gap persisted, indicating that the majority of the productivity gap was due to negative worker selection into remote work. Difference-in-differences designs also indicate that remote work degraded call quality— particularly for inexperienced workers—and reduced workers’ promotion rates. In a model of the market provision of remote work, we find that firms were in a prisoner’s dilemma: all firms would have gained from offering comparable remote and on-site jobs, but any individual firm was loathe to attract less productive workers.
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Adverse selection consequently offers an important missing piece to the puzzle of remote work’s rarity prior to Covid-19. Our estimates suggest that adverse selection distorts the decisions of 22 percent of call-center workers who do not choose to be remote because they do not want to pool with less productive types. There is promise that the pandemic could nudge the market into a more efficient equilbrium. Yet distortions will likely persist unless career opportunities can be equalized. Indeed, pre-pandemic remote workers were half as likely to be promoted as on-site workers, consistent with Bloom et al. (2015)’s RCT evidence

John C. Williams, President and Chief Executive Officer of the New York Fed, gave a speech titled This Is the Way:

Nationally, we are also seeing improvements on the supply side of the labor market. As you’ll recall, when businesses reopened after the 2020 pandemic shutdowns, many faced a dire shortage of workers.

Since then, we have seen a rebound in labor force participation, with the 25-to 54-year-old age group slightly above pre-pandemic levels. Although overall participation is below where it was before Covid, economists at the New York Fed have found that this shortfall is more than fully accounted for by the aging—or what I prefer to call “maturing”—of the workforce.2

This increase in labor force participation has helped alleviate some of the imbalance in the labor market. But with baby boomers increasingly reaching retirement age, population aging will continue to put downward pressure on participation in the medium term. Increases in the labor force from immigration, which has picked up from its pandemic lows, can partially offset this, but it is unlikely to fully undo the impact.
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At the same time, the March price data indicate some moderation in overall rent inflation. And rents for new leases have been showing slower rates of increases, which should bring down shelter inflation in coming months. This is important because shelter inflation had been a significant driver of higher inflation over the past year.

But the most persistent area of inflation is in core services excluding housing, which has been running around 4-1/2 percent since last August . This is driven by a continued imbalance in overall supply and demand, and it will take the longest to bring down.
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Because of the lag between policy actions and their effects, it will take time for the FOMC’s actions to restore balance to the economy and return inflation to our 2 percent target. I expect inflation to decline to around 3-1/4 percent this year, before returning to our longer-run goal of 2 percent over the next two years.

As tighter monetary policy continues to take effect, I expect real GDP to grow modestly this year, with growth then picking up somewhat next year.

And I anticipate slow growth will continue to cool the labor market, with unemployment gradually rising to about 4 to 4-1/2 percent over the next year.

François Villeroy de Galhau, Governor of the Bank of France, gave a speech titled Monetary policy transmission:

Overall, evidence shows a quick and smooth pass-through of ECB decisions to broad financing conditions, which is the first step of monetary policy transmission. The growth rate of bank loans to households and firms has slowed due to a combination of higher borrowing rates, lower demand, and – for firms – tighter credit standards. Volumes of loans are decelerating, even though growth in outstanding amounts remains positive [+3.3% in the euro area for mortgages to households and +5.2% for loans to businesses]. By the way, the growth of loans in France remains significantly higher than in the euro area average.

The second step of monetary policy transmission goes from the overall financing conditions to the economy and to inflation. In the textbook theory, tighter financial conditions moderate aggregate demand, and then decrease inflation with some lags. The estimated transmission lags of monetary policy in the literature vary from one year1 to more than two years2. At the current juncture several factors may bring us closer to the upper range:

The current tightening cycle started from exceptionally low levels of real interest rates. It is only from the end of 2022 that we achieved positive real rates at all maturities – but we are now clearly in restrictive territory.
the proportion of fixed-rate long-term loans is particularly high by historical standards. This is welcome for financial stability, especially for mortgages. But as a result, the pass-through of higher policy rates is more gradual.
The origin and sectorial composition of inflation matters. The current surge in inflation does not primarily originate in overheated demand but in supply shocks. This has implication for the transmission lags.
(i) The rise in the price of commodities and input costs was at the root of inflation. Their pass-through to producer prices and subsequently to CPI inflation might be asymmetric, faster and more complete on the way up than on the way down. It implies that the current decline in energy and input costs may not fully translate yet into lower inflation.

(ii) Services inflation, in part fuelled by wage developments, has gradually but steadily surged over recent quarters, and is likely to become the dominant source of inflation in the euro area. Historically, services are the most persistent and important component of both headline and core inflation, and their share in consumption increased significantly in the last decades. They are less directly sensitive to interest rates; the dampening effect of monetary policy on aggregate demand will be felt, but it will take more time.
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Monetary policy is at work and rest assured, we’ll do the job: we’ll bring inflation back towards 2%. We’ll do it with the necessary patience – looking at the 2025 horizon for full transmission, with persistence – maintaining restrictive interest rates for long enough, and pragmatism – monitoring actual economic data. But once more, monetary policy cannot be the only game in town. Fiscal policies should adjust and consolidate, first and foremost scrapping energy subsidies as the European Commission rightly advocated yesterday ; wage negotiations and mark-up decisions by firms should incorporate the expected decrease in inflation; and still more, structural reforms are needed more than ever to increase the supply-side capacity and flexibility in Europe and in France.3 And this is where Capital Markets Union would greatly help to finance investment and innovation, and hence reduce inflation. Let us acknowledge it: if we are lagging behind today in Europe, it’s in this domain of supply transformations, and not in monetary policy.

And Christopher J Waller, Member of the Board of Governors of the Federal Reserve System, gave a speech titled Hike, skip, or pause?:

Let me turn to the implications for monetary policy. There is a lot of discussion about the next step for policy. There are three options: hike, skip, or pause. Let me outline reasons why each of these options may be appropriate.

One might lean toward hiking by focusing on the economic data and interpreting it to suggest that inflation and economic activity are not consistent with significant and ongoing progress toward the FOMC’s 2 percent inflation goal. Based solely on the data we have in hand as of today, we are not making much progress on inflation. If one doesn’t believe the incoming data will be much better, one could advocate for another 25-basis-point hike as the appropriate action in June.

Alternatively, one might view the current and incoming data as supporting a hike in June but believe that caution is warranted because there is a high level of uncertainty about how credit conditions are evolving. Another hike combined with an abrupt and unexpected tightening of credit conditions may push the economy down in a rapid and undesirable manner. This possibility is the downside risk of an additional rate hike in the current environment. If one is sufficiently worried about this downside risk, then prudent risk management would suggest skipping a hike at the June meeting but leaning toward hiking in July based on the incoming inflation data. There is a little over a month between the June and July FOMC meetings, and during that time we will learn more about how credit conditions are evolving. Over four months will have passed between the Silicon Valley Bank failure and the July meeting. By then we will have a much clearer idea about credit conditions. If banking conditions do not appear to have tightened excessively, then hiking in July could well be the appropriate policy.

Lastly, one might want to pause hikes at the June meeting, meaning that the target range is at its terminal rate, if the current stance of policy is thought to be enough to bring inflation down over time. Between policy lags and possible tightening credit conditions, the current stance of monetary policy may be seen, at that point, as sufficiently restrictive to move us toward the dual mandate. From this viewpoint, the policy rate is high enough and we simply need to hold it there to bring inflation down toward our 2 percent target.

I do not expect the data coming in over the next couple of months will make it clear that we have reached the terminal rate. And I do not support stopping rate hikes unless we get clear evidence that inflation is moving down towards our 2 percent objective. But whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks. We will get additional labor market data, with some information about wages, and additional inflation numbers in the next few weeks that will continue to shape my view on where we stand relative to the FOMC’s dual mandate. During this time, I’ll also be reviewing data on credit conditions to evaluate how much potential tightening is coming from the banking sector.

TXPR closed at 521.45, up 0.51% on the day. Volume today was 816,230, below the median of the past 21 trading days.

CPD closed at 10.43, up 0.68% on the day. Volume was 18,110, second-lowest of the past 21 trading days.

ZPR closed at 8.56, up 0.12% on the day. Volume was 133,860, near the median of the past 21 trading days.

Five-year Canada yields up to 3.62% today.

I went to a book signing by Jo Nesbo tonight. There were over 200 people there! Impressive!

Nervousness regarding a possible US default continues to run high:

Treasury securities are used widely as collateral across markets. A key question for market participants is how would bonds that are maturing next month be treated if a deal is not reached in time and the Treasury is unable to pay principal and interest on debt.

One such area is the $4 trillion repurchase, or repo, market, for short-term funding used by banks, money market funds and others to borrow and lend. Some counterparties, including banks, were shying away from Treasury bills maturing in June in bilateral repos, where the trade is between two parties, said an executive at a U.S. fund manager who decline to be named. There are 14 T-bills maturing in June.

Scott Skyrm, executive vice president for fixed income and repo at broker-dealer Curvature Securities, said some repo buyers or cash lenders did not want to accept any bills maturing within a year. Skyrm said stress began to appear in the market at the start of May, with some lenders refusing to accept Treasury bills that they perceived as at risk of delayed payments in some types of trades. He declined to name buyers who were not accepting T-bills.
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In the case that it needs to delay payments on some securities that are maturing, expert groups have suggested in the past that Treasury could help markets to keep functioning by extending the so-called “operational maturity date.” The proposal, detailed in a December 2021 contingency planning document prepared by an expert group, calls for extending the maturities of securities at risk of default by one day at a time.

That could allow the security to be technically traded and available for settlement on the Fedwire Securities Service system used for government debt. However, the group warned that it would need many broker-dealers to adjust their trading systems to also be able to do so and the consequences of a delay in payments on securities would still be severe.

The broker-dealer executive said the process was cumbersome because maturity dates subsumed several other calculations about the value of the security. Extending the maturities required the firm to “basically break their own system,” the executive said.

The X-Date is now June 5:

Treasury Secretary Janet L. Yellen said on Friday that the United States will run out of money to pay its bills on time by June 5, moving the goal posts back slightly while maintaining the urgency for congressional leaders to reach a deal to raise or suspend the debt limit.

The letter provided the most precise date yet for when the United States is expected to run out of cash. Ms. Yellen had previously said the United States could hit the so-called X-date — the moment when it does not have enough money to pay all of its bills on time — as soon as June 1.

While the letter to lawmakers provides a tiny bit of wiggle room, it also makes clear the dire financial situation that Treasury is facing. The federal government is required to make more than $130 billion in scheduled payments during the first two days of June — including money to veterans and Social Security and Medicare recipients.

And PCE inflation ticked higher:

The Personal Consumption Expenditures index climbed 4.4 percent in April from a year earlier. That was a slight increase from March, when prices climbed 4.2 percent on an annual basis. Still, prices are not climbing as fast they were in February, when the index rose 5.1 percent on an annual basis.

A “core” measure that tries to gauge underlying inflation trends by stripping out volatile food and energy prices rose 4.7 percent in the year through April, up slightly from 4.6 percent in March.
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Although Fed officials have noted that inflation has eased in recent months, they have called it “unacceptably high” and far from the central bank’s 2 percent goal.

They have also acknowledged some cooling in the labor market, as the number of job openings has fallen recently. But Fed officials have said labor market conditions are still too hot, pointing to solid monthly job gains, steady wage growth and an unemployment rate near historically low levels.

And the IMF has weighed in with a hawkish ‘concluding statement’:

The strength in demand and in labor market outcomes is a double-edged sword, contributing to more persistent inflation. Goods inflation has leveled out and shelter price growth is expected to start moderating in the coming months. However, past nominal wage increases are now feeding into non-shelter services. While core and headline PCE inflation are expected to continue falling during 2023, they will remain materially above the Fed’s 2 percent target throughout 2023 and 2024.

Achieving a sustained disinflation will necessitate a loosening of labor market conditions that, so far, has not been evident in the data. To bring inflation firmly back to target will require an extended period of tight monetary policy, with the federal funds rate remaining at 5¼–5½ percent until late in 2024. Model estimates suggest such a path would be sufficient to slow demand, restore balance to the labor market, and lower wage and price inflation. However, insofar as models are calibrated on past experiences, they offer only an imperfect guide to the current conjuncture.
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The resilience of the economy and the robustness of labor markets are good news. However, it is possible that the large and rapid increase in interest rates that has already been put in place may not be sufficient to expeditiously bring inflation back to target. With a large share of household and corporate debt contracted at relatively long duration and fixed rates, household consumption and corporate investment have proven less interest-sensitive than in past tightening cycles. This creates a material risk that the Federal Reserve will have to raise the policy rate by significantly more than is currently expected to return inflation to 2 percent. On the positive side, near-term growth outcomes could be better than currently anticipated. However, this would only mean that the economy would slow more abruptly at a later stage (possibly in 2024), creating a recession as tighter monetary policy takes hold. The combination of higher U.S. interest rates, a stronger dollar, and a sharper slowdown in U.S. activity would have significant negative macro-financial spillovers to the rest of the world.

The downside risks associated with a less effective monetary transmission, and a more protracted disinflation, could be further complicated by two additional considerations:

First, a higher path for interest rates could reveal larger, more systemic balance sheet problems in banks, nonbanks, or corporates than we have seen to-date. Unrealized losses from holdings of long duration securities would increase in both banks and nonbanks and the cost of new financing for both households and corporates could become unmanageable. Such a tightening of financial conditions could trigger an increase in bankruptcies, worsen credit quality, and heighten stress for those entities carrying high levels of leverage and with large near-term gross financing needs. These financial stability problems could be further exacerbated if the functioning of the Treasury market also becomes compromised. The longer that higher interest rates persist, the greater the likelihood that such fractures will be revealed. Recent failures of large, non-internationally active banks—which have, so far, only had a modest effect on credit conditions—could potentially be a prelude to more serious and ingrained systemic financial stability problems.

Second, brinkmanship over the federal debt ceiling could create a further, entirely avoidable systemic risk to both the U.S. and the global economy at a time when there are already visible strains. To avoid exacerbating downside risks, the debt ceiling should be immediately raised or suspended by Congress, allowing negotiations over the FY2024 budget to begin in earnest. Furthermore, a more permanent solution to this recurring stand-off should be found through institutional changes that ensure that, once appropriations are approved, the corresponding space on the debt ceiling is automatically provided to finance that spending.

Credit losses, whether real or projected, have been in the news lately – and BIS has released a Working Paper by Li Lian Ong, Christian Schmieder and Min Wei titled Insights into Credit Loss Rates: A Global Database:

Focus
Credit risk was a key factor in the Great Financial Crisis and numerous other crises. Banks’ overall credit losses tend to increase suddenly during a crisis from the typically low levels seen during “normal” times. The Covid-19 pandemic underscored the need for accurate credit risk assessments of bank balance sheets. In this paper, we present alternative micro- and macroprudential concepts and metrics to establish actual credit loss rates as well as forward-looking market- and macro-implied credit loss rate estimates for most jurisdictions worldwide. We also provide a public dashboard featuring 10 downloadable economy-level credit loss rate metrics, which will be updated regularly.

Contribution
This project aims to help close the long-standing data gap issue on economy-level credit loss information by providing a valuable public resource for researchers, policymakers and practitioners. Building upon previous work by Daniel Hardy and Christian Schmieder, we combine time series of actual credit losses with forward-looking market- and macro-implied credit loss estimates. We provide various credit loss rate series for as many jurisdictions worldwide as possible, which will be updated as new information becomes available. The estimates are available in a dashboard, and users can easily download the data sets of credit loss metrics for the desired jurisdictions and time periods. Additionally, we provide a tool for users to run simplified scenario analyses based on projected GDP growth paths.

Findings
The paper presents various metrics of credit loss rates derived from multiple sources, each with its own unique purpose and usefulness. While granular information, such as sector-level statistics, would be ideal for precise loss estimation, such data remain scarce. The economy-specific time series estimated in the paper can be valuable for credit loss analyses and projections, but future work on calibrations may be necessary. Given the challenges associated with anticipating peaks in credit loss rates, one option presented in this paper is to use GDP-implied loss rate simulations, akin to those typically applied in stress tests.

Abstract
Credit risk has played a significant role in many financial crises, including the great financial crisis. The COVID-19 pandemic also highlighted bank credit losses to the private sector. However, there remains a significant gap in terms of reliable economy-level credit risk data for financial stability analysis, given that such information is not readily available to the public in any systematic manner. Building upon the work of Hardy and Schmieder (2020), we derive time series of actual as well as forward-looking market- and macro-implied credit loss rates for the majority of jurisdictions around the world. Our database, intended as a public good, is available through a user-friendly interactive dashboard, which allows downloads of credit loss rate time series for the desired jurisdiction(s). Users are also able to run simple scenario analyses based on their projected GDP paths. The data series will be updated on an ongoing basis as new information is published by the original sources.
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The possible uses of the estimated data series are illustrated with a variety of examples, covering the majority of jurisdictions worldwide (https://www.amro-asia.org/credit-lossrates/).

TXPR closed at 521.30, down 1.11% on the day after setting a new 52-week low. Volume today was 1.34-million, highest of the past 21 trading days.

CPD closed at 10.34, down 1.24% on the day after setting a new 52-week low. Volume was 38,640, below the median of the past 21 trading days.

ZPR closed at 8.55, down 1.16% on the day after setting a new 52-week low. Volume was 98,600, fifth-lowest of the past 21 trading days.

Five-year Canada yields up to 3.55% today.

It’s hard to tell what’s going on here – perhaps the market has entered a self-reinforcing declining phase that will only stop when some institutional money is put on the table? All I can really say is … it’s time to take off your hat and fill it with preferred shares! ‘Be fearful when others are greedy …’

The Boston Fed has released a ‘Current Policy Perspective’ By Falk Bräuning and Viacheslav Sheremirov titled The Historical Effects of Banking Distress on Economic Activity:

The failures of several U.S. regional banks have stimulated discussions about the macroeconomic effects of a likely credit contraction triggered by the recent banking turmoil. Drawing on historical evidence from advanced economies, this study documents a sizable and persistent decline in output and rise in unemployment following non-systemic financial distress. The effects of a systemic banking crisis are two to four times as large. High corporate leverage exacerbates banking turmoil, whereas high bank capitalization and a relatively large share of market financing in corporate debt mitigate it. These channels approximately offset one another so that the estimates tailored to the current U.S. economy are in line with the average effect.
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The non-systemic financial distress episodes are distributed more evenly than the systemic crises. Such episodes include those that occurred in the United Kingdom in the mid-1970s, mid-1980s, and early 1990s; in Germany in the late 1970s; in Canada in the mid-1980s; in the United States in the late 1980s (the savings and loan crisis); in Australia and Italy in the early 1990s; in France in the mid-1990s; and others. For six countries, the Global Financial Crisis was also an episode of non-systemic distress. Thus, history provides substantial variation in the geography, time, and severity of financial distress to identify its impact on the economy
…
In lieu of concluding remarks, this study performs back-of-the-envelope calculations of the effect of non-systemic financial distress, similar in size to the typical episode in the sample, on domestic output. These calculations combine the latest observations of debt over GDP, bank loans over business debt, and the bank capital ratio for the United States with the estimates discussed above. The negative effect of relatively high corporate leverage in the United States is almost entirely offset by the positive effects of relatively high bank capitalization and a relatively small share of bank loans in business debt. The resulting estimate of output decline one year after the onset of non-systemic financial distress equals 1.4 percent, which is statistically indistinguishable from the 1.3 percent estimated in the full sample without accounting for heterogeneity.

There is speculation that the US debt limit showdown will end with everybody doing some grandstanding:

Top White House officials and Republican lawmakers were closing in on Thursday on a deal that would raise the debt limit for two years while capping federal spending on everything but the military and veterans for the same period. Officials were racing to cement an agreement in time to avert a federal default that is projected in just one week.

The deal taking shape would allow Republicans to say that they were reducing some federal spending — even as spending on the military and veterans’ programs would continue to grow — and allow Democrats to say they had spared most domestic programs from significant cuts.

Negotiators from both sides were talking into the evening and beginning to draft legislative text, though some details remained in flux.

A deal would be a Good Thing because, for instance:

On Wednesday evening, Fitch fired its first shot across the government’s bow, placing the United States’ rating on watch for a downgrade, a move that “reflects increased political partisanship that is hindering reaching a resolution to raise or suspend the debt limit,” the agency’s analysts warned.

The United States has never deliberately reneged on its debt in the modern era, but even a brief default would alter the perception of debt-ceiling brinkmanship as political theater and turn it into a real risk to the creditworthiness of the government, Moody’s has warned.

“Our view is that we would need to reflect that permanently in the rating,” said William Foster, the lead analyst for the United States at the rating agency. The agency has said that if the Treasury Department misses one interest payment, its credit rating would be lowered by a notch. For the United States to regain its previous top rating, according to Mr. Foster, lawmakers would have to significantly alter the debt limit or remove it entirely.

… and DBRS has warned:

DBRS, Inc. (DBRS Morningstar) placed the United States of America’s Long-Term Foreign and Local Currency – Issuer Ratings of AAA Under Review with Negative Implications. In addition, DBRS Morningstar placed the United States of America’s Short-Term Foreign and Local Currency – Issuer Ratings of R-1 (high) Under Review with Negative Implications.

The Under Review with Negative Implications reflects the risk of Congress failing to increase or suspend the debt ceiling in a timely manner. If Congress does not act, the U.S. federal government will not be able to pay all of its obligations. The precise timing of when the federal government will exhaust available cash and extraordinary measures, the so-called X-date, is somewhat unclear. However, Treasury Secretary Janet Yellen reiterated her warning on May 22 that the X-date could come as early as June 1. Judging from the latest data on daily net inflows into the Treasury General Account, we believe it is reasonable to assume the X-date could arrive within weeks if not days.

While we still expect Congress to raise the debt ceiling before Treasury runs out of available resources, there is a risk of Congressional inaction as the X-date approaches. DBRS Morningstar would consider any missed payment of interest or principal as a default. In such a scenario, the relevant U.S. Issuer Ratings would be downgraded to “Selective Default.”

But it’s a big world. BIS has released a committee report titled Central bank digital currencies: ongoing policy perspectives:

In 2021, this group noted there was a balance between facilitating adoption of any CBDC to realise policy objectives and managing any potential excess demand for CBDC. CBDC design will need to account for potentially wide ranges of demand or CBDC adoption in the early/introductory stages, and preparedness for market stresses or other extraordinary scenarios must be there from the outset. To the extent that any central bank wishes to actively shape demand for CBDC, as part of its larger policy toolkit, there is likely no one-size-fits-all solution for whether pricing or quantity control approaches are most suitable, either in the introductory phase or over time (see Box 3). In designing and implementing any measures, central banks would need to be mindful of central bank balance sheets, interaction with bank regulation and how CBDC compares with other forms of money.

CBDCs, if issued, must be interoperable with other forms of money and existing payment systems. Two key issues are how CBDC would connect with instant payment infrastructure,7 and how CBDC transactions could be processed at point of sale (PoS) terminals. Similar to its role in existing infrastructure and a diverse set of industries, international standardisation could be highly beneficial in supporting the development of the CBDC ecosystem.

Decisions to deepen technology investments will also carry meaningful cost. Testing and development of solutions has not yet led any member of this group to make firm choices around one technology or system design, although such choices are likely to occur in the coming years. For example, the use of blockchain within CBDC systems remains a possibility, although it is currently not deemed essential to the functioning of a potential CBDC system (see Box 4).
…
Many experiments with wholesale CBDC for cross-border payments have enabled a wider set of participants to have direct access to central bank systems. Broadening access arrangements to a wider set of participants (domestically and/or internationally) would be a significant policy choice that could also be undertaken without CBDC. Therefore, further work is needed to understand how value could be drawn through issuing a wholesale CBDC – particularly what it may provide over and above upgrades and improvements to existing systems. Making improvements with CBDCs may also require central banks to consider the role of further governance and standardisation or alignment in areas beyond messaging standards.

TXPR closed at 527.13, down 0.69% on the day after setting a new 52-week low. Volume today was 1.29-million, second-highest of the past 21 trading days.

CPD closed at 10.47, down 0.95% on the day after setting a new 52-week low. Volume was 48,880, near the median of the past 21 trading days.

ZPR closed at 8.645, down 0.52% on the day after setting a new 52-week low. Volume was 170,500, above the median of the past 21 trading days.

Five-year Canada yields up to 3.50% today.

The CPPIB did well (if we trust the private market valuations!):

Canada Pension Plan Investment Board reported a 1.3-per-cent return in its last fiscal year as gains from private investments helped offset weak performance from public stocks and bonds.

The plan’s modest results beat a composite benchmark it uses to measure its performance, which gained 0.1 per cent in the fiscal year that ended March 31.
…
By contrast, private equity returned 6.8 per cent, credit investments gained 6 per cent, and infrastructure investments – which often perform well when inflation rises – were up 5.6 per cent.
…
In the fiscal year, CPPIB’s operating expenses increased by $112-million as it hired more staff and invested in technology and data infrastructure. But its costs are relatively steady over five years when measured as a percentage of its assets, at an average of 0.29 per cent.

Luis de Guindos, Vice-President of the European Central Bank, gave a speech titled Towards a stronger non-bank financial sector:

Well-developed and broad capital markets can help to efficiently allocate capital to the most innovative and productive companies, thereby contributing to economic growth. Market-based finance also allows companies to diversify their funding sources and facilitates increased cross-border funding. This can result in greater risk-sharing across the euro area and contribute to overall financial resilience. Investment funds, for instance, play an important role in financial integration. However, if we are to strengthen the euro area financial sector’s capacity to attract and intermediate funding for euro area companies, we must make further progress on the banking union and continue to develop the capital markets union (CMU).

The CMU seeks to integrate national capital markets into a genuine single market, in turn making financing more accessible to EU companies and transforming Europe into an even more attractive place to save and invest. Consequently, this means scaling up market-based financing in the EU, leading to a larger role for the non-bank financial sector than is already the case.
…
In the euro area, the combined total assets of investment funds, money market funds (MMFs), insurance corporations, pension funds and financial vehicle corporations have doubled since the global financial crisis from €15 trillion to €31 trillion.

The sector has become increasingly important in financing the euro area real economy in recent years. As
a share of credit granted by all financial institutions, credit granted by non-banks to euro area nonfinancial corporates has almost doubled since 2008, from 15% to 26% at the end of last year.
…
First, the strong growth of the non-bank financial sector – especially the asset management industry – over the past 15 years has been accompanied by an increase in liquidity mismatches.

A key contributing factor is that investors in open-ended funds – which account for the largest part of the investment fund sector – can typically redeem their shares on a daily basis without prior notice. This creates a liquidity mismatch especially in funds that invest in relatively illiquid assets, such as high-yield corporate bonds.
…
The second vulnerability in the non-bank financial system relates to financial and synthetic leverage, which can amplify shocks and create spillover risks for banks.

We saw an example of this with Archegos Capital Management, which defaulted on its losses from leveraged equity trades in March 2021. The fact that Archegos used total return swaps to generate synthetic exposures highlights another challenge in identifying leverage, as leverage can be embedded in derivative exposures. While the Archegos default had only a limited impact on the broader financial system, the event nevertheless highlighted possible contagion channels to banks through the provision of synthetic leverage by prime brokers.
…
The third vulnerability in the non-bank sector results from an insufficient preparedness to meet large demand for liquidity, especially from margin calls – as the recent stress episode in the UK pension fund sector has highlighted.

In the United Kingdom, pension funds had made extensive use of leveraged strategies to hedge long-term interest rate risk and free up capital to generate higher returns in their investment portfolios.
…
First, we need to reduce the risks of mismatch between funds’ asset liquidity and their redemption policies. Funds need to ensure that their redemption policies are closely aligned with the liquidity of their portfolio assets.

For instance, funds that invest in illiquid assets, such as real estate or private debt, should have commensurate redemption notice periods to mitigate liquidity risk. At the same time, funds that offer daily redemptions should be required to invest in sufficiently liquid assets and maintain high liquidity management standards to enable them to meet redemption requests under both normal and stressed market conditions.
…
Second, we must renew our efforts to reform the MMF sector in the EU.
…
Third, it is essential to address risks from non-bank leverage from various perspectives.
…
Fourth, there is a need to enhance margining practices and liquidity preparedness to meet margin calls.

Since the March 2020 market turmoil, the non-bank financial sector has been repeatedly confronted with periods of high market volatility and surging liquidity needs from margin calls. Increasing the transparency and predictability of initial margin models and assessing their responsiveness to market stress can help reduce the procyclical demand for liquidity. In addition, ensuring robust liquidity risk management and contingency planning frameworks would mitigate risks associated with inadequate liquidity preparedness

BIS has released a working paper by Claudio Borio titled Getting up from the floor:

Focus
How do central banks set interest rates? While the techniques are appreciated only by experts, their implications for the financial system can be surprisingly wide-ranging. This paper examines the evolution of techniques since the Great Financial Crisis (GFC), evaluates their merits and proposes a way forward.

Contribution
Since the GFC, a growing number of central banks have adopted abundant reserves systems (“floors”) to set the interest rate. How do these compare with the pre-GFC scarce reserve systems (“corridors”)? The paper’s contribution is to explore this question with fresh eyes and with reference to the broader question of the optimal size and composition of central bank balance sheets.

Findings
In contrast to a widely held view, there are good reasons for returning to scarce reserve systems (“corridors”). First, the costs of floor systems take considerable time to appear, are likely to grow and tend to be less visible. They can be attributed to features of the environment which, in fact, are to a large extent a consequence of the systems themselves. Second, for much the same reasons, there is a risk of grossly overestimating the implementation difficulties of corridor systems, in particular the instability of the demand for reserves. Third, there is no need to wait for the central bank balance sheet to shrink before moving in that direction: for a given size, the central bank can adjust the composition of its liabilities. Ultimately, the design of the implementation system should follow from a strategic view of the central bank’s balance sheet. A useful guiding principle is that its size should be as small as possible, and its composition as riskless as possible, in a way that is compatible with the central bank fulfilling its mandate effectively.

Abstract
Since the Great Financial Crisis, a growing number of central banks have adopted abundant reserves systems (“floors”) to set the interest rate. However, there are good grounds to return to scarce reserve systems (“corridors”). First, the costs of floor systems take considerable time to appear, are likely to grow and tend to be less visible. They can be attributed to independent features of the environment which, in fact, are to a significant extent a consequence of the systems themselves. Second, for much the same reasons, there is a risk of grossly overestimating the implementation difficulties of corridor systems, in particular the instability of the demand for reserves. Third, there is no need to wait for the central bank balance sheet to shrink before moving in that direction: for a given size, the central bank can adjust the composition of its liabilities. Ultimately, the design of the implementation system should follow from a strategic view of the central bank’s balance sheet. A useful guiding principle is that its size should be as small as possible, and its composition as riskless as possible, in a way that is compatible with the central bank fulfilling its mandate effectively.

As noted on May 15 the BoC adopted a corridor system at the beginning of the pandemic and has decided to keep it.

BIS has released a Bulletin by Rodney Garratt and Hyun Song Shin titled Stablecoins versus tokenised deposits: implications for the singleness of money:

Key takeaways

• • Private tokenised monies that circulate as bearer instruments, like stablecoins, may entail departures in their relative exchange values away from par in violation of the “singleness of money”.
• • In contrast, tokenised deposits that do not circulate as bearer instruments but rather settle in central bank money are more conducive to singleness.
• • Tokenised deposits may enable expanded functionality by building on the capacity of programmable ledgers to introduce contingent execution and composability of transactions

A cornerstone of the modern monetary system is the “singleness of money”. Singleness ensures that monetary exchange is not subject to fluctuating exchange rates between different forms of money, whether they be privately issued money (eg deposits) or publicly issued money (eg cash). With singleness of money, there is an unambiguous unit of account that underpins all economic transactions in society.

Ruling out exchange rates between different forms of money allows money to serve its role as a coordinating device for economic activity. In this context, “approximate singleness” is an oxymoron. Small departures from par introduce frictions in trade and exchange that are amplified when they reverberate through economic transactions. Ultimately, such amplifications of frictions can be debilitating for monetary exchange (Morris and Shin (2012), Doepke and Schneider (2017))
…
This Bulletin evaluates two models of private tokenised money. In both cases, private money tokens represent liabilities of the issuer, and the holder has a claim on the issuer for redemption at par value in the sovereign unit of account. However, the transfer process differs in the two cases. In one model, which resembles current asset-backed stablecoins, private tokenised money circulates as a digital bearer instrument. Such a model may not be compatible with singleness for reasons to be outlined below. The second model – that of “tokenised deposits” – does not involve a direct transfer of claims. The model of tokenised deposits envisages participants to be customers of regulated financial institutions (such as banks), and transfers are recorded at the individual bank level and settled automatically using tokenised central bank money (ie CBDC). Under this model of non-transferable liabilities, a person or firm knows that when they accept a payment from the customer of any bank, the payment will be credited to their own account at face value. Settlement using central bank money is the key feature that promotes singleness.

PerpetualDiscounts now yield 6.44%, equivalent to 8.37% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.91% on 2023-5-12 and since then the closing price has changed from 15.40 to 14.89, a decline of 331bp in price, with a Duration of 12.39 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies an increase in yield of about 27bp since 5/12 to 5.18%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed slightly (and perhaps spuriously) to about 320bp from the 325bp reported May 17.