PrefBlog

TXPR closed at 572.75, up 0.53% on the day. Volume today was 1.43-million, fifth-highest of the past 21 trading days.

CPD closed at 11.35, up 0.35% on the day. Volume was 81,670, near the median of the past 21 trading days.

ZPR closed at 9.51, up 0.21% on the day. Volume was 233,840, well above the median of the past 21 trading days.

Five-year Canada yields were up sharply to 3.46% today.

Apparently:

U.S. private employers stepped up hiring in September, the ADP National Employment report on Wednesday showed, suggesting rising rates and tighter financial conditions have yet to curb labor demand as the Fed battles high inflation.

The Institute for Supply Management’s services industry employment gauge shot up in another sign labour remains strong as the overall industry slowed modestly in September.

The Fed is expected to deliver a fourth straight 75-basis-point rate hike when policymakers meet Nov. 1-2, the pricing of fed fund futures shows, according to CME’s FedWatch tool.

San Francisco Fed President Mary Daly told Bloomberg TV in an interview that inflation is problematic and that the U.S. central bank would stay the course.

“The path is clear: we are going to raise rates to restrictive territory, then hold them there for a while,” she said. “We are committed to bringing inflation down, staying course until we are well and truly done.”

PerpetualDiscounts now yield 6.48%, equivalent to 8.42% interest at the standard equivalency factor of 1.3x. Long corporates continue to yield 5.00%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has eased to 340bp from the 355bp reported September 28.

TXPR closed at 569.72, down 0.53% on the day. Volume today was 1.46-million, third-highest of the past 21 trading days.

CPD closed at 11.31, down 0.53% on the day. Volume was 103,020, above the median of the past 21 trading days.

ZPR closed at 9.49, down 0.63% on the day. Volume was 250,400, third-highest of the past 21 trading days.

Five-year Canada yields were up a few beeps to 3.30% today.

I really don’t know how low this market can go. Yields are already phenomenally high due to pending dividend increases and current price declines. I had some vague hopes that the reset of TD.PF.I to 6.301% would spark a little interest, but it appears that the market is sneering at a mere 6.3% preferred dividend yield from a major bank.

I am left with the suspicion that the market is expecting an imminent recession and the return of near-zero yields:

U.S. and Canadian stocks rallied for a second straight day on Tuesday after softer U.S. economic data and a smaller-than-expected interest rate hike by the Australian central bank stirred hope that the Federal Reserve might temper its aggressive raising of rates. After gaining 2.4% on Monday, the Canadian benchmark stock index rose almost another 2.6% for its best gain in two-and-a-half years.

While labour demand remains fairly strong, U.S. job openings fell by the most in nearly 2-1/2 years in August in a sign the Fed’s mission to tame inflation by hiking rates was working to slow the economy.

Earlier, the Reserve Bank of Australia surprised markets with a smaller-than-expected interest rate hike of 25 basis points. Its cash rate rose to a nine-year peak after six rate hikes in as many months in a tightening cycle other central banks are engaged in as well.
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Still, Fed Governor Philip Jefferson said inflation is the most serious problem facing the U.S. central bank and it “may take some time” to address. San Francisco Fed President Mary Daly said the central bank needs to deliver more rate hikes.

How long will it take before the market decides that a 3.25% yield on five year Canada’s when inflation expectations are 2% is reasonably normal and that 0.5% with the same expectations is grossly abnormal? Will we all be dead by then?

The Delaware Court of Chancery released a trove of Elon Musk’s eMails (Exhibit H, page 82 of the PDF) that are public due to his lawsuit with Twitter. Reading them is, apparently, an emperor has no clothes moment:

What is so illuminating about the Musk messages is just how unimpressive, unimaginative, and sycophantic the powerful men in Musk’s contacts appear to be. Whoever said there are no bad ideas in brainstorming never had access to Elon Musk’s phone.
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In no time, the texts were the central subject of discussion among tech workers and watchers. “The dominant reaction from all the threads I’m in is Everyone looks fucking dumb,” one former social-media executive, whom I’ve granted anonymity because they have relationships with many of the people in Musk’s texts, told me. “It’s been a general Is this really how business is done? There’s no real strategic thought or analysis. It’s just emotional and done without any real care for consequence.”

I have long taken the view that hard (and smart!) work and good ideas will get you a decent life and a lottery ticket. If your ticket is a winner, you can get unimaginably rich and there’s nothing more to the process than that; but if your ticket doesn’t come up, at least you’ve still got the decent life! Before entering the full-time workforce, I thought that the business world was run by smart, careful individuals who spent a lot of time checking their data and considering arguments. Then I started working and …. nahhhhh.

TXPR closed at 571.13, down 0.85% on the day. Volume today was 610,570, lowest of the past 21 trading days.

CPD closed at 11.38, down 0.35% on the day. Volume was 76,520, above the median of the past 21 trading days.

ZPR closed at 9.57, down 0.21% on the day. Volume of 143,460, near the median of the past 21 trading days.

Five-year Canada yields were unchanged today, as the market was on holiday.

David Parkinson of the Globe wrote a fine column on BoC transparency, by which I mean I agree with it:

Jeremy Harrison, the bank’s managing director of communications, told reporters that the document will be a “high-level summary” of the council’s discussions, rather than anything approaching a formal transcript of its meetings.

“Given our consensus-based decision-making system, the summary won’t provide attribution to individual council members, nor will it record votes because there are no votes in our system,” he said.
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It falls short of the decision-making transparency of most of the Bank of Canada’s leading global peers, which publish transcripts or minutes of their meetings, and publicly record the votes of each committee member.
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The black box of policy making has become an obstacle to the central banks’ credibility, as it works feverishly to not only fight inflation, but convince the Canadian public that it can win the fight, and that it has their best interests in mind. Two and a half years of policy extremes, of uncertainty and of an inflation problem that went unchecked for too long have cultivated distrust.

The bank needs to lift the curtain and be willing to be totally up-front with those doubters, to share not only its consensus views, but the compelling, passionate dissenting opinions that colour them. It needs to put more human faces on its process – even if those faces don’t always agree.

The Canadian economy remains sluggish:

Canada’s economic activity unexpectedly edged up in July, while gross domestic product in August was most likely flat, data showed on Thursday, with the surprise gain seen unlikely to change much for the central bank.

The Canadian economy grew 0.1 per cent in July, compared with analysts’ forecast for a 0.1 per cent decline, Statistics Canada data showed. Growth in goods-producing industries more than offset the first decrease in services-producing industries since January.

“The economy fared better than anticipated this summer, but the showing still wasn’t much to write home about,” Royce Mendes, head of macro strategy at Desjardins Group, said in a note.

The slight gain in July and likely lack of growth in August suggest third-quarter annualized GDP growth of about 1 per cent, well below the Bank of Canada’s most recent forecast of 2.0 per cent, analysts said.

German inflation came in high:

Consumer prices, harmonised to make them comparable with inflation data from other European Union countries (HICP), increased by 10.9% on the year, the federal statistics office said. A Reuters poll of analysts predicted a rise of 10.0%.

That was the highest reading since comparable data going back to 1996.

The increase was due to higher costs for energy – which were 43.9% higher compared with September 2021 – after a popular cheap transport ticket offer and a fuel tax cut expired at the end of August.

I’ve missed quite a few prospective clients to the siren call of private mortgages, so it was with some satisfaction that I read about Romspen:

Romspen Investment Corp., one of Canada’s largest private debt managers, is restricting redemptions from its flagship real estate fund, as the North American mortgage market adjusts to a prolonged period of rising interest rates.

This week, Romspen told its investors looking to cash out from the Romspen Mortgage Investment Fund that they may have to wait, citing delays in loan repayments and the need to protect against loan losses. The company uses investor money to provide mortgages to higher-risk commercial developers, who typically don’t qualify for bank loans.

The fund’s ability to pay back its investors largely relies on its borrowers’ ability to refinance their debt. But soaring mortgage rates have taken a toll on the cost and availability of refinancing in commercial real estate markets in the U.S. and Canada.

In a notice to unitholders on Monday, Romspen said it can’t continue to honour investor redemptions at the pace they’re being requested.

More than $700-million has been returned to Romspen’s investors over the past 18 months, and the current redemption queue represents roughly another $325-million – about 12 per cent of the fund’s assets. The fund had $2.8-billion in assets as of the end of June.

I’ve been trying to come to grips with the recent Gilt market fiasco:

Traders had reported heavy selling of long-dated Gilts as so-called liability-driven investment strategies managing defined benefit pension schemes have been forced to raise money to fund margin calls on their portfolios. Those margin calls had threatened to create a self-reinforcing feedback loop, where rising yields precipitate more calls for collateral and further selling, pushing up yields once more.

In one example of the extremity of market moves, the yield on 30-year UK inflation-linked bonds (which have historically been popular with LDI investors) jumped from below 0% the previous week to above 2.5% on Wednesday prior to the BoE’s announcement, before falling back to 0.7% on Thursday.

“We’ve been hearing that LDI investors have had to raise collateral by selling bonds and that’s a big reason why long-dated Gilts – and inflation-linked bonds in particular – have been under so much pressure,” said Mike Riddell, a senior portfolio manager at Allianz Global Investors.
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Experts note the rise in Gilt yields isn’t all bad news for UK pension funds, as it has also decreased the value of their defined benefit liabilities at the same time. Some funds that haven’t used so many derivatives to hedge their liabilities, or leveraged their Gilt holdings in repo markets, may also see the rise in yields as a buying opportunity.

“If you’re an LDI fund your overall funding level has improved because of the fall in the value of your liabilities, but it’s the cash that needs to be posted against your hedges – that’s the issue. And it’s unclear how the dynamic plays out to be honest because all LDI funds are very different,” said [senior portfolio manager at Federated Hermes, Orla] Garvey.

There is the usual attempt to defend the product:

PAN Trustees chairman Steve Delo agrees that it is the sudden stress situation that caused the problems in the market: “We have a situation where sensible decisions have been taken by pension schemes in a sensible way over the years to put on large LDI positions. LDI has served everyone very well. But in this circumstance, the aggregation of it all across the industry has resulted in panic and urgency, and that’s what we’ve had to deal with.”

Widely used investment vehicles are now not quite as flexible or as liquid as everyone perhaps thought they would be during a stress situation, he adds: “Suddenly everything becomes cumbersome, locked up, bureaucratic at a time where swift decisions need to be taken while still trying to maintain robust governance.”

But finally I found an informative Washington Post column:

1. What’s ‘liability-driven’ investment?

It’s a strategy used by pension funds to manage their assets to ensure they can meet future liabilities, thus the name. The trades are typically used by so-called defined benefit pension plans, which guarantee retirees a certain payout regardless of swings in financial markets. The strategy often involves derivatives — interest-rate swaps and other contracts that allow them to hedge their bets in case the market moves against them. To arrange them, the funds have to put up some collateral for the trade. If yields fall they make money and if yields rise they typically face a margin call and have to pay more to the counterparty because the bonds are worth less.

2. Who’s doing it?

Firms including BlackRock Inc., Legal & General Group Plc and Schroders Plc manage LDI funds on behalf of pension clients. Many pension funds outsource their entire portfolios, including LDI trades, to those managers, while others might just use LDI funds offered by asset managers. There are firms, like Cardano and Insight Investments where LDI is the main bulk of their business. The amount of liabilities held by UK pension funds that have been hedged with LDI strategies has more than tripled in size to £1.5 trillion ($1.6 trillion) in the 10 years through 2020, according to the UK’s Investment Association. The entire UK government debt market is £2.3 trillion. retirees a certain payout regardless of swings in financial markets. The strategy often involves derivatives — interest-rate swaps and other contracts that allow them to hedge their bets in case the market moves against them. To arrange them, the funds have to put up some collateral for the trade. If yields fall they make money and if yields rise they typically face a margin call and have to pay more to the counterparty because the bonds are worth less.

So there’s a place to start, anyway. Blackrock even has a website section devoted to their awesome and wonderful LDI funds – but it’s completely worthless. Just a bit of juvenile marketting bumf published with the objective of getting you to call a salesman; no meat on that bone!

That’s a shame, but fortunately the Washington Post comes to my aid again:

The resulting problems for pension funds were twofold. First, to offset liabilities they had bought long-dated gilts (and probably some long-dated inflation-linked bonds) via counterparts who held those positions for them. Second, because the UK market is relatively small, they had also bought fairly low-quality investment-grade credit in the US and swapped these exposures into sterling. That left them with a dollar short position on one leg of the swap. Both types of trade were done via counterparts who demanded collateral — lots of it. Often, that meant selling other assets, hence the vortex of the past few days which the BOE has, rightly, alleviated by its actions. I am not sure that this is the end of the story.

So it’s useful to know that one reason to use derivatives is because the market simply isn’t big enough to accomodate all those who want to invest in it. And then there’s leverage:

“As a result of the extreme volatility in the gilts market this week, we have been working expediently over recent days to support our clients’ interests,” a BlackRock spokesperson said in an emailed statement.

“We have been reducing leverage in some of our LDI funds, acting prudently to preserve our clients’ capital in extraordinary market conditions. Trading in BlackRock funds has not been halted, nor has BlackRock ceased trading in gilts.”

LDI funds can be leveraged up to four times, industry consultants say.

So I’m still a little foggy on the function of these “LDI firms” who take leveraged positions via interest-rate swaps on gilts. Why do they do it? There’s the suggestion that the funds want some kind of asset-liability duration matching (“immunization” is the word usually used on PrefBlog!), which is fine. Very good, in fact; I have praised the pension fund HOOPP on this blog, for taking the time – almost uniquely in the financial world – of talking to their clients, understanding what they want their portfolios to do (‘pay off this schedule of obligations!’) and investing accordingly to minimize risk – the word ‘risk’ being defined in a meaningful way, that is, not by some brain-dead MBA/CFA parrotting dim memories of the Capital Asset Pricing Model.

I still haven’t come up with a sensible explanation of why these exposures should be leveraged, however. One possibility is that it’s simply a mechanism to buy as much duration as possible with the least amount of cash, but I haven’t seen any explainers at all on this. Another thing that I don’t know is just how these leveraged derivative bets work. The presence of margin calls suggest that the funds will attempt to keep a fixed number of contracts alive per unit in the fund, rather than operating like a retail leverage fund, in which the attempt is to maintain a fixed amount of leverage on the capital in the fund – which, notoriously, imposes a buy-high-sell-low investment strategy on the operation – but this is not quite clear. Blackrock reduced leverage in its funds … were they mechanically buying high and selling low, or what’s the whole story here?

The claim that the gilt market is simply too small to absorb the pension funds that are dependent upon it is interesting. There is at least one article in the Interesting External Papers category of PrefBlog that shows the regulators have been very worried in the past about what I call ‘liquidity inversions’ – situations in which a small, illiquid physical market is used to price a large, very liquid, derivatives market (another resource is my piece on Liquidity Black Holes). Even a dominance of the pension funds in the physical market could be problematic – financial markets work best when there is a wide variety of players with differing rationales buying and selling with each other. The commentary I’ve seen has been mainly in the context of derivative-based ETFs on Emerging Market equities being sold in the west; could this have really happened with gilts? I look forward to the next few years and the publication of learned treatises on the September 2022 Gilt Saga.

Anyway, back to more domestic matters – Mohammed El-Erian writes a piece about the implications of damaged Fed credibility:

Ominously, these market signals indicate that the US economy (and therefore the global economy) lacks both a monetary-policy anchor and a sufficiently credible central bank. As a result, the US needs more monetary-policy tightening than it would have if the Fed had reacted in a timely and credible fashion. That will indeed produce “pain,” in the form of foregone growth (actual and potential) and higher unemployment, which will hit the most vulnerable segments of society the hardest.

For the global economy, this will translate into even greater growth fragility at a time when Europe is heading into recession, China’s performance is increasingly lagging its economic potential, and little fires are burning across the developing world. Despite this increased fragility, many other central banks will have no choice but to follow the Fed in raising interest rates beyond what would have otherwise been needed, in order to avoid “importing” more damaging inflation and unsettling financial instability.

Now that the Fed finds itself in such an uncomfortable situation – one mostly of its own making – it may be inclined to eschew further rate hikes, particularly given the growing criticism that it is tipping the economy into recession, destroying wealth, and fueling instability. Yet such a course of action would risk repeating the monetary-policy mistake of the 1970s, saddling America and the world with an even longer period of stagflationary trends. Instead, the Fed should be doing much more to contain the adverse spillovers of its policy mistake, including through innovative thinking about its monetary-policy framework and more proactive collaboration with other policymaking entities (domestic and abroad).

And in Canada:

The Securities and Exchange Commission today announced insider trading charges against two Canadian software engineers who made $1.6 million by trading ahead of non-public, market-moving financial information.

According to the SEC’s complaint, from at least May 2018 to July 2021, Harpreet Saini and John Lester Mandac Natividad, both of Ontario, were employed by a newswire distribution company specializing in corporate press releases, and had access to its internal press release distribution system that allowed them to preview headlines, times, and publication dates of forthcoming announcements. As alleged, Saini and Natividad collectively traded in advance of more than 1,600 announcements distributed by their employer and would routinely exit their positions after the market reacted to the news in the press releases.
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The Ontario Securities Commission (OSC) today announced that Saini and Natividad have been charged with fraud and insider trading offenses under the Ontario Securities Act.

Sorry this is late! I had better things to do last night!