September 28, 2012

There’s renewed grumbling about currency manipulation:

The new idea in trade negotiations is an old idea: punish currency manipulation.

Avery Shenfeld, chief economist at CIBC World Markets, said Thursday in a new commentary that currency policy should be included in any new free-trade agreements.

“Free trade, but free currencies as well,” Mr. Shenfeld wrote. “Trade may be liberalized, but are the exchange rates that set relative prices and costs also going to have their shackles removed? If not, the free market will be anything but free.”

Mr. Shenfeld says that since 2007, international investors have purchased Canadian-dollar bonds worth $280-billion, compared with $65-billion over the previous five years.

That demand is partly explained by a healthy appetite for AAA-rated securities. But international investors also are buying Canada because they are being pushed out of other markets by interventionist central banks. Canada’s dollar is among the most overvalued in the world, Mr. Shenfeld said, citing calculations by the International Monetary Fund.

I can’t agree that great excitement is required over currency manipulation. Just as security price manipulation gives rise to exploitable opportunities for fundamental investors, so does currency manipulation allow consumers and cross-border purchasers to make a killing. If the Chinese want to sell me $1.00 worth of goods for $0.50, I say ‘Fine! Back up the truck!’

On a related note, Spend-Every-Penny has realized it’s good to lock in low yields for longer terms:

The Honourable Jim Flaherty, Minister of Finance, today highlighted adjustments to the debt strategy plan for 2012–13. These adjustments include the temporary reallocation of short-term bond issuance towards long-term bonds.

Since the release of the 2012–13 Debt Management Strategy, published as part of Budget 2012, long-term interest rates have continued to fall and remain near historically low levels.

“Given this environment, it is both advantageous and prudent for our Government to lock in additional long-term funding,” said the Minister. “These adjustments help us meet our goal of raising stable and low-cost funding to meet the financial needs of our Government to best serve taxpayers.”

Further details are provided in the Notice accompanying the Quarterly Bond Schedule on the Bank of Canada website.

The Bank of Canada highlights:

As an extension of the plan outlined in the Debt Management Strategy for 2012-13 to lock in funding at attractive rates, the Government plans to reallocate short-term bond issuance toward long-term bonds. Consequently, for the remainder of 2012-13, the following changes are planned:

Bond Auctions
•10-year bonds – one additional auction will be held in the last quarter of 2012-13;
•30-year nominal bonds – one additional auction will be held, resulting in a total of four auctions in 2012-13; and
•The size of 10-year and 30-year nominal bond auctions may be increased, subject to market conditions.

Regular Bond Buyback Program
•30-year bond buyback operations on a cash basis – operations will be halted for the remainder of 2012-13; and
•30-year bond buyback operations on a switch basis – one additional operation will be conducted in the last quarter of 2012-13.

In all other respects, the implementation of the medium-term debt strategy, announced in Budget 2011, will continue. The adjustments to the debt strategy outlined above will be monitored and, if necessary, modified to ensure that the market for Government of Canada securities continues to function well.

The problem with the Bank of Canada’s debt management process is that the planning horizon is only ten years. This reduces the advantage of issuing long bonds relative to a more rational thirty-year planning horizon.

It looks like there’s a little bit of profit-taking in the junk bond market:

Speculative-grade bonds in the U.S. are poised for their biggest weekly loss since May as buyers withdraw money from domestic funds that buy the debt for the first time in more than three months.

The securities lost 0.6 percent this week through yesterday after gains in the five previous periods, Bank of America Merrill Lynch index data show. Funds that buy the notes reported $5 million of outflows, with investors pulling $65 million from exchange-traded funds, according to a Sept. 27 Bank of America Corp. (BAC) report.

Yields on speculative-grade bonds closed at 7.125 percent yesterday, up from a record low 6.948 percent reached on Sept. 19 as an unexpected drop in demand for U.S. durable goods other than transportation signaled a slowdown in business investment and exports. Investors sold the debt as concern mounted that the European Central Bank’s current bailout funds would be insufficient to prevent a sovereign default.

“There was legitimate selling for the first time,” said Timothy Gramatovich, chief investment officer at Peritus Asset Management LLC. “This is the first week in recent memory that we actually saw bonds offered out there.”

Investors yanked 3.9 million shares, worth about $157 million, from State Street Corp.’s ETF that buys junk bonds on Sept. 27, the biggest outflow since May 21, according to data compiled by Bloomberg. U.S. high-yield bond funds reported net withdrawals of $310 million, the first decline after 13 consecutive weeks of inflows, according to Lipper.

The regulatory pretense of concern over LIBOR has had its intended effect:

Oversight of Libor will be handed to the U.K.’s financial regulator, and dozens of the currencies and maturities that make up the benchmark axed, under proposals designed to revive confidence in a rate tarnished by scandal.

The British Bankers’ Association should be stripped of the responsibility for managing the rate and other organizations invited to replace it, Financial Services Authority Managing Director Martin Wheatley said in London today. More than 100 Libor rates tied to currencies and maturities where there isn’t enough trading data to set them properly should be scrapped, and a code of conduct introduced for how lenders contribute to the benchmark backed by criminal penalties, he added

“Governance of Libor has completely failed,” Wheatley said as he unveiled a report on the future of Libor. “This problem has been exacerbated by a lack of regulation and a comprehensive mechanism to punish those who manipulate the system.”

The FSA should receive greater powers to vet bankers who contribute to the rate, according to Wheatley, who will become the chief executive officer of the Financial Conduct Authority, when the FSA splits into two agencies next year.

The “first priority” of Libor’s new administrator will be to create a code of conduct for rate submitters with specific guidelines that the submissions be corroborated by trade data, he said.

“Transactions will need to be recorded and there needs to be a requirement for regular external audit of submitting firms,” Wheatley said.

The Bank of Canada has released a completely unconvincing discussion paper by David Xiao Chen, H. Evren Damar, Hani Soubra and Yaz Terajima titled Canadian Bank Balance-Sheet Management: Breakdown by Types of Canadian Financial Institutions. My hackles rose as early as the third paragraph:

Our main findings regarding the first objective are summarized as follows. First, risk indicators have decreased during the past three decades for most non‐Big Six financial institutions, and have remained relatively unchanged for the Big Six banks. As a result, a divergence between non‐Big Six and the Big Six banks is observed, especially in leverage and capital ratios. Second, heterogeneity among non‐Big Six financial institutions has increased, especially in capital and funding ratios. The observed overall decline and increased heterogeneity in the risk indicators follow certain regulatory changes, such as the introduction of liquidity guidelines on funding in 1995 and the implementation of bank‐specific leverage requirements in 2000. This suggests that regulatory changes have had significant and heterogeneous effects on the management of balance sheets by financial institutions and, given that these regulations required more balance‐sheet risk management, they contributed to the increased resilience of the banking sector.

Excuse me? Isn’t that last line a bit of circular reasoning? Regulating funding and leverage certainly had an effect on funding and leverage. Whether this has any connection with “resilience” is another matter entirely, one that is not addressed in the paper.

The mystery is resolved in the concluding statements:

The resilience of the Canadian financial system could be attributed to the conservatism and prudent approach of its regulatory bodies. Over the past couple of decades, Canadian banks were resilient to several financial stresses that, for the most part, originated outside Canada’s borders. More
recently, at the onset of the 2007 financial crisis, while many international foreign banks faced difficulties and required public capital injections and debt guarantees, the Canadian financial system did not require any public assistance or experience any bank failures. It has been argued that this was due in large part to the tighter regulatory ratios set by the Office of the Superintendent of Financial Institutions (OSFI), which exceeded international minimums. Potentially more important is OSFI’s regulatory approach based on individual financial institutions. A part of the observed heterogeneity in balance‐sheet ratios among Canadian banks is likely attributable to this.

OK, so the purpose of the paper was to evangelize OSFI-worship. Next!

The Canadian preferred share market closed the month and quarter with a good day: Perpetual premiums won 18bp, FixedResets gained 7bp and DeemedRetractibles were up 2bp. Volatility was average. Volume was average.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -0.4917 % 2,449.5
FixedFloater 4.42 % 3.80 % 35,785 17.68 1 0.0466 % 3,601.2
Floater 2.99 % 3.01 % 59,265 19.69 3 -0.4917 % 2,644.8
OpRet 4.66 % 3.35 % 54,048 1.44 4 -0.1726 % 2,550.4
SplitShare 5.44 % 4.91 % 73,317 4.56 3 0.1191 % 2,822.0
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.1726 % 2,332.1
Perpetual-Premium 5.28 % 2.07 % 93,565 0.40 28 0.1777 % 2,299.9
Perpetual-Discount 4.91 % 4.88 % 105,397 15.69 3 0.2625 % 2,578.7
FixedReset 4.96 % 2.95 % 176,613 4.03 72 0.0687 % 2,436.7
Deemed-Retractible 4.94 % 3.48 % 124,996 1.06 46 0.0194 % 2,375.7
Performance Highlights
Issue Index Change Notes
GWO.PR.N FixedReset -3.57 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.20
Bid-YTW : 3.97 %
POW.PR.D Perpetual-Premium 1.07 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2012-10-31
Maturity Price : 25.50
Evaluated at bid price : 25.56
Bid-YTW : -0.23 %
SLF.PR.H FixedReset 1.07 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.60
Bid-YTW : 3.90 %
Volume Highlights
Issue Index Shares
BNS.PR.L Deemed-Retractible 149,445 National crossed blocks of 50,000 and 19,800 at 25.75; they also bought blocks of 47,100 and 22,700 from Nesbitt at the same price.
Maturity Type : Call
Maturity Date : 2016-04-27
Maturity Price : 25.00
Evaluated at bid price : 25.58
Bid-YTW : 3.70 %
TD.PR.G FixedReset 125,845 Scotia bought 13,400 from RBC at 26.95; TD crossed two blocks of 50,000 each at the same price.
Maturity Type : Call
Maturity Date : 2014-04-30
Maturity Price : 25.00
Evaluated at bid price : 26.95
Bid-YTW : 1.87 %
BNS.PR.X FixedReset 87,095 Scotia bought 77,800 from RBC at 26.55.
Maturity Type : Call
Maturity Date : 2014-04-25
Maturity Price : 25.00
Evaluated at bid price : 26.54
Bid-YTW : 1.89 %
ENB.PR.P FixedReset 86,580 Recent new issue.
Maturity Type : Limit Maturity
Maturity Date : 2042-09-28
Maturity Price : 23.11
Evaluated at bid price : 25.06
Bid-YTW : 3.75 %
TD.PR.A FixedReset 72,726 National crossed 30,000 at 25.93, then bought 39,200 from Nesbitt at the same price.
Maturity Type : Call
Maturity Date : 2014-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.93
Bid-YTW : 2.78 %
SLF.PR.F FixedReset 72,176 RBC sold 48,100 to Scotia at 26.48, then crossed 19,100 at the same price.
Maturity Type : Call
Maturity Date : 2014-06-30
Maturity Price : 25.00
Evaluated at bid price : 26.49
Bid-YTW : 2.52 %
There were 32 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
GWO.PR.N FixedReset Quote: 23.20 – 24.05
Spot Rate : 0.8500
Average : 0.5704

Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.20
Bid-YTW : 3.97 %

TCA.PR.X Perpetual-Premium Quote: 51.27 – 51.89
Spot Rate : 0.6200
Average : 0.3999

Maturity Type : Call
Maturity Date : 2013-10-15
Maturity Price : 50.00
Evaluated at bid price : 51.27
Bid-YTW : 2.65 %

BNA.PR.C SplitShare Quote: 24.10 – 24.43
Spot Rate : 0.3300
Average : 0.2029

Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 24.10
Bid-YTW : 5.10 %

POW.PR.A Perpetual-Premium Quote: 25.30 – 25.59
Spot Rate : 0.2900
Average : 0.1744

Maturity Type : Call
Maturity Date : 2012-10-28
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : -11.74 %

FTS.PR.E OpRet Quote: 26.47 – 26.88
Spot Rate : 0.4100
Average : 0.3259

Maturity Type : Call
Maturity Date : 2013-06-01
Maturity Price : 25.75
Evaluated at bid price : 26.47
Bid-YTW : 1.14 %

BNS.PR.L Deemed-Retractible Quote: 25.58 – 25.80
Spot Rate : 0.2200
Average : 0.1404

Maturity Type : Call
Maturity Date : 2016-04-27
Maturity Price : 25.00
Evaluated at bid price : 25.58
Bid-YTW : 3.70 %

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