by MrBill » Fri 08 Jun 2007, 03:31:34
[align=center]The case for a steepening yield curve[/align]
Well, first of all, Brent crude is $71, and so far nothing unusual has even happend, yet! WTI is only $67 because there is not enough refining capacity, so Cushing, Oklahoma, is over-supplied. i.e. not enough refining capacity to turn crude into products. Refining margins have retreated from their highs, but are still a healthy $20-22 per barrel, which is more than twice as high as the start of the year. So energy prices are not a moderating influence on inflation at the moment. *
*Quick Update: Today the ECB's Garganos said as much in comments on Reuters (maybe he read that here first?).
$this->bbcode_second_pass_quote('', '[')b]The headline number in yesterday’s employment cost report from the Bureau of Labor Statistics (BLS) was the upward revision in Q1:07 overall business unit labour cost growth from 0.7% to 1.9% (quarterly growth at seasonally adjusted annualised rate). This upward revision is surely not good news, but it was largely predictable from the downward revision to Q1 GDP that was released at end-May. Compounding that setback, though, was an unexpected upward revision to the increase in hourly compensation from 1.9% to 2.5% (again SAAR). In fact, the preliminary report of a 0.7% unit labour cost pace issued a month ago did not have the ring of truth anyway. Moreover, neither 2.5% wage growth nor 1.9% unit labour cost growth is alarming.
Also released, however, was a preliminary Q1:07 evaluation of unit labour cost growth among non-financial corporations only. Economists prefer this sub-measure because productivity in the financial sector is so hard to assess. Non-financial productivity rose only 0.6% (SAAR), while hourly compensation advanced 4.7% (SAAR). Together they produced a unit labour cost increase of 4.1%, which is unsettling. Placed in the context of consumer price increases of 3.9% in Q1, the result does not look so terrible; labour costs rose only slightly faster than prices in general. This is of little comfort, however, to producers of goods and services whose prices have not risen in tandem with that of gasoline!
We are reassured by our expectation that GDP growth will rebound substantially in Q2:07, which will tend to raise productivity and therefore depress unit cost advances, other things being equal. However, the recent acceleration of compensation among non-financial firms is still potentially worrisome. In the completely independent report on personal income and outlays issued monthly by the Bureau of Economic Analysis, there has been explicit discussion of unusually large bonus payments and exercises of stock options that inflated Q1 measures of compensation gains. This has probably affected the BLS readings as well, in which case Q2 hourly compensation increases are likely to be much lower. For the moment, we are not worried about wage-push inflation.
Source:
ResearchStrategy@Standardbank.com So, in a nutshell, although the analysts are not out and out worried about wage-push inflation, unit labor costs are rising faster than productivity, and so are wages. That sounds like inflation to me? It certainly limits the Fed's ability to cut rates even if they are not inclined to raise them at the moment. As far as the bond market is concerned, higher expectations of future growth and inflation mean higher long-term yields. A steepening yield curve.
$this->bbcode_second_pass_quote('', ' ')The yield on the benchmark Treasury is climbing--again.
Yesterday, the 10 year closed at just under 4.98%, the highest since last August. The immediate cause of the renaissance in the price of money is the growing suspicion that the recession has been postponed--again.
-------------------------------------------------------------------------------------
The bubbling of pricing pressure hasn't been lost on the bond market, which now sees fit to err on the side of caution as to what comes next. Adding to the anxiety in pricing money is yesterday's counsel from Fed Chairman Ben Bernanke on the always delicate matter of inflation. "Although core inflation seems likely to moderate gradually over time," the chairman said in prepared remarks for the International Monetary conference in South Africa, "the risks to this forecast remain to the upside."
The potential for future inflation trouble, in short, isn't quite dead, he warned--again.
Meanwhile, today brings news that the European Central Bank has raised interest rates--again. The Continent's benchmark refinancing rate was elevated to 4.0%, the highest in six years. "This decision was taken," said ECB President Jean-Claude Trichet, "in view of the prevailing upside risks to price stability over the medium term that we have identified through both our economic and monetary analyses."
The ECB, in other words, is worried about inflation--again.
source:
IT'S ALL ABOUT INTEREST RATES--AGAINAs we can see it is not just about US dollar zone inflation - affecting energy, commodities, base metals and other exports denominated in US dollars - but also a global uptick in inflation that is causing central banks from Sydney to The City to hike rates in concert. Against this backdrop is hard to imagine the Fed aggressively easing, while the ECB is still tightening, and, if so, then we can expect a much weaker US dollar vis a vie the euro, which again fuels imported inflation into the USA, while stimulating demand for those commodity exports denominated in US dollars, but purchased in converted euro, yen and yuan.
A couple of days ago I promised to post a little about hedging in a steepening yield curve environment either from higher inflation, stronger growth, a weaker dollar, or a combination of all three. Here is one proposal I received earlier this week.
$this->bbcode_second_pass_quote('', ' ')
Hi MrBill,
further to our conversation please find the presentation of Steepener Max, which is a very innovative product that looks at the USD Curve.
As I have mentioned on our call we could also enter into a repo where Big Bank would finance the purchase of this bond so you dont sacrifice liquidity . Very roughly (subject to credit constraints) we could finance this at LIBOR flat.
I am looking forward to your comments.
The product is very simple to describe :
The client invests 100% today
At maturity, the note redeems at 95% + Steepener Max
Steepener Max equals 35 times the maximum level of the 10y UST - 2y UST over the 5-year period.
The very strong selling points are as follows :
Over the last 15 years, the note would have redeemed on average at 177% (more than 12% p.a.)
There is no timing concern. The client just needs the curve to be steep at anytime over the next 5 years
There is no mark-to-market concern. The client locks in the maximum level.
If there is an economic slowdown (or equity crash, or property crash, etc.), the curve is likely to be steep -> very good hedge
95% principal protected - but historical redemption over 15 years has never been below 100% (actually 127%)
It is a very good product in itself, but also a very good hedge and diversifier for equity and real estate portfolios.
Structure as follows :
Form: EMTN issued by Big Bank
Currency: USD
Re-offer: 100%
Maturity: 5 years
Redemption: 95.00% + 35 x Max (Steepener Max, 0)
Steepener Max: The maximum level of UST10y - UST2y observed quarterly during the life of the note
You can find the Powerpoint presentation and the termsheets attached.
Kind regards,
Your friendly Salesperson.
Source: Big Bank, June 05, 2007
Just to clarify her point about a slowing economy, and my point about faster growth. She means if the economy does slow, 2 year yields will fall relative to 10 year yields. I mean if the economy picks up pace, and inflation is persistant, then 10 year yields will increase. So it is a spread position. Not just a directional play.
However, she is right, it is an interesting product. Of course, one can synthetically recreate it without buying a note issued by Big Bank by buying 10y UST yields, by selling the 10y UST future, and simultaneously buying a 2y UST bond. Without the leverage of course.
The Steepener Max offers up to 35x the yield difference, but the upfront risk is the 5% difference between a bond that matures at PAR 100 where the capital guarantee is 95%, and of course you have to fund your trade for 5-years. In this case they are prepared to fund me at LIBOR when I repo the note with Big Bank, but my cost of funding is still higher than LIBOR. And there is an opportunity cost to locking up those funds for 5-years.
Still, I am impressed that financial engineers do sit around all day and think about these products to either hedge risk or express a view. Something for everyone just in case you were feeling a little bit helpless about the future.
Update: On balance of payment (BOP) data supporting the case for a lower US dollar
because short-term rates caught up to long-term rates i.e. flattening of the yield curve. $this->bbcode_second_pass_quote('', ' ') Third, I think the income balance is poised to deteriorate significantly. That is the real source of my pessimism. The market no longer expects the Fed to ease by much. Short-term rates will stay around 5%. And long-rates have moved close to 5%. That suggests to me that the interest bill on the United States external debt is set to rise: the US will be taking on new debt at 5% plus to cover its deficit, as well as rolling over an awful lot of old debt at higher prices.
In 2006, short-rates rose faster than long-rates – and short-term debt intrinsically reprices faster than long-term debt. The net result was that the implied interest rate on the United States roughly $5 trillion in external lending rose faster than the implied rate on its $10 trillion in debt, since the US tends to lend short and borrow long. I expect the US lending/ borrowing spread to shrink dramatically in 2007.
Source:The organized state is a wonderful invention whereby everyone can live at someone else's expense.
by MrBill » Mon 11 Jun 2007, 09:32:17
On Friday I ended the week talking about yield steepening trades. While what better place to start this week, eh? More fuel on the fire from various sources, starting with central banks raising rates on inflation concerns, and comments from Bill Gross of PIMCO fame.
$this->bbcode_second_pass_quote('', 'T')he cozy world of easy money and rallying stock markets is slowly fading as bond yields in the United States and abroad surge on fears of inflation and on central bank interest rate hikes.
The jump in bond yields portends a sustained period of higher interest rates, increasing the cost of capital for Corporate America. It may also keep the furious run in global stock markets and corporate credit sectors from overheating.
This week alone, the European Central Bank, Reserve Bank of New Zealand and South Africa's central bank raised interest rates, citing inflationary pressures as the dominant factor behind their decisions.
Additionally, Federal Reserve Chairman Ben Bernanke on Tuesday quashed speculation of any interest-rate cuts when he warned inflationary risks remain high.
Even long-time bond bull Bill Gross, chief investment officer for Pacific Investment Management Co., which manages the world's largest bond fund, conceded on Thursday that the solid pace of global economic growth and inflation will likely keep bonds under pressure.
That forecast prompted Gross to acknowledge himself a "bear market manager" after a quarter of a century as the global bond market's most powerful bull.
Rising global interest rates shut off easy moneyThis contrasts markedly from an article written at the end of 2006 here.
$this->bbcode_second_pass_quote('', 'C')apital markets are awash in money, lifting all manner of assets to records this year and brightening prospects for 2007, but key money managers fret that an errant move by a key central bank could crash that party.
Liquidity wave lifts markets, but beware droughtSome reasons why the market may be more worried about a pick-up in inflation now than they were last year? Well, some recent trends that had helped keep prices down, despite rising commodity, energy and metals prices, now seem to have run their natural course and are experiencing late stage diminishing returns.
$this->bbcode_second_pass_quote('', 'A')ll of a sudden, inflation is back.
At least that's what one would be led to believe based on a
resurgence of inflation articles, if not the re-emergence of
That 70s Scourge itself.
It seems that global growth is turning up the heat on
prices. Remember those billion Chinese and Indian workers being
inducted into the industrial labor force, offering their
services cheaply to any and all bidders? That excess capacity is
now gone, based on what I read.
How about the forces of globalization, working to keep
costs and prices down? A one-time event.
And what about the adoption of inflation targets by central
banks around the world, more committed than ever to price
stability? Central banks by and large are currently engaged in
raising benchmark interest rates.
Source: Caroline Baum, Is Inflation Coming Back or Just Filling a Void? Bloomberg, June 8, 2007
And Larry Krohn from Standard Bank asks what will happen if rates keep rising? A fair question given what is currently happening.
$this->bbcode_second_pass_quote('', 'H')appily, short-term UST yields are backing off today while European and US (but not Asian) equity markets appear to be stabilizing. But that is no guarantee of long term respite, especially since US 10- and 30-year yields have continued to rise, reaching levels unthinkable as this week began. Yesterday’s stock and bond market sell-off was brutal, transforming what might have been construed as a correction into a financial event not well understood, not easily remedied and therefore very dangerous.
The economic fundamentals driving the US economy and its markets have not warranted price declines of this magnitude. What was the trigger on May 10 when the sell-off began? And this week’s? Was it last Friday’s May employment growth of 0.1%? Important housing indicators are released from about the 18th to the 26th of the month; outside those days, should we pretend that home building is a full participant in the recovery and not a drag on the economy?
At this point, the fundamentals do not seem to matter. The bond market slide now has a month’s worth of momentum; one need not be a technician to find that ominous. Standard now feels compelled to enunciate a grim scenario that would have appeared alarmist and irresponsible just a few days ago. And it is not the one where the Fed tightens because some indicator came in on the wrong side of neutrality.
Markets are plunging world- wide, of course, but the US is especially vulnerable on two counts: first, although consumer credit rose at a mere 1.3% pace in April (in data released yesterday by the Fed), credit outstanding from earlier borrowing is very high. As we noted earlier this week, American households have been dissaving throughout the housing slump. Mortgage debt in particular, though slowing over the last year, is still very high (nearly US$10tn) after rapid growth in the 2002 – 2005 period. Second, the cumulative current account deficits of the US as a whole made it a net international debtor several years ago, with large amounts of its bonded indebtedness – and not just Treasuries – in the hands of (doubtless nervous) non-residents and readily marketable.
Put yourself in the shoes of a typical US homeowner with funds invested in a 401k or other retirement account. Two years ago, your home was appreciating and your portfolio was adding value with almost every monthly statement. Last year, your house had stopped appreciating, or nearly so, but your retirement portfolio continued to prosper (though not steadily, of course). Today, both are falling and $3.00 gas is eating into your disposable income. With an eye on your net worth, you spent freely and probably borrowed, even after home prices had turned the corner, because your financial assets were performing. Now your stocks and bonds are losing value, and on days like yesterday the loss potential appeared open-ended. Even though your job looks secure, you are increasingly worried so you moderate your spending out of fear and necessity.
The above illustrates the wealth effect, not witnessed so far in this housing slump. The only persuasive explanation of its absence is the equity market bonanza that has offset and thus masked it. If the wealth effect on consumption now asserts itself, given the ongoing decline in housing activity (exacerbated by rising fixed-rate mortgage interest rates) and an inevitable business investment reaction to higher borrowing charges, the US could plunge into the recession that had recently vanished from street forecasts.
If non-resident holders of depreciating US debt simultaneously decide to cut some of their losses, the upward pressure on US interest rates could intensify. By that time, the dollar, which has firmed a bit recently on the hope that the Fed might tighten, might well be sinking under the weight of these non-resident sales, further fuelling the downturn. It could get ugly.
This is not our base case scenario, which calls for yields to pull back and the US economy to grow slowly without accelerating inflation. Obviously, though, volatility and the uncertainty attaching to all economic and market forecasts have greatly increased.
The organized state is a wonderful invention whereby everyone can live at someone else's expense.
by MrBill » Tue 12 Jun 2007, 05:24:48
This article on the FT.com will soon be password protected, so I am taking the liberty of posting it here in its entirety. Thanks.
$this->bbcode_second_pass_quote('', '[')b]Putin calls for new financial world order
Russian president Vladimir Putin called on Sunday for a radical overhaul of the world’s financial and trade institutions to reflect the growing economic power of emerging market countries – including Russia.
Mr Putin said the world needed to create a new international financial architecture to replace an existing model that had become ‘archaic, undemocratic and unwieldy’.
His apparent challenge to western dominance of the world economic order came at a forum in St Petersburg designed to showcase the country’s economic recovery. Among 6,000 delegates at the biggest business forum ever held in post-Soviet Russia were scores of international chief executives including heads of Deutsche Bank, BP, Royal Dutch Shell, Nestle, Chevron, Siemens and Coca-Cola.
Business deals worth more than $4bn were signed at the conference – including an order by Aeroflot for Boeing jets – as executives said they were continuing to invest in Russia despite deteriorating relations with the west.
Mr Putin’s hosting of the forum capped a week in which he dominated the international stage. He warned last Monday that Russia might target nuclear missiles at Europe if the US built a missile shield in Poland and the Czech Republic, then offered a compromise at the G8 summit involving switching part of the US system to Azerbaijan.
His speech on financial institutions suggested that, along with an aggressive recent campaign against US ‘unilateralism’ in foreign policy, he was also seeking to challenge western dominance of the world economic order.
Mr Putin said 50 years ago, 60 per cent of world gross domestic product came from the Group of Seven industrial nations. Today, 60 per cent of world GDP came from outside the G7.
‘The interests of stable economic development would be best served by a new architecture of international economic relations based on trust and mutually beneficial integration,’ Mr Putin said.
The Russian president said there was increasing evidence that existing organisations were ‘not doing a good job regulating global economic relations’.
‘Institutions created with a focus on a small number of active players sometimes look archaic, undemocratic and unwieldy. They are a far cry from recognising the existing balance of power,’ he said.
Source: FT.com, June 11, 2007
The IEA sees higher world oil demand, ups pressure on OPEC. Source: Reuters, June 12
$this->bbcode_second_pass_quote('', 'I')nternational Energy Agency confirms that Tuesday's sharp world oil demand revision upward for this year pushes it through 86mln b/d for the first time. IEA sees annual demand growth boosted to 2% against 1.8% last month, or 170,000 b/d.
Source: Dow Jones
$this->bbcode_second_pass_quote('', '
')Commodity Watch
Improved economic outlook will likely support commodity demand
Despite an improved demand outlook, we maintain our 12-month return forecast for the S&P GSCITM Total Return Index at 6.4% and our recommendation for a neutral allocation to commodities. We continue to recommend an overweight toward energy over the medium term.
Commodities did not escape last week's asset volatility
Concerns over rising global interest rates and inflation fears that led to an exceptionally large correction in the US bond market last week also led to substantial declines in commodity markets, leaving the S&P GSCITM Total Return Index up 3.1% this year.
The demand outlook for commodities has broadly improved
While the global economy is clearly walking a fine line between growth and inflation, with the US economy likely hitting a trough in 1Q2007 and European and Asian economies still gaining momentum, the near and medium term outlook for commodity demand has, if anything, improved.
Still high price levels and supply responses leave us neutral
Despite the improved economic outlook, prices have generally already reached high levels and supply drivers in some instances present downside risk from current levels. As a result, we maintain our 6.4% return forecast and our recommendation for a neutral allocation to commodities. We also maintain an overweight towards energy.
source: Goldman Sachs Commodities Research
June 11, 2007
Today is a holiday in Russia, so I will soon join my colleagues, and take the rest of the day off. It is so nice that it would be a shame not to. Still, wanted to check some mails and came across that Putin article in the FT, so looked it up to post here. Luckily, it was still there from yesterday.
Is it me? Probably, but to be brutally honest, with all the talk about steep learning curves and leap frog technology, I think it is a pretty pathetic statment to say, that 50-years ago the G7 accounted for 60% of GDP, and now 60% comes from outside the G7.
I mean let's be serious about this. 50-years of the fastest international development in modern history - where international trade outstripped GDP growth - and all the Asian Tigers and other would-be economic powerhouses could achieve is a 20% increase in market share over their mature slow-growing rivals? Scandalous! It just shows how backward they were - with so much corruption, bureaucracy, red-tape and crony capitalism - that it was all they could achieve.
I am glad the BRICs of this world can take their own place on the global stage, but really, I have to say, 'HAKOHEch!' Or, 'it is about time!' I wonder how they would have faired without great dollops of technology transfers from western countries as well as sending their best and brightest to study engineering, sciences and business in our schools and universities? Things that make you wanna say, hmmm?
Enjoy. I am outta here! ; - )
The organized state is a wonderful invention whereby everyone can live at someone else's expense.
by MrBill » Wed 13 Jun 2007, 04:02:12
$this->bbcode_second_pass_quote('Doly', '')$this->bbcode_second_pass_quote('MrBill', '
')Is it me? Probably, but to be brutally honest, with all the talk about steep learning curves and leap frog technology, I think it is a pretty pathetic statment to say, that 50-years ago the G7 accounted for 60% of GDP, and now 60% comes from outside the G7.
I mean let's be serious about this. 50-years of the fastest international development in modern history - where international trade outstripped GDP growth - and all the Asian Tigers and other would-be economic powerhouses could achieve is a 20% increase in market share over their mature slow-growing rivals? Scandalous!
It is you, Mr Bill.
As anybody knows, the game is stacked in such a way that if you are rich, there is a strong likelihood of remaining rich, and if you are poor, there is a strong likelihood of remaining poor. So, achieving a 20% increase in market share is no mean feat.
As anybody knows? Actually, 'objective' research shows that downward social mobility is more common. Or as they say, "short sleeves to short sleeves in three generations."
I was being a little provactive, but, of course, if these BRICs and Asian Tigers really want to take their place on the world stage, and replace archaic institutions like the G7, UN, WTO, IMF, etc., then I guess the proof will be in their concrete actions not in their rhetoric.
All the empty words in the world do not add up to one concrete action.
Russia might symbolically start by giving up their veto on the UNSC as a token move towards reforming the UN to give Japan, Germany, Brazil and India more say. That would be an important first step to reforming an archaic institution that has become quite obsolete.
Of course, the AU and ASEAN might also start to enforce a uniform code of conduct amoung their members with regards to corruption and human rights as well. But will they any time soon? It is much easier to rail against the system than to reform it. Especially, as the fruits of power are very tempting once you're in charge.
However, feel free to prove me wrong. You may want to start with this survey of Brazil. Please explain to me in detail how the outside world is keeping Brazil poorer than it could be? Thanks.
$this->bbcode_second_pass_quote('', 'F')ecundity and frustration sum up the state of Brazil these days. It is bursting with the commodities coveted by the rising economies of Asia, from soya to iron ore. No other country is better placed to cash in on the global craze for biofuels. Yet Brazil refuses to grow in line with the expectations of its 188m people. Since the end of the “miracle years” of the 1960s and 70s, when it was the world's second-fastest-growing large economy, Brazil has lagged (see chart 1). In the past four years, whereas developing countries as a whole have grown at an average of 7.3%, Brazil has loped along at 3.3%.
In 2003 Goldman Sachs, an investment bank, selected Brazil, along with Russia, India and China, as one of the four “BRICs”—the developing countries that would share dominance of the world economy by 2050. It has been the slowest-growing by far, leading some Brazilians to wonder whether the “B” would be dropped. South Korea's income per person overtook Brazil's in the 1980s; it may not be so long before China's and India's do the same.
Brazilians have non-economic grounds to fret, too. In its first crack at national power the Workers' Party (PT) of President Luiz Inacio Lula da Silva—which used to crusade against corruption—orchestrated a baroque scheme involving bribes to Congressmen in exchange for votes, known as the mensalao (monthly allowance). The Congress that ended its four-year mandate in December is widely reviled as “the worst in history”. Within the past year Brazil's two biggest cities, Sao Paulo and Rio de Janeiro, have been terrorised by gangs operating from inside the prison system. Education, perhaps Brazil's biggest failing, seems to be getting worse rather than better. Air travel has been crippled following the mid-air collision last year between a passenger plane and an executive jet. Brazil is “falling to pieces”, lamented Lya Luft, a columnist for Veja, the biggest news magazine, last year.
Souce:
Brazil is big, democratic, stable and rich in resources. So why is it not doing a lot better?
The organized state is a wonderful invention whereby everyone can live at someone else's expense.
by MrBill » Wed 13 Jun 2007, 04:47:01
[align=center]Yield curve steepening PLUS a sell-off in the bonds [/align]
Here is what ML has to say about it. Keeping in mind that - as the world's largest securities firm - they get paid 'to sell stuff', so they are not usually known for being bearish on anything, unless they are more bullish on something else! ; - )
$this->bbcode_second_pass_quote('', 'M')ACRO
1/ David Rosenberg expects the near-term view on 10 year bonds to tick up to 5.5% before heading back down to 4.5%. Check out his "dirty dozen" - 12 reasons why bond investors have "thrown in the towel". These include foreign governments buying alternative securities (i.e. Blackstone), infrastructure spending, commodity inflation. Rosie thinks that the bond sell-off will be stopped in its tracks before long. But if we are indeed a secular bear market in bonds, equity investors should look to 1981 when the secular bull bond market led the equity market by nearly a year.
Bearish Case for Bonds.
Check out the "dirty dozen" - 12 reasons why bond investors have "thrown in the towel". $this->bbcode_second_pass_quote('', 'T')he “dirty dozen”
In that vein, we have identified 12 — what we call the “dirty dozen” — reasons that so many pundits have thrown in the towel and turned both near-term and long-term bearish on bonds:
1. The “reverse conundrum”: Convergence of real interest rate in the Treasury market to the real growth rate in the economy (2.0-2.5%) as growth expectations get revised up. The global economy has expanded 5%+ for three years in a row which last happened four decades ago.
2. This is also in part due to reduced foreign central bank support as monetary authorities toy with the idea of shifting from bonds to alternative securities.
3. Global capex boom — “savings glut coming to an end”. The liquidity that had been sitting in government bonds is being siphoned into stepped-up infrastructure overseas.
4. Commodity inflation — foodstuffs now joining energy on the resource inflation treadmill.
5. Worldwide shortage of skilled labor — labor force participation rates declining in USA, China to run out of surplus labor by ‘08-‘09.
6. Productivity Deceleration: No killer app this cycle, no capital deepening in weakest business spending cycle ever.
7. Reduced potential noninflationary speed limit from factors 4 and 5 — from 4%+ to 3%-. This means the Fed needs to stay tighter for longer.
8. As in '70s, we have booming global money supply growth on our hands — the broad money aggregates have exploded to the upside almost everywhere on the planet.
9. The 25-year downtrend line of 5.02% on the 10-year note yield was broken last week — this has called into question whether a secular shift has occurred (though this happened before).
10. War — Iraq proving to be intractable (Vietnam lasted 14 years). This is adding to fiscal and inflation pressures.
11. Growing trade protectionist sentiment in Congress.
12. Political change to the “left” come Nov/08 — a shift perhaps to more populist policies. More risks to globalization and the low inflation world it ushered in.
These are concerns that are at the forefront of everybody's minds these days, which implies that we are getting closer to the end of this correction. Now that the “dirty dozen” bearish assumptions are being priced into the market, we will be watching for any signs that they do not live up to their advanced billing. Sentiment has swung to such massive negative levels that if any or all of these
factors cited above do not come to fruition to the extent many now believe, this bond sell-off will be stopped in its tracks before long.
But if this is indeed the onset of a secular bear market in bonds, then equity investors should keep in mind that the secular bull market began in August 1981 — which led the secular bull market in stocks by nearly a year. Source: ML, Economic Commentary
12 June 2007
Here is their Global Emerging Market (GEM) Survey as to where fund managers are parking their cash at the moment.
$this->bbcode_second_pass_quote('', 'T')alking points from the GEM & Global Fund Manager Surveys
In the Global survey investors love energy and hate banks. It's the opposite in GEM where investors love banks and hate energy. Two contrarian pair trades: long GEM energy/short DM energy and long DM banks/short GEM banks.
Surprisingly GEM investors continue to underweight materials, despite the sector's brilliant year-to-date performance (+27%). That's positive for materials. We think industrials are a much more tempting short given universal bullishness.
It's consensus in GEM to be OW Brazil and Korea. And it's consensus to be underweight India, Mexico and South Africa. GEM investors have become much more bullish on Thailand and much more bearish on China.
In ML's Global survey: the highest growth expectations and the lowest global cash balances (3.7%) since Jan '06. There's optimism and profits to clip no doubt. But our risk appetite reading is modest by recent standards, so this FMS argues for choppy consolidation in equities rather than free-fall. Source: Merill Lynch
And it ain't just yields in the US that are headed higher either, mate.
$this->bbcode_second_pass_quote('', 'E')xpectations of higher global interest rates pushed U.S. government bonds to five-year lows on Wednesday, dragging stocks down but lifting the dollar to a 4-1/2 year high against the low-yielding yen.
Yields on benchmark 10-year Treasury notes spiked as high as 5.31 percent in early Asian trade, their highest since 2002 and above the fed funds rate target of 5.25 percent.
Hefty selling from mortgage players in the U.S. session amid fading expectations of interest rate cuts from the Federal Reserve were blamed for the renewed sell-off, along with a lackluster bond auction which highlighted the lack of interest from overseas buyers of U.S. paper.
Bond yields globally have been rising sharply in recent weeks as central banks tighten monetary policy in the face of strong demand.
Source: The organized state is a wonderful invention whereby everyone can live at someone else's expense.
by MrBill » Fri 15 Jun 2007, 06:10:47
Crude off its highs this morning, probably reflecting a tendency to take profit on recent longs, rather than a change in underlying sentiment. Certainly from the technical side the futures are ending the week on a strong note with no 'clear' reversal in sight (more on that).
The day's pivot point is around $67.50 in the August WTI ($70.85 in the Brent). Above there and it is a strong close to the week. Not much use in talking about support levels. They are all much lower. The daily support is at $65.45-75 and the weekly support down at $62.45-$64.45. We are certainly in no danger of testing those levels this week.
The resistance is a little closer. On the trading envelopes measuring over-bought conditions in the crude the WTI contract finds resistance at $67.85, which is just shy of its contract high at $68.09 in March. While the Brent is close to resistance near $71.95, which is above its contract high of $71.80 in May. That is measured by taking 2-standard deviations from the 21-day mean, and is usually a reliable indicator of over-bought/over-sold conditions. That means upside is limited ex-any external weather or geo-political supply interuptions that unexpectedly come to fruition.
Crack margins are supporting the price of crude as well as geo-political supply worries eminating out of the ME (where else?) despite OPEC comments that they would keep markets well-supplied if need arose.
The crack margin for WTI for August is currently $21-22 per barrel or approximately 31-32% of the cost of the crude. It ain't the oil producers getting rich this summer, but those who own the refineries.
However, the S&P Energy Index (GSPE) is up at very high levels - on the back of tight fundamentals in supply and wide refining margins - after doing a marginal correction last week. Support for the GSPE is near 510 which was recently tested, while the high is 537. The pivot point is around 521.50-524. A close above that area this week would indicate that energy stocks are still go, go a ga-ga.
That along with strong Chinese demand is not alleviating inflation concerns one little bit. The IEA announced this week that they have raised global demand forecasts for 2007 to 86 mbpd. If we peaked in oil production in 2005; and if there can be no economic growth without increasing amounts of energy; then how did the world economy expand 4-5% p.a. since 2005? I guess it is just me (again)?
$this->bbcode_second_pass_quote('', 'T')he yen hit a 4-1/2 year low versus the dollar on Friday after the Bank of Japan left interest rates on hold and gave limited guidance on future tightening.
The dollar was broadly firmer as investors anticipated U.S. inflation data could boost the view the next move from the Federal Reserve on rates would be up rather than down.
The BOJ left rates at 0.5 percent and governor Toshihiko Fukui said he had no preconceived idea about a future rate rise, adding that he wanted to be more convinced on the sustainability of domestic capital spending and consumption.
"The market had been assuming there would be a rate hike at the August meeting but (the Fukui comments) suggest that it was not a done deal which the yen didn't like," said Adam Cole, senior currency strategist at Royal Bank of Canada.
By 0740 GMT, the dollar was up a quarter percent at 123.28 yen, its highest since December 2002.
The euro was up 0.3 percent at 164.04 yen, closing in on the record high above 164.60 set earlier in June.
The single currency was steady at $1.3309, having hit an 11-week low this week.
Source:
Yen plumbs 4-1/2 year low vs dollar after BOJ
Well, with higher interest rates and high oil prices fueling inflation one might expect weaker stock markets? Certainly, one might expect those countries with stronger currencies to be feeling the pressure at the moment? Wrong on all accounts.
Although the euro is stronger and the ECB is raising rates - the 10y bund is yielding 4.68% versus one year EURIBOR of 4.51% - the DAX is up 19.44% YTD. That compares with the S&P500 up 7.38% over the same period.
Meanwhile, the Hang Seng and the Nikkei, which one might expect to be benefiting from growth in China and/or a weak yen, we see that the HS is only up 5.27% YTD and the Nikkei225 up 4.33% over the same period. That is without the currency effect. Measured in USD the HS is up just 4.72% and the Nikkei up a piddly 0.64% YTD. And this in what's supposed to be the era of cheap money and excess global liquidity raising all prices. Huh? Measured in CNY the HS is only up 2.35% and the Nikkei is actually down -1.65% YTD. That compares with the DAX30 up 18% and the S&P500 up 4.94% YTD as measured in CNY.
Okay, you can slice and dice the numbers seven ways from Sunday, but the story is not just higher interest rates equal lower stock prices, or the domestic economy getting a free-ride off exporters who are benefiting from a weak yen. It is a little more complicated - at least up to now.
My feeling is that a steepening yield curve as central banks raise rates to tame inflation will erode stock market gains due to slower growth rates; reduced disposable income net of interest payments; higher funding costs for companies; lower PV to FV due to discounting; and from a stronger currencies - the EUR against CNY and the USD against the JPY for example - but these effects may take time to make themselves readily apparent. Plus their effects are being masked at the moment by excess money supply growth caused by prolific governments as well as oil producers and exporters that are sterilizing their export earning inflows to their domestic economy.
On top of the rate tightening, we need less money supply growth. We are not seeing it, which is one reason why the 10Y UST is up from 4.60% to 5.24% in a few short months. The bond market just not believe the Fed is on top of inflation at the moment with headline inflation at 2.6% and core still at 2.3% year on year.
As a matter of fact the money market is pricing 1-year LIBOR at 5.50% - up from 5.25% a few months ago - on expectations that the Fed may indeed be forced to raise rates rather than lower them going forward. That is going to eat away at the attractiveness of stocks as well as many other 'plays' that entail funding. One or two percent spread margin on top of 5.50% money market rates means investments break-even only over and above 6.5-7.5% p.a. in funding costs. Looking at stock market gains year to date, and only certain markets are paying for their long-term cost of capital at the moment, and many more are in minus even without currency gains or losses.
Just something to think about over the weekend. Take care and all the best. Cheers.
The organized state is a wonderful invention whereby everyone can live at someone else's expense.
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MrBill
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by MrBill » Fri 15 Jun 2007, 11:55:49
$this->bbcode_second_pass_quote('pup55', 'M')r. Bill:
How are we going to play yesterday's runup in WTI?
Alternatives:
See this as the narrow channel breakout we have been waiting for, and prepare to go long and stay long, riding it up to 80.
See this as an anomaly, and short the market below the close yesterday, and wait for it to fall back into the trading range of 61-64 as it has been for the last 6 months.
This is why I never made money in the commodities. I can see both scenarios.
I agree with your earlier comment that there is a lot of resistance at this point. But, with the middle east starting to blow up, little baby hurricanes starting to form in the gulf, all at exactly the same time the US drivers fire up the car for the annual road trip, there is a lot of fundamental and political upward pressure.
I think there is about $4 to be made on the short side, but maybe about $2 to be made on the long side, because there will probably be some resistance at 70, so maybe that is the answer.
Also we were looking at the RBOB, heating oil and crude oil contracts farther out yesterday. The October crude oil contract is about $2 higher than the July, but the RBOB October contract is about 20 cents lower than July. So, the spread farther out is even wider than in the front month. What do you think of shorting October crude and going long on RBOB and heating oil?
Wow, too late. I am just picking up messages before I disappear for the weekend. I cannot comment on spread plays at all. My feeling is that 'spreads' will remain historically wide for the time being. There is no new supply coming on line, so any increase in demand has to come at a price!!
My feeling is that the US situation is rather like an over-flowing bathtub, that a plugged drain - refining capacity - is responsible for high gasoline prices and wide crack spread rather than lack of supply.
But I have said the same thing since 2005. It is not like anyone care 'what' I think? That is why I retreated into oil supply companies and refiners as opposed to playing flat-priced crude this year.
The organized state is a wonderful invention whereby everyone can live at someone else's expense.
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MrBill
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by MrBill » Fri 15 Jun 2007, 12:27:43
$this->bbcode_second_pass_quote('seahorse', 'M')r. Bill,
You asked how can the world have increased economic growth with flat oil production. More along those lines, how can China and the US in particularly have increased oil usage is production has been flat? I can only assume that its because some countries are using less, i.e. Japan has used less. I can only assume other countries, namely third world like Zimbabwe for example are using less, which allows places like the US and China to use more. I don't know, only guessing, but would hope someone that can answer this question to do so.
I know that Japan has used less year on year. They have become more efficient. However, obviously, substitution plays an important role. My point was a jab at the point of view that growth 'must' always come from increased supply versus higher prices moderating demand and increasing efficiency.
I know you do not mean to, but do not insult 'us/ me' by trumpeting out anything about Zimbabwe as proof of anything
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by MOCKBA » Fri 15 Jun 2007, 16:24:37
$this->bbcode_second_pass_quote('MrBill', '
')$this->bbcode_second_pass_quote('', '
')
Form: EMTN issued by Big Bank
Currency: USD
Re-offer: 100%
Maturity: 5 years
Redemption: 95.00% + 35 x Max (Steepener Max, 0)
Steepener Max: The maximum level of UST10y - UST2y observed quarterly during the life of the note
You can find the Powerpoint presentation and the termsheets attached.
Kind regards,
Your friendly Salesperson.
Source: Big Bank, June 05, 2007
Just to clarify her point about a slowing economy, and my point about faster growth. She means if the economy does slow, 2 year yields will fall relative to 10 year yields. I mean if the economy picks up pace, and inflation is persistant, then 10 year yields will increase. So it is a spread position. Not just a directional play.
However, she is right, it is an interesting product. Of course, one can synthetically recreate it without buying a note issued by Big Bank by buying 10y UST yields, by selling the 10y UST future, and simultaneously buying a 2y UST bond. Without the leverage of course.
Interesting product indeed. However retail investors could play the same by simply buying TIP (without leverage and 35x multiplier that is). If the ecomony would slow the bond would do better then most other investments. If inflation would be presistant then both the 10 year portion would outperform and they would be compensated for inflation. Couple more treasury auctions and probably I would be taking position. I wanted to sterilize inflation out of TIP, but without trading bond futures it is not possible, so TIP is the next best thing and it is so damn easy.
Talking about differences in financial markets - in China you have to gamble IPO and real estate hoping the government will not evict you, in Russia you have to buy and rent out garages and hope your investments in Yukos or whatever are not next on the list of the government to reposses. In US you could be Joe six-pack taking a note of Bud price trends and directing your 401K accordingly.
by Mechler » Sat 16 Jun 2007, 00:24:48
$this->bbcode_second_pass_quote('drew', 'A')m I stupid for taking a profit? We'll see won't we. I sold my RIM today for $185 having bought it at the end of last quarter for 149. I think it was an expensive share at 149 let alone what I just sold for.
I took some profits today, too, gambling on the fact that after a 3-day run, next week may start lower.
In regards to RIM, I'm just put off by how tech stocks are expensive in general (especially in relation to energy). But, there have been some huge gains in RIM, GOOG, AMZN, AAPL, etc.
But, refiners have had huge gains as well, and thanks to Pup and DP, we should have seen that coming (so why didn't I?)
I know MrBill has eluded to an overbought situation in energy, but if oil drops back to $65 or lower I'm jumping back in.
But, I'm an amateur and will probably lose my money. What are you guys looking for before you get back in?
Drew, your long CEF - what's your view on PMs in the short term? GLD, SLV, and GDX have been laggards for me (I dumped GDX today).
"It is certain that free societies would have no easy time in a future dark age. The rapid return to universal penury will be accomplished by violence and cruelties of a kind now forgotten." - Roberto Vacca, The Coming Dark Age
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