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>>> High-Grade Bond-Fund Outflows Hit $35.6 Billion, Smashing Record
Bloomberg
By Claire Boston, Olivia Raimonde, and Alex Harris
March 19, 2020
https://www.bloomberg.com/news/articles/2020-03-19/investors-pull-record-35-6-billion-from-investment-grade-debt?srnd=premium
Withdrawal dwarfs second-largest outflow of $7.3 billion
Record $249 billion added to government money-market funds
Investors withdrew an unprecedented $35.6 billion from U.S. funds that buy up investment-grade debt this week as the global market rout from the spreading coronavirus intensified. At the same time, a record $249 billion poured into U.S. government money-market funds.
The withdrawals from corporate high-grade debt blow through the previous record $7.3 billion outflow from last week, according to Refinitiv Lipper. Funds that buy junk bonds lost $2.9 billion in the five business days ended March 18, while leveraged loan investors withdrew about $3.5 billion.
Credit markets had another volatile week amid a worldwide meltdown in risk assets. Risk premiums on investment-grade bonds reached levels not seen since the financial crisis, while junk bond yields breached 10% for the first time in more than eight years.
”The number is off the charts, but so is the magnitude of this market correction,” Dorian Garay, a portfolio manager at NN Investment Partners, said in reference to the investment-grade bond outflows.
Despite the turmoil, investment-grade companies including Walt Disney Co. and PepsiCo Inc. seized moments of relative calm to issue new debt. Many firms selling bonds this week were doing so to reduce their reliance on the commercial paper market, where prices have risen rapidly amid a broad market seize-up. Lipper fund flow data covers investment-grade funds that manage about $1.3 trillion in assets.
“The flows into IG have been so steady over the past eight years, that it was like the farmer coming with a daily handful of grain to feed the turkey in the back yard,” said Gregory Staples, head of fixed income at DWS Investment Management. “Today what the farmer had in his hand was an axe.”
Investment-grade bonds are poised for another one of the largest weekly losses on record as spreads widen to crisis levels. The three most recent daily outflows from high-grade funds and exchange-traded funds are the largest on record, Bank of America Corp. strategists led by Hans Mikkelsen said in a report Wednesday.
Money-Market Funds
The Federal Reserve stepped in on Tuesday, announcing that it would reintroduce the Commercial Paper Funding Facility, a measure it used during the financial crisis to shore up short-term funding markets.
Total assets in government money-market funds rose to an all-time high of $3.09 trillion in the week ended March 18, according to Investment Company Institute data that stretches back to 2007.
The prior weekly inflows record of $176 billion was set in September 2008 during the financial crisis caused by the collapse of Lehman Brothers.
Prime money-market funds, which tend to invest in higher-risk assets such as commercial paper, saw outflows of $85.4 billion, the largest move since October 2016, according to ICI. Total assets fell to $713 billion.
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>>> Fed unleashes commercial paper funding to support non-bank companies
by Brian CheungReporter
Yahoo Finance
March 17, 2020
https://investorshub.advfn.com/secure/post_new.aspx?board_id=8141
The Federal Reserve announced Tuesday that it will open a commercial paper funding facility to support the financing needs of companies facing stress amid the coronavirus outbreak.
The facility will support rollovers of commercial paper, a commonly used form of unsecured, short-term debt issued to raise funds.
With businesses forced to close and with consumer activity capped by quarantines around the country, concern has built up over previous weeks that companies will not be able to find funding to survive the public health crisis.
The commercial paper funding facility will establish a special purpose vehicle (SPV) that will purchase unsecured and asset-backed commercial paper from eligible companies as long as the paper is rated A1/P1 as of March 17. The facility would be available to companies of various industries, not just banks.
“An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak,” the Fed said in a statement.
The facility was opened in coordination with the U.S. Treasury, which will provide $10 billion of credit production via its Exchange Stabilization Fund.
The Fed has taken a number of uncommon actions recently amid the coronavirus outbreak.
An emergency 50 basis point cut from the Federal Reserve on March 3 was not enough to stop market turmoil, and on Sunday night, the central bank made another abrupt announcement by slashing rates to zero.
Fed Chairman Jerome Powell said the central bank’s actions over the past two weeks did not calm financial conditions as policymakers hoped, spurring the second emergency meeting.
In addition to pushing rates down to zero, the Fed also restarted the crisis-era policy of asset purchases, announced U.S. dollar swap lines, and eased bank rules to encourage lending.
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>>> Fed to Widen Treasury Buying, Expand Repo to Ease Market Strain
Bloomberg
By Matthew Boesler
March 12, 2020
https://www.bloomberg.com/news/articles/2020-03-12/n-y-fed-to-conduct-purchases-across-range-of-maturities-k7ozy3u5?srnd=premium
The Federal Reserve took aggressive steps Thursday to ease what it called “temporary disruptions” in Treasury financing markets, flooding the market with liquidity and widening its purchases of U.S. government securities in a measure that recalls the quantitative easing it used during the financial crisis.
The Federal Reserve Bank of New York said in a statement that the moves were “to address temporary disruptions in Treasury financing markets” at the direction of Fed Chairman Jerome Powell in consultation with the Federal Open Market Committee.
U.S. stocks trimmed staggering losses of more than 8% earlier in the day as investors absorbed the Fed’s muscular decision.
The buying will include coupon-bearing notes and match the maturity composition of the Treasury market, it said. Ten-year U.S. Treasury yields fell sharply to trade around 0.68%.
“The Treasury securities operation schedule includes a change in the maturity composition of purchases to support functioning in the market for U.S. Treasury securities,” the New York Fed said.
Term repo operations in large size have also been added to help markets function, it also said. The New York Fed said it would offer $500 billion in a three-month repo operation at 1:30 p.m. and repeat the exercise tomorrow, along with another $500 billion in a one-month operation, and continue on a weekly basis for the rest of the monthly calendar.
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>>> Stampede Into Treasuries Sets Up Auctions at Record Low Rates
Bloomberg
By Emily Barrett
March 8, 2020
https://www.bloomberg.com/news/articles/2020-03-08/stampede-into-treasuries-sets-up-auctions-at-record-low-rates?srnd=premium
Haven rush pushes 10-year yields to unprecedented levels
ECB to meet Thursday with expectations divided on outcome
Flight-to-safety in the world’s largest bond market will take on new meaning this week, with some Wall Street firms considering contingency plans for the spread of the coronavirus.
While traders await updates on their working arrangements, there may be little standing in the way of the haven trade that drove the U.S. 10-year yield down to an unprecedented 0.66% Friday amid an equities rout. The market will be watching for further liquidity strains in Treasury futures, and how that might translate into demand for more haven assets at this week’s Treasury auctions. Over the weekend, Saudi Arabia declared an all-out price war in the oil market, adding to the wall of worries over a looming recession and signs of strain in credit markets that have driven investors to the safety of Treasuries.
The Treasury is poised to sell a combined $78 billion of coupon securities at historically low yields. Wednesday brings $24 billion of 10-year notes. To get a sense of the ferocity of the bond rally in recent days as fear over the virus’s impact intensified, the last auction of this maturity, on Feb. 12, drew a yield of 1.62%.
This week's 10-year auction could easily break prior record-low yield
“Given those moves we’re seeing in the 10-year, that implies to me there’s a lack of inventory out there and you’ve got to think the auctions will go well,” said Lee Ferridge, a macro strategist at State Street Corp. “The risk from here has to be that things get worse before they start getting better.”
He’s now looking for the 10-year yield to head toward 0.5%, from a closing level of 0.76% last week.
Relentless demand has taken the maturity’s price to lofty levels going into this week’s auction. The current 10-year carries a higher price than any reopening since 2009.
Friday’s market moves have already drawn comparisons with the financial crisis, though with less confidence that policy makers can do much to combat the economic impact of the disease.
Markets barely registered last week’s pledge from the Group-of-Seven that it was ready to act, and the emergency rate cut from the Federal Reserve. As for the robust U.S. jobs report, Columbia Threadneedle strategist Ed Al-Hussainy dismissed it as “roadkill for this rates market.”
The underwhelmed market reaction to the Fed demonstrated the difficult task facing European Central Bank Governor Christine LaGarde on Thursday. Economists are split on whether the bank will unleash monetary stimulus at this meeting, and hopes are building instead for some fiscal response.
In the meantime, market participants are fixated on what sort of liquidity conditions will greet them in what promises to be another turbulent week.
“Markets are functioning, but it seems to me that on a day when the 10-year yield is lower by 20 basis points, that’s not orderly, that’s a gap,” said Mike Schumacher, head of rates strategy at Wells Fargo Securities, referring to the most extreme levels in Friday’s trading.
“I wish I had more answers,” he said. “We all do.”
What to Watch
Fed officials are in a blackout period ahead of the March 17-18 meeting, but markets will be fixated on the message from the ECB on Thursday.
The New York Fed will release new schedules on March 12 for its Treasury purchases and repo operations
Here’s the economic calendar:
March 10: NFIB small business optimism
March 11: MBA mortgage applications; consumer price index; real average earnings; monthly budget statement
March 12: Producer price index; jobless claims; Bloomberg consumer comfort; household change in net worth
March 13: Import/export prices; Bloomberg U.S. economic survey; University of Michigan sentiment
The auction slate is busy:
March 9: $42 billion of 13-week bills; $36 billion of 26-week bills
March 10: $38 billion of 3-year notes
March 11: $24 billion of 10-year notes reopening
March 12: 4-, 8-week bills; $16 billion of 30-year bonds reopening
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>>> JPMorgan Sees ‘Early Signs’ of Stress on Credit and Funding
Bloomberg
By Joanna Ossinger
March 7, 2020
https://www.bloomberg.com/news/articles/2020-03-08/jpmorgan-sees-early-signs-of-stress-on-credit-and-funding?srnd=premium
The fallout from the global spread of coronavirus may be starting to affect credit and funding markets, according to JPMorgan Chase & Co.
Supply-chain disruptions and demand shock from the virus fallout could already be causing cash-flow problems for businesses, JPMorgan strategist Nikolaos Panigirtzoglou wrote in a note Friday. That’s probably even more true for smaller companies and those in sectors like travel and lodging, he said.
“If these shifts in credit and funding markets are sustained over the coming weeks and months, especially in the issuance space, credit channels might start amplifying the economic fallout from the Covid-19 crisis,” Panigirtzoglou said. Unless “credit support by central banks and/or governments is broad, fast and direct, we note credit markets are facing an increased risk of the cycle turning with a lot more downgrades or even defaults over the coming months.”
Credit markets suffered their worst day in a decade on Friday amid fears that coronavirus will hurt corporate income and stymie some companies’ ability to repay their debt. Travel- and leisure-related companies were hit, while energy-company bonds and loans fell further into distress. A derivatives index that measures the perceived risk of corporate credit surged by the most since at least 2011 and in Europe the cost of insuring senior financial debt skyrocketed.
High-grade CDS index spread jumps by most since at least 2011
Market concerns about ratings downgrades and companies dropping to junk status are justified by a look at credit fundamentals, the JPMorgan report said. The median net-debt-to-Ebitda ratio for companies in JPMorgan’s high-grade and high-yield companies in the U.S. and Europe has risen steeply in the past decade and is now higher than in the previous two cycles in 2007/2008 and 2001/2002, it said.
“Companies are currently much more vulnerable to a decline in incomes and/or a rise in corporate bond spreads and yields than in the previous two recessions,” Panigirtzoglou wrote. “This is especially true for U.S. credit and for Euro high yield given the absence there of the backstop from the European Central Bank’s corporate bond program that solely benefits Euro high grade.”
There are some signs of stress in Yankee issuance as well, the report said, noting it tends to be more sensitive to funding concerns because non-U.S. companies can find it harder to raise dollar funding relative to domestic U.S. companies in periods of stress.
Read more: Europe’s ‘Zombie’ Borrowers Besieged by Spread of Coronavirus
It’s also the case that credit appears most vulnerable to an economic downturn, according to the note, using an analysis which looks at the historical behavior of various asset classes around past U.S. recessions, particularly the move from the pre-recession peak to the trough during the event.
relates to JPMorgan Sees ‘Early Signs’ of Stress on Credit and Funding
“Rate markets are now implying that something that looks like a U.S. recession is almost a certainty and have become even more disconnected from risky asset classes,” Panigirtzoglou wrote. “U.S. credit seems to be still most vulnerable to U.S. recession risks followed by U.S. equities.”
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>>> Hottest Bond Market in History Is Starting to Make Some Nervous
Bloomberg
By Cecile Gutscher and Anchalee Worrachate
March 3, 2020
https://www.bloomberg.com/news/articles/2020-03-03/hottest-bond-market-in-history-is-starting-to-make-some-nervous?srnd=premium
Duration bets at a record as coronavirus spurs caution
Haven play may turn dangerous if doomsday doesn’t come
Surging rate-cut expectations and a desperate lunge for safe assets amid the coronavirus outbreak have earned the bond market a lot of fans in recent weeks. The resulting rally is creating a few detractors, too.
A growing chorus of strategists and money managers is voicing concern as investors charge into government debt at seemingly any price.
The fear is they’re exposing themselves to interest rate risk like never before, risking a precipitous slump on even a modest bump in yields. One breakthrough in the fight against the illness, or a sign the global economy is recovering faster-than-expected, might be all it takes.
The yield on 10-year Treasuries touched an all-time low on Monday but traders didn’t have to look far for clues of just how fast the narrative can change. The S&P 500 Index surged 4.6% on bets central banks would coordinate to limit the economic impact of the virus. The moves highlight belief in some corners that policy action will stoke growth, creating upward pressure for stocks and bond yields.
“If things go a little better -- if there is a cure in the next two, three months or if with warmer weather the virus fades -- then long-end rates will sell off,” said Alberto Gallo at Algebris Investments. “Duration is expensive to protect the portfolio.”
The London-based money manager said he’s using short positions in credit to hedge the risk of a deeper sell-off.
Bond duration risk rises to record
Amid a rally so ferocious that it has stirred speculation some Treasury yields could even be headed below zero, the danger of rising bond yields still seems remote. Even those flagging it as a concern aren’t ready to unwind their bets on longer bonds -- for now.
The Federal Reserve’s announcement Friday that it was ready to act if needed took 10- and 30-year Treasury yields to new lows, with futures markets now pricing in more than 100 basis points of Fed cuts this year. The announcement by the Fed, a rare departure from typical central bank protocol, ushered in similar assurances from the Bank of Japan and the Bank of England.
The yield on the Bloomberg Barclays Global Aggregate Bond Index, which includes developed and emerging-market debt from governments and corporations, tumbled to 1.05% Monday, its lowest ever.
Global bond yields hit record low as investors seek virus havens
Still, the risks of taking one-way bets on bonds at such elevated valuations loom large. Sensitivity to changes in rates measured by duration is running at a record 8.6 years in the Bloomberg Barclays Global Aggregate Treasuries Index. That means every percentage point increase in average yields would spark a price decline of about 8.6%.
Bond traders throwing their faith behind policy makers should also be thinking about how steps to shore up confidence will affect those bets, according to Jim McCormick, the London-based global head of desk strategy at NatWest Markets. A boost to economic growth would ultimately mean higher long-dated yields.
“Central banks will likely cut and unlikely unwind them when things settle, but a recovery plus more fiscal policy should pressure the back end of the curve,” he said. “The curve steepens if the combination of policy response works.”
A sobering assessment by the OECD Monday did little to assuage market panic. The Paris-based group warned of possible global contraction this quarter and cut its full-year growth to just 2.4% from 2.9%, which would be the weakest since 2009.
As the number of new virus cases in China declines, those elsewhere are climbing, with countries like Brazil and Pakistan reporting instances of the illness for the first time.
But if measures to contain and stamp out the illness take hold, China returns to work and records an upswing in growth in the second quarter, bets on expensive government bonds may start to look dangerous.
Bond momentum signals tracked by a type of systematic investors known as trend followers have turned so extreme their bullish bets are now vulnerable to profit-taking, according to JPMorgan Chase & Co.
TLT posts its largest weekly outflow in more than a month
Wariness is reflected in passive flows in the world’s most heavily traded government debt product, the iShares 20+ Year Treasury Bond fund, which shows investors’ love affair with duration may be cooling somewhat. The ETF just posted its largest weekly outflow in more than a month.
“Chasing bonds when yields are at an all-time low seems very risky,” said Mark Dowding, a money manager at BlueBay Asset Management, who has a neutral stance on duration. “At the same time it seems that news flow on the virus will get worse before it gets better.”
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>>> Coronavirus Chaos Slams Credit Markets, Brings Deals to a Halt
Bloomberg
By Hannah Benjamin and Tasos Vossos
February 26, 2020
European bond market faces first day without deals in 2020
Warnings mount of hit to earnings as virus impacts growth
https://www.bloomberg.com/news/articles/2020-02-26/coronavirus-chaos-brings-corporate-debt-market-to-its-knees?srnd=premium
The global credit machine is grinding to a halt.
The $2.6 trillion international bond market where the world’s biggest companies raise money to finance themselves, has come to a virtual standstill around the world as the coronavirus spreads fear through company boardrooms.
In Europe, which had been enjoying the strongest ever start to the year -- with 239 billion euros ($260 billion) of bonds sold in January alone -- Wednesday saw no deals for the first time in 2020. The U.S. hasn’t seen a transaction since Friday while Asia, where the virus first emerged, has slowed to a trickle.
While such shutdowns are common during public holidays such as Christmas, they are extremely rare at other times of year.
Investors are rattled by the potential impact on company earnings from disruption caused by the virus, which has seen huge parts of global supply chains shutting down.
“It’s pretty serious,” said Shanawaz Bhimji, a fixed-income strategist at ABN Amro Bank NV, calling it a “very difficult” moment for investments in credit markets.
Deep Freeze
Coronavirus takes its toll on European primary bond market activity
Honeywell International Inc., Virgin Money UK Plc and Transport for London are among the European borrowers readying deals before financial markets started turning hostile.
Borrowing costs in euros for investment-grade companies have surged to 95 basis points, the highest level reached this year, according to a Bloomberg Barclays index, while default swaps insuring the debt of high-grade companies surged to the highest in four months. A closely-watched measure of risk in the junk-bond market also soared to a six-month high on Wednesday.
The number of coronavirus cases continues to climb, with the global death toll nearing 3,000. U.S. health officials have warned citizens to prepare for an outbreak, while South Korea has also emerged as a hot spot, with more than 1,000 reported cases there.
The worsening crisis is already taking a toll on companies’ balance sheets, with drinks maker Diageo Plc set to book as much as a 325 million-pound ($422 million) hit to organic net sales following significant disruption in Greater China since the end of January. French food maker Danone SA lowered its target for 2020 sales growth after slowing bottled water sales in China.
In the U.S., Mastercard Inc. shares tumbled as much as 7% this week after the company cut its revenue forecast as the spreading virus curbs international travel, while Apple Inc. said demand for iPhones in China tumbled 28% in January on the previous month.
Just four borrowers have visited Europe’s debt market so far this week, including ING Groep NV with a downsized sale of Additional Tier 1 notes on Monday. New deal announcements have also dried up, with only one mandate from the region yesterday.
Any sign that the epidemic is stabilizing may prove a fillip for sales, according to Luke Hickmore, investment director at Aberdeen Standard Investments in Edinburgh.
“We have seen before that any stability in markets tends to attract new issuance,” he said.
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>>> There’s a Wall of Cash Eager to Buy Treasuries on Any Price Dip
Bloomberg
By Liz McCormick and Ruth Carson
February 16, 2020
https://www.bloomberg.com/news/articles/2020-02-16/there-s-a-wall-of-cash-eager-to-buy-treasuries-on-any-price-dip?srnd=premium
It’s ‘a resilience play that makes sense’: BlackRock’s Thiel
Pensions, mutual funds and hedge funds have all piled in
Investors overseeing trillions of dollars are plowing money into U.S. government debt like never before, in a wave that’s only gaining strength as the spreading coronavirus casts doubt on the global growth outlook.
Evidence of the insatiable demand can be found across the fixed-income universe. Pensions, which have been ramping up bond allocations for more than a decade after a change in regulations, now hold a record amount of longer-dated Treasuries. Bond mutual funds saw a historic inflow of money last year, with no sign of a slowdown. Even hedge funds have piled in.
The wall of cash is a boon to American taxpayers as the federal deficit swells. It’s keeping Treasury yields, a benchmark for global borrowing, near all-time lows. With buyers ready to pounce, even surging stocks, record auction sizes and the tightest labor market since the 1960s can barely make a dent in bond prices.
“Treasuries are a resilience play that makes sense,” said Scott Thiel, chief fixed-income strategist at BlackRock Inc. “And so far, people have been rewarded for coming in and buying when yields get to the high end of the range.”
Investors have been buying on dips in Treasury prices
Just weeks ago, global economic reflation and the seeming inevitability of higher yields were the buzz among strategists and investors. The virus’s onslaught is unraveling that narrative, which already faced skepticism from those who argue that persistently low inflation and shifting demographics will pull yields lower.
“I expect the Treasury 10-year yield to fall to zero, perhaps within two years,” said Akira Takei, a global fixed-income fund manager at Asset Management One Co., which oversees more than $450 billion. “I’ve been overweight U.S. Treasuries. That’s based on my view that developed economies are facing a combination of aging demographics and falling birth rates, slow growth and low inflation.”
Investors snapping up Treasuries as an insurance policy have turned the U.S. yield curve on its head. With inflation still subdued and concern mounting that the spreading illness will damage an already fragile global economy, traders have boosted bets on Federal Reserve rate cuts in 2020. That prospect is in turn supporting equities.
The appetite for debt has extended to sovereign obligations of all flavors. One example: Greek 10-year rates once near 45% slid below 1% this month. The country’s junk rating is proving little deterrent with the world’s pile of negative-yield debt climbing above $13 trillion amid the latest global bond rally.
Benchmark 10-year U.S. yields have dropped to around 1.6%, from a 2020 peak of 1.94% in the first week of the year. The world’s biggest bond market has earned about 2.2% this year, after a 6.9% return in 2019 -- the best performance since 2011.
READ MORE
Bond Market Braces for Fresh Trillion-Dollar Fund Flow Wave
Bond Funds See Record Inflows After Virus Spurs Bets on Stimulus
Inverting Treasury Curve Shows Global Fear More Than U.S. Slump
“You still need a duration ballast and shock absorber,” said Con Michalakis, chief investment officer of retirement fund Statewide Superannuation Pty., which manages about $7 billion in Adelaide, Australia. “And I don’t see yields moving materially higher from here.”
The likely economic hit from the virus reinforces that view. Fed Chairman Jerome Powell last week cited the outbreak as a risk. Goldman Sachs Group Inc. predicts it will subtract two percentage points from annualized global growth this quarter.
“If the Fed is staying super-accommodative -- basically in reflation mode -- then you want to buy equities, credit and, strangely, you also want to buy Treasuries,” said Ralph Axel, an analyst at Bank of America Corp.
The demand for Treasuries in some corners has been building for years. U.S. corporate pensions, for example, have been big buyers since the federal Pension Protection Act, passed in 2006.
For the top 100 funds, with combined assets of more than $1.4 trillion, the fixed-income allocation surged to about 49% at the end of 2018 from 29% in 2005, as equities’ share fell by half to 31%, according to Milliman Inc., a pension and risk advisory firm. JPMorgan Chase & Co. strategists estimate the debt portion topped 50% as of December.
An up-to-date read on retirement funds’ demand can be seen in the record surge in Strips, which are created when Treasuries are split into principal- and interest-only securities. Pensions tend to favor these assets, which have longer duration, or sensitivity to interest-rate changes, to match the length of their liabilities.
Pension funds' Treasury demand seen in Strips rise
Soaring stocks are also spurring buying of bonds on price declines.
U.S. public pensions, with total assets of over $4 trillion, have kept holdings steady over the past five years, at about 25% in fixed income, 50% in public equities and the rest in alternative investments, according to data from the Pew Charitable Trusts.
As equities have climbed, the funds have needed to buy more debt to keep the breakdown stable, said Greg Mennis, director of public sector retirement systems at Pew.
Veteran bond manager Dan Fuss says he’s been been buying Treasuries as a safety play. He points to last week’s 10-year auction as a sign that yields won’t bust higher anytime soon. A measure of demand for the $27 billion sale was the highest since March.
“When you look at the bids for the 10-year notes, you’d have thought, ‘Wow, the government was giving out free ice cream’,” said Fuss, vice chairman of Loomis Sayles & Co. “There’s just more money available to invest than there’s marketable investment opportunities, and no risk of inflation at this time.”
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>>> Kraft Heinz’s Junk Downgrade Rekindles Bond Market Jitters
By Molly Smith and Jonathan Roeder
February 14, 2020
https://www.bloomberg.com/news/articles/2020-02-14/kraft-heinz-cut-to-junk-by-fitch-following-lackluster-earnings?srnd=premium
Packaged-food company cut to high yield by Fitch and S&P
More BBB debt has some investors wary that others may follow
Kraft Heinz Co., the iconic food giant created in a merger five years ago, was downgraded to junk by two credit raters, raising fresh worries among investors that a slowing economy could threaten the broader corporate bond market.
The packaged-food company was cut one level to BB+ by S&P Global Ratings, following Fitch Ratings earlier Friday. It will now become a so-called fallen angel, taking it out of investment-grade indexes.
Though Kraft Heinz, with just under $30 billion of debt, is a relatively small investment-grade issuer, it will become one of the top three in high yield. It’s just one of many companies that have wound up with a massive debt load as the result of deals, jeopardizing credit ratings in the process.
The food giant, created in a deal orchestrated by Warren Buffett and the private equity firm 3G Capital, is in the midst of a turnaround as its brands fall out of favor with consumers. It reported a drop in fourth-quarter sales Thursday that sent its bonds and stock tumbling, the latest sign that the company’s turnaround plan still has a long way to go.
“Kraft is to investment grade as Velveeta is to cheese,” said Christian Hoffmann, a portfolio manager at Thornburg Investment Management. “The ingredients dictate what something is and Kraft Heinz is junk.”
Profit Margins
That assessment is a far cry from the days of the merger when 3G went on a high-profile cost-cutting spree that was expected to eventually produce fatter profit margins. Instead, Kraft Heinz was left with a stable of tired brands and few new products that could appeal to consumers’ preference for more natural and less processed foods. Last year, it wrote down the value of its brand portfolio by more than $15 billion.
The turmoil has been a headache for Buffett’s Berkshire Hathaway Inc., whose stake over the past year has fallen to about $8.9 billion, down from $14 billion at the end of 2018. The stock was one of the worst performers last year.
S&P and Fitch cut the company one level to their highest junk rating. Kraft Heinz debt is already on the way to trading like junk. Its bonds due 2029 now yield about 3.5%, compared to the 2.88% for the average BBB company with similar duration. It’s the worst-performing issuer in both the U.S. and European markets Friday, and the cost to protect its debt against default has spiked to levels last seen in October.
Kraft Heinz bonds trade wider than BBB peers with similar duration
Fitch said Kraft Heinz may need to divest a sizable portion of its business in order to reduce debt. Kraft Heinz also needs to cut its dividend, Fitch said in August, but the company said Thursday it would maintain the annual $2 billion payout to shareholders. Fitch maintains a stable outlook, while S&P’s is negative. Moody’s rates the company one step above junk with a negative outlook as of Friday.
“We believe it’s important to Kraft Heinz shareholders to maintain our dividend during this time of transformation,” Michael Mullen, a spokesman for the company, said in an emailed statement earlier Friday. Kraft Heinz remains committed to reducing leverage “over time,” he said. The company plans to release a more detailed turnaround plan around the time of its next earnings report in early May.
Kraft Heinz was one of many companies with BBB ratings, the lowest level of investment grade, which now comprises half of the broader $5.9 trillion market. It’s grown steadily since the financial crisis, as a decade of low interest rates prompted companies to load up on debt for mergers and acquisitions, often at the expense of credit ratings.
UBS Group AG strategists led by Matthew Mish predict there could be as much as $90 billion of investment-grade debt to fall to high yield this year. That compares to just under $22 billion in 2019, close to a 20-year low, according to Bank of America Corp. strategists.
But a wave of fallen angels, which some investors fear, has yet to follow. Many strategists contend that BBB companies have the ability to defend their investment-grade ratings, whether by selling assets or cutting dividends. Companies like General Electric Co. and AT&T Inc. have done just that to stave off downgrades.
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>>> Treasury Inversion Is Not About the U.S., It Is About the Whole World
Bloomberg
By Anchalee Worrachate and Liz McCormick
February 10, 2020
https://www.bloomberg.com/news/articles/2020-02-10/the-inverting-curve-is-flashing-global-fear-more-than-u-s-slump?srnd=premium
Safety grab may be bigger cause of inversion than U.S. outlook
Half of world’s haven pool is Treasuries: Eurizon’s Jen
The U.S. yield curve is flirting with another broad-based inversion again, reigniting Wall Street fears over the fate of the American economy.
A growing chorus of voices is being swayed by another notion: The signal might say more about the state of the world than the U.S. business cycle.
Treasuries now make up more than half of all global haven assets, double the share they accounted for during the financial crisis, according to Eurizon SLJ Capital. That complicates matters when long- and short-term yields flip: What used to be a reliable American recession indicator is instead an barometer of investors diving for cover worldwide.
It’s a narrative that makes a lot of sense as the threat from the coronavirus continues to grow, and it revives the frantic debate from last year about how much predictive power the curve actually has left.
Treasury yields flattening again as virus sparks global hunt for havens
“In a grab for safety and duration, everyone is going for U.S. Treasuries,” said Gregory Faranello, the head of U.S. rates at AmeriVet Securities. “The yield curve inversion is a signal now of global growth issues, and not really reflecting what is going on in the U.S.”
After a respite early last week the curve is once again flattening, and the gap between the rate on 10-year and three-month Treasuries narrowed for a third day on Monday. At the height of coronavirus angst and an equity sell-off at the end of last month it briefly inverted for the first time since October.
Bond yields typically rise alongside the duration of debt because they provide compensation for the effects of inflation. If rates on a 10-year note are lower than a three-month bill it suggests investors have a pessimistic view of growth and inflation a decade from now.
Stephen Jen, the chief executive officer at Eurizon SLJ, says global hunger for U.S. bonds helps explain American exceptionalism in growth, currency markets and stocks.
He predicts that by 2022, U.S. government debt will account for two-thirds of the world’s pool of haven bonds thanks to large issuance and quantitative easing by other central banks. His calculations are based on the outstanding amount of government debt in the U.S., Japan, and the three largest European economies, subtracting out the portion that is owned by central banks.
“The U.S. might, perversely, thrive because of troubles elsewhere,” Jen said in an interview. “When U.S. Treasury yields fall due to shocks outside of the U.S. that may or may not have an impact on the U.S. economy, it often provides added stimulus.”
It’s a view Federal Reserve officials are playing close attention to as global risks from the virus mount. In an interview with Bloomberg TV, Fed Vice Chairman Richard Clarida played down the inversion and said the negative spread is “really driven not so much by an outlook for the U.S. economy, but globally.” When there’s uncertainty money flows to America, he said, so current yield moves don’t reflect the U.S. outlook.
Campbell Harvey is credited with drawing the link between the slope of the yield curve and economic growth. The professor at Duke University’s Fuqua School of Business says corporate America is much more attuned to the yield curve signal and will take preventative action.
“CFOs and CEOs are more aware and aren’t likely to take on the risk of just ignoring it,” Harvey said. “They are being a little more cautious now.”
The gap between the yield on three-month and 10-year Treasuries recently slipped to as low as about minus 6 basis points. The spread -- which has inverted before each of the past seven U.S. recessions -- had initially fallen below zero in March 2019 as economic conditions deteriorated at the height of the trade war. The spread between two- and 10-year yields, which was negative as recently as September, remains above that mark at 17 basis points.
On Wall Street, strategists at JPMorgan Chase & Co. still see plenty of reason to fret the slope of the curve. Their favorite indicator -- and a part of the curve that remains inverted -- is the gap between two-year forward and one-year forward rates, which can shed light on the bond market’s expectations of what the Fed will do.
In this case, it shows a “rising probability of a more protracted Fed rate cut cycle extending to 2021,” said Nikolaos Panigirtzoglou, a strategist at JPMorgan.
For now, there aren’t many other alarm bells in an American economy with unemployment rates near 50-year lows and the longest stretch without a recession since World War II. Even so, economists forecast that GDP growth will slow to 1.8% compared with 2.3% in 2019, and it’s too early to determine whether the coronavirus outbreak in China will significantly affect the U.S. economy.
“When Treasuries become most dominant, investors from anywhere in the world naturally buy of lot of these bonds when they want a safe haven,” said Jen. “The yield curve in the U.S. is increasingly reflecting the fears of the rest of the world.”
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>>> High-Tax States’ Bonds Are So in Demand That Ratings Don’t Matter
Bloomberg
By Danielle Moran
February 6, 2020
https://www.bloomberg.com/news/articles/2020-02-06/high-tax-states-bonds-so-in-demand-that-ratings-don-t-matter?srnd=premium
‘To boil it down, it’s 99.999% because of the SALT cap’
California, New York yields holding below the AAA benchmark
There’s so much money chasing after the bonds sold by America’s high-tax states that buyers don’t seem to care too much about what credit-rating companies think.
The heavy demand overall has driven municipal yields to their lowest in more than six-decades. And with rates so low, the yield penalties that would typically differentiate a deeply indebted state from a thrifty one have become little more than rounding errors that in some cases contrast with their standing in the ratings pecking order.
California’s general-obligation debt, for example, is yielding about 1 basis points less than the AAA benchmark, even though the state is rated as many as four steps below that, according to data compiled by Bloomberg. New York, one step below AAA, is paying about 8 basis points less than top-rated borrowers. Over the past year, New Jersey’s yield premium has been cut nearly in half even though its rating hasn’t changed. Connecticut’s is roughly a third of what it was.
Both NY and CA debt yield less than top rated bonds
By contrast, bonds issued by AAA rated Texas and Florida, where there’s no state income tax, pay above-benchmark yields.
This dynamic shows how dramatic the demand has become for tax-exempt securities since President Donald Trump’s 2017 tax law limited state and local deductions. That change drove investors in high tax-states like California, New York and New Jersey into municipal bonds as an alternative way to drive down what they owe.
“To boil it down, it’s 99.999% because of the SALT cap,” said James Iselin, portfolio manager at Neuberger Berman Group LLC in New York. “Because there’s is so much demand in the market -- there is less of a credit differentiation that the market is making.”
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>>> Corporate Debt: A Slow-Motion Train Wreck
FEBRUARY 4, 2020
BY SCHIFFGOLD
https://schiffgold.com/key-gold-news/corporate-debt-a-slow-motion-train-wreck/
Corporate debt has blown through the roof over the last several years. So much so that the Federal Reserve has issued warnings about the increasing levels of corporate indebtedness.
Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid weak credit standards.”
But as Brandon Smith of alt-market.com noted in an article published at LewRockwell.com, this is a subject the mainstream media “seems specifically determined to avoid discussing these days when it comes to the economy.
Smith called corporate debt “the key pillar of the false economy.”
It has been utilized time and time again to keep the Everything Bubble from completely deflating, however, the fundamentals are starting to catch up to the fantasy.”
Business debt skyrocketed to a record $16 trillion in 2019. That represents a 5.1% year-on-year, much faster than economic growth. As a result, debt levels have also reached historic highs in terms of percentage of GDP. According to the Federal Reserve report, debt growth has outpaced economic output “through most of the current expansion.”
Smith pointed out that corporations have been using borrowed money for stock buybacks. He called this the single most vital mechanism behind stock market inflation.
Corporations buy their own stocks, often using cash borrowed from each other and from the Federal Reserve, in order to reduce the number of shares on the market and artificially boost the value of the remaining shares. This process is essentially legal manipulation of equities, and to be sure, it has been effective so far at keeping markets elevated.”
Smith said that corporate stock buybacks appear set to decline in 2020. But he doesn’t think this is because companies want to stop using the tactic. The problem is the amount of accumulated debt is outpacing falling profits. Corporate profits peaked in Q3 2018 and have been falling ever since.
Price-to-Earnings ratio, as well as the Price-to-Sales ratio, are now well above their historic peak during the dot-com bubble, meaning, stocks have never been more overvalued compared to the profits that corporations are actually bringing in.”
It’s not just that massive level of corporate debt that is worrisome. Much of the debt is categorized as risky. The Fed report expressed concern about the high level of leveraged loans and what it describes as “weak underwriting standards.” There are more than$1.1 trillion in leveraged loans outstanding. These are loans made to firms already deeply in debt. Think subprime loans for corporations.
A broad indicator of the leverage of businesses—the ratio of debt to assets for all publicly traded nonfinancial firms—is at its highest level in 20 years.”
As Smith points out, this level of borrowing always comes with consequences.
Even if central banks were to intervene on a level similar to TARP, which saturated markets with $16 trillion in liquidity, the amount of cash needed is so immense and the economic returns so muted that such measures are ultimately a waste of time. The Federal Reserve fueled this bubble, and now there is no stopping its demise. Though, they’re behavior and minimal response to the problem suggests that they have no intention of stopping it anyway.”
Peter Schiff has been saying the record stock market valuations have no real connection to the actual economy. He insists stocks really should be coming down and the only thing really supporting them is the Federal Reserve and all the money they’re printing with their QE program. Smith made a similar point.
While corporations, the Fed and Trump have been putting some effort into keeping stock markets from imploding, the real economy has been evaporating. Global import/exports are crashing, US manufacturing is in recession territory, US GDP is in decline (even according to rigged official numbers), US retail outlets are closing by the thousands, the poverty rate jumped in 30% of US counties in the past year, and high paying jobs are disappearing and being replaced with minimum wage service sector jobs.”
Smith called the corporate debt situation a “slow-motion train wreck.” And as he put it, a slow-motion wreck is still a wreck.
The damage can only be mitigated by removing one’s self from the train, and preparing for the fallout. Do not think that simply because the system has been able to drag it’s nearly lifeless body along for ten years that this means all is well. All bubbles collapse, and corporate debt has already sealed the fate of the Everything Bubble.”
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>>> Ford’s Lending Arm Is Generating More Profit Than Ever
Bloomberg
Molly Smith and Keith Naughton
February 3, 2020
https://finance.yahoo.com/news/ford-lending-arm-generating-more-110001090.html
Ford’s Lending Arm Is Generating More Profit Than Ever
(Bloomberg) -- Aside from F-Series pickups hauling in gobs of profit, Ford Motor Co.’s automotive business isn’t carrying much weight lately.
Thank goodness for the finance guys.
Ford Credit, the lending arm that’s become accustomed to propping up the company in good times and bad, now generates about half the automaker’s profit, up from 15% to 20% in the past.
Ford Credit is designed to perform a relatively simple task: make loans to the dealers stocking vehicles, then the consumers who buy them. Now, Ford is relying on its finance unit to help fund multibillion-dollar outlays on electric and self-driving cars while it simultaneously racks up $11 billion in charges from a restructuring that could take years.
“It’s like the ballast that keeps the ship steady,” said Lawrence Orlowski, an analyst at S&P Global Ratings. “It’s a balancing act.”
Ford’s been selling fewer and fewer U.S. vehicles for the last three years, and it’s losing billions overseas, including in China, where its annual vehicle deliveries fell by half during that time span. On Tuesday, analysts expect the company to report lower fourth-quarter automotive revenue and a 44% plunge in adjusted net income. Profit on that basis could be the lowest since 2009.
Ford shares rose as much as 3.6% -- their biggest intraday in three months -- and traded up 2.7% to $9.06 as of 10:30 a.m. in New York. The stock rose 22% last year.
The second-largest U.S. automaker would be far worse off without its Ford Motor Credit Co. unit, which is effectively funding turnaround efforts by routinely borrowing in the debt markets and paying a dividend back to the parent company. The credit unit is expected to contribute almost $3 billion annually to Ford over the next two years, according to Benchmark Co. analyst Mike Ward. That’s up from just a $400 million contribution in 2017.
Ford Credit borrowed around $10 billion in the U.S. investment-grade bond market in the past year, apart from funds raised in other currencies and securitized debt. By contrast, it’s been more than three years since Ford Motor last issued bonds, according to data compiled by Bloomberg, as investors fretted about the company’s high debt load and slowing sales.
Credit graders are responding to Ford’s poor automotive performance, with Moody’s Investors Service the most aggressive so far. It downgraded Ford to junk in September, casting doubt on Chief Executive Officer Jim Hackett’s turnaround plan in the process.
S&P then cut Ford to the lowest investment-grade rating in October after the carmaker lowered its full-year profit forecast. Another downgrade by S&P would take Ford out of major high-grade indexes, which investors and analysts have contemplated for more than a year. If cut, Ford would be the largest U.S. nonfinancial high-yield issuer, which could add near-term pressure to its funding costs. It has about $35 billion of debt in the Bloomberg Barclays U.S. investment-grade index.
It’s not going to get any easier for the carmaker. Amid growing fears of an industry wide downturn, Ford is rolling out a critically important series of new sport utility vehicles and redesigning the F-150, its most profitable and best-selling model. Analysts are already flagging cost and execution risk tied to those introductions, especially after Ford botched the launch of its Explorer SUV last year.
“It’s quite clear Ford is not where it should be, but the finance arm is a bright spot,” said David Whiston, an equity strategist with Morningstar in Chicago who rates the automaker’s shares the equivalent of a buy. “Obviously you want the whole company operating at full power, which you don’t have right now.”
Ford Credit is contributing more and more to the parent’s earnings. In a normal operating environment, manufacturing cars and trucks should drive most of earnings, with credit only generating 15%-20% of profits, said Bloomberg Intelligence analyst Joel Levington. For much of last year, Ford Credit constituted somewhere around half the company’s profit.
Ford and its finance arm are inextricably linked. Each supports the other operationally and financially under a a relationship agreement that governs the connection between the two.
Ford Credit is also protecting the automaker’s prized dividend. The unit paid $2.4 billion back to its parent in the first nine months of 2019, covering the dividend cost for the entire year. That may be “unsustainable” in the long run, because Ford’s dividend consumes a much greater percentage of its cash flow than peers, according to BI’s Levington. Ford has repeatedly said it will not cut the dividend.
In a recession, Ford Credit’s role becomes even more important. It doesn’t play much in the subprime market, so the ratio of its losses to total customer bills outstanding stayed below 2% during the Great Recession, a low level. Its repossession rate never got higher than 3.2%.
Those strong metrics allowed Ford’s captive finance unit to generate a dividend for the parent even in 2009, when U.S. auto sales slumped to a 27-year low.
“With a healthy portfolio, a captive balance sheet in an economic downturn actually starts generating and kicking off a bunch of cash flow,” Tim Stone, Ford’s chief financial officer, said during a November interview at Bloomberg News headquarters in New York. “We take a very thoughtful approach to that business.”
Over the past two decades, Ford Credit has sent $28 billion up to Ford, according to company data.
“That’s not a bad thing -- that’s exactly the reason you want to have a healthy financial-services company,” said Hitin Anand, a senior analyst at CreditSights. “Ford Credit will come to the rescue of Ford Motor in more ways than one. It’s one of the best-run captive-finance companies in the entire universe.”
Finance companies can be a burden for manufacturers in downturns, as General Electric Co. discovered in the financial crisis. The conglomerate’s credit arm weighed on its share price as investors grew more concerned about complicated financial institutions. GE has been selling off and shrinking the unit’s assets for most of the last decade.
Ford Credit is a bright spot in Ford’s portfolio, and also among its peers. It prides itself on lending to consumers with higher credit scores, which keeps asset quality high and defaults low compared with rivals General Motors Financial Co. Inc. and Santander Consumer USA Holdings Inc.
In the third quarter, Ford Credit’s 60-day delinquency rate was just 0.14%. That’s low in an industry where 4.71% of auto loans were at least 90 days late, the highest in more than nine years, according to Federal Reserve data.
“As a credit analyst, I focus on glass half empty. Ford Credit is the positive part of the story,” said Olesya Zhovtanetska, senior director of public fixed income at SLC Management. “They need that cash cow.”
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>>> Moody’s downgrades Ford credit rating to junk status
CNBC
SEP 9 2019
Associated Press
https://www.cnbc.com/2019/09/09/moodys-downgrades-ford-credit-rating-to-junk-status.html
Moody’s Investors Service has downgraded Ford’s credit rating to junk status.
The service says it expects weak earnings and cash generation as Ford pursues a costly and lengthy restructuring plan.
The ratings service said Ford’s outlook remains stable, but its cash flow and profit margins are below expectations and the performance of peer companies in the auto industry
Moody’s Investors Service has downgraded Ford’s credit rating to junk status.
The service says it expects weak earnings and cash generation as Ford pursues a costly and lengthy restructuring plan.
Ford responded with a statement saying that its underlying business is strong and its balance sheet is solid.
The rating for Ford’s senior unsecured notes and its corporate family dropped to Ba1, the top rating for debt that’s not investment grade. It had been Baa3, the lowest investment grade rating.
Ford’s fight to remain an American icon
Moody’s says it expects Ford’s restructuring to extend for several years with $11 billion in charges and a $7 billion cash cost.
The ratings service said Ford’s outlook remains stable, but its cash flow and profit margins are below expectations and the performance of peer companies in the auto industry. “These measures are likely to remain weak through the 2020/2021 period including a lengthy period of negative cash flow from the restructuring programs,” Moody’s Senior Vice President of Corporate Finance Bruce Clark wrote in a note to investors Monday.
Ford’s erosion in performance happened while the global auto industry was healthy, Clark wrote. Now the company and CEO Jim Hackett must address operational problems as demand for vehicles is softening in major markets, he wrote.
The company has $23.2 billion in cash, which is more than its debt, according to Moody’s. The stable outlook reflects Moody’s expectation that the restructuring will contribute to gradual improvement in earnings, profit margins and cash generation, Clark wrote.
Ford said it has plenty of liquidity to invest in its future.
“We are making significant progress on a comprehensive global redesign — reinvigorating our product lineup and aggressively restructuring our businesses around the world,” Ford’s statement said.
The statement said Ford already is addressing operating inefficiencies and problems with its China business.
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>>> Debt-Laden Merchants Face Reckoning Amid Retail Apocalypse
Bloomberg
By Eliza Ronalds-Hannon
December 23, 2019
https://www.bloomberg.com/news/articles/2019-12-23/stores-that-stocked-up-on-debt-face-a-harsh-holiday-reckoning
Department stores fall out of favor with shoppers and lenders
Countdown is on for Forever 21’s plan to keep doors open
Retailers are strapping in for the final days of their traditional do-or-die holiday shopping period. For some, that could be meant literally, as creditors and vendors decide which ones are still worth supporting in a field plagued by fewer shoppers, more online competition and too much debt.
Some of the most familiar names -- Forever 21 Inc., Barneys New York Inc. and Payless Inc.-- have already collapsed into bankruptcy or liquidated this year. In 2019 alone, Coresight Research estimates, retailers have shut more than 9,300 stores. Among the survivors, fates have diverged, according to the restructuring experts at FTI Consulting Inc.
“The retail sector is becoming more segmented between winners and losers,” Christa Hart, a senior managing director in FTI’s retail and consumer practice, said in an interview. “The ‘average’ has disappeared.”
At Risk
Merchants could use a strong finish after last year’s holiday season, when retailers wound up with their worst sales drop for December since 2008, according to U.S. Census Bureau data analyzed by FTI. This holiday season “will be disproportionately great for the strong players and disproportionately weak for the other ones,” Hart said.
Some of the most vulnerable are the traditional department-store chains. Moody’s Investors Service predicted in a November report that by the end of 2019, those retailers will have seen their operating income fall by more than 15%. This, despite heavy investing to improve inventory efficiency and to build their online capabilities.
Department store sales have been declining for decades
“It’s not 1985 anymore,” said Perry Mandarino, head of restructuring and co-head of investment banking at B. Riley FBR Inc. “People don’t need a one-stop shop where they can get everything from vacuum cleaners to jewelry.”
Here are some retailers being closely watched by credit investors and lenders.
J.C Penney
Debt outstanding: About $4.2 billion
J.C. Penney Co. backed out of its appliance business earlier this year as one of the initiatives of new Chief Executive Officer Jill Soltau. She’s trying to design a strategy that will revive a chain suffering from slow-moving inventory and outdated merchandise.
Same-store sales, a key retail metric, dropped 9.3% last quarter. Foot traffic is falling and comparable sales have slid for five straight quarters.
Department stores should be focused on deepening their offerings in one particular area, such as appliances, FTI’s Hart said. “Sadly, many of these department stores took out their hardline and home businesses in favor of apparel, and now they are feeling the results of those decisions,” she said.
S&P Global Ratings cut J.C. Penney to CCC in August, noting that while the company doesn’t plan to file for bankruptcy, “we think an out-of-court restructuring is increasingly likely.” The following month, Bloomberg reported the chain is preparing for talks with its creditors on possible transactions to ease its debt burden.
A representative for the Plano, Texas-based retailer declined to comment.
Neiman Marcus
Debt Outstanding: About $5.7 billion
Neiman Marcus Group Inc. engineered an out-of-court note exchange in June that bought it more time to ease its high leverage.
But the luxury retailer still has about $700 million due by 2023, adjusted earnings continue to decline, and some of its bonds sell for a third of face value. Even the new debt issued during the exchange, which started trading at 97 cents, has already traded down to around half of its face value.
Credit raters take a dim view of Neiman Marcus. S&P said in June that the exchange didn’t make the debt load any less onerous and that there’s “continued risk of a restructuring or default over the next 12 months.”
The company is still mulling what to do with its successful European e-commerce business MyTheresa, and that may be its ticket back from the brink. It hired Lazard Ltd. in May to help it pursue a sale that could fetch more than $560 million.
A representative for the Dallas-based retailer declined to comment.
Belk Inc.
Debt outstanding: About $2.4 billion
Owned by Sycamore Partners LLC, this mid-priced chain concentrated in the southern U.S. typefies the pressures facing department stores, as shoppers seek out specialized outlets or take their household shopping online.
Belk is better off than some its peers, with a B2 rating from Moody’s. The credit rater cited a loyal customer base, better merchandising, good liquidity and stable cash flow in a June report. Another strength: About half its stores aren’t in malls, which are plagued by waning foot traffic.
Still, investors are shying from Belk’s term loan, which was quoted recently 71 cents on the dollar even after the company pushed its maturity out to 2025.
“Discount retailers are going to do better” than their higher-end peers in 2020, Mandarino said. “But they have to tailor their merchandise well. A lot of people have short attention spans, so you really have to cater to what your core buyer wants.”
A representative for New York-based Sycamore Partners declined to comment.
Forever 21
Debt Outstanding: About $350 million, excluding trade debt
Among all big retailers, Forever 21 Inc. may be the one whose survival is most at risk.
The trendy fashion chain went bankrupt in September, citing the cash-guzzling impact of an ambitious international expansion. Sales continue to lag, and revenue has been below expectations, Bloomberg reported in December. Inventory bottlenecks also threaten to curtail sales during the crucial holiday season, people familiar with the chain’s operations have said, making would-be rescuers hesitate to lend more money.
The company needs a new loan to finance its exit from bankruptcy, but prospective lenders are concerned about the weak results as well as the ongoing influence of husband-and-wife founders Do Won and Jin Sook Chang, who ran the company during its successful years as well as during its descent into insolvency.
A budget that Forever 21 filed with the bankruptcy court Nov. 16 cut its forecast for total sales in November to about $191 million, down 20% from what it predicted the month before.
A representative for Los Angeles-based Forever 21 declined to comment.
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>>> The Bedrock of Ultra-Low Yields Is at Risk
Bloomberg
By Emily Barrett, Chikako Mogi, and James Hirai
December 29, 2019
https://www.bloomberg.com/news/articles/2019-12-29/the-bedrock-of-ultra-low-yields-is-at-risk-as-fiscal-tide-turns?srnd=premium
‘The green shoots of fiscal spending are happening’: Loomis
Fragile growth, monetary action still curbing rise in yields
The new decade could be the dawn of a tougher era for bond investors, as conditions that sustained the historic bull run in government debt fall away.
Unprecedented central bank action has dominated economic stimulus since the global crisis and suppressed yields around the world. The skew may now be shifting more toward fiscal expansion that could pressure rates higher. Austerity is on the wane in Europe, spending packages are landing in Asia, and U.S. borrowing is on track for even bigger records in the next couple of years.
The handoff from monetary to fiscal policy is a longer-run investment theme, says Mark Dowding at BlueBay Asset Management, and he’s already trading it in the U.K., by betting against gilts.
“When you look at the U.K., what we’re witnessing now is some pretty material easing in fiscal policy,” said Dowding. “It’s a theme that we expect to see more broadly.”
The Organisation for Economic Cooperation and Development says government spending globally has helped widen the fiscal deficit from 2.9% of world gross domestic product in 2018 to an estimated 3.3% next year. Also, OECD economists are among the growing ranks pushing for more disbursements to tackle slowing global growth and climate change.
The trouble for investors is working out when government spending may reach a critical mass to push yields higher. As of now it’s still in fledgling stages, while central banks continue to pump massive stimulus.
“To me this is the story of the next decade,” said Elaine Stokes, portfolio manager at Loomis Sayles & Co. “The green shoots of fiscal spending are happening across the globe, but it hasn’t gotten to a place where it is coordinated.”
“In the next 5 to 10 years it becomes a factor in markets,” Stokes said. “So that’s where the market has to go -- we have to turn to a rising rate environment from a falling rate environment.”
From South Korea to Brazil, a Global Guide to Stimulus Plans in 2020
The risk of a reversal in the last decade’s trend of falling yields is palpable. The governments of the two largest economies are spending more, and relying on debt to plug much of their revenue shortfall. Alicia Garcia-Herrero, chief economist for Asia Pacific at Natixis SA, sees China’s issuance growing as the budget gap widens from 7.9% this year to 9% of GDP.
“Monetary policy has been less effective by itself, especially in the EU and China, the economy thus calls for more expansionary fiscal policy to grow,” said Garcia-Herrero, who previously worked for the European Central Bank and the International Monetary Fund. “One drawback of fiscal expansion is its upward pressure on interest rates.”
So far that pressure is barely registering in borrowing costs. The world’s benchmark, the U.S. 10-year yield, is mired below 2%, and $11 trillion of debt worldwide yields less than zero. While that total has shrunk by more than a third since August -- when global yields troughed -- investors continue to seize on assets that offer some return. And it still looks way riskier to trade against haven flows and central bank purchases while the global economic outlook remains fragile.
Global rates sell-off has shrunk the pool of negative-yielding debt by a third
That’s a popular and persuasive case against higher yields in the U.S. for now, even as lawmakers on both sides of the aisle look ready to embrace blowout deficits. The Treasury may manage to keep borrowing steady this year -- albeit at a record level -- in part because the Federal Reserve’s current plan to stabilize short-term funding rates could trawl roughly $240 billion of bills out of the market in the coming months.
Investors like Dowding are focusing on regions where monetary policy looks most exhausted. He reckons the market is overestimating the likely stimulus from the Bank of England. And his call in the U.K. isn’t an outlier -- Goldman Sachs Group Inc. strategist George Cole estimated that issuance to fund current spending and public-sector investment could be worth a boost of around 25-40 basis points in gilt yields next year.
Across the channel, ECB President Christine Lagarde is clearly taking up the push for more fiscal spending and may have more success than her predecessor. That said, expansive policy is emerging mainly in the peripheral countries, as a backlash against austerity. The region’s savers -- including its largest economy -- aren’t showing much sign of shifting their stance.
“We’ve seen this movie before,” said Brad Setser, senior fellow at the Council on Foreign Relations. “There is building pressure in Germany to increase investment and increase green investment in particular, but so far it hasn’t catalyzed an enormous shift in policy.”
Lagarde Eyes Dozen Euro Members With Precious Room to Spend More
In Japan, BNP Paribas SA sees increased government spending helping the 10-year yield edge up to +0.1% in 2020 from its current level just below zero.
But the Bank of Japan is scooping up bonds at such a rate, it’s still swamping fiscal efforts so far, according to UBS chief Japan economist Masamichi Adachi. This month’s $239 billion spending package may be only just enough to avert a recession following October’s sales-tax increase.
“The stimulus package isn’t a bold shift from the past and won’t significantly affect the outlook for markets or the Japanese economy,” Adachi said. “At most, it helps support confidence.”
But the rationale for higher yields is in place, at least in theory. S&P Global Ratings’ leading arbiter on the quality of the world’s government debt said that it’s gotten sketchier, as countries have seized on low interest rates to borrow more.
“You’re looking at close to 65 or 70% of world GDP that has today a lower credit quality than it had pre-2008 crisis,” said Roberto Sifon Arevalo. Government debt is “riskier today than it was before, but it’s not reflected in the market.”
Emerging markets have tended to pay a higher price for profligacy than developed economies with more room to spend, he said. And it’s worth remembering that when S&P cut the U.S.’s top-shelf credit rating, in 2011, Treasury yields plummeted as investors flooded into the world’s safest debt market. But the overall trend is clear.
“The market seems a bit complacent with the idea that interest rates will stay low for the foreseeable future,” said Sifon Arevalo.
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>>> The Corporate Bond Market’s $100 Billion Buyer Is Here to Stay
Bloomberg
By Molly Smith and David Caleb Mutua
December 26, 2019
https://www.bloomberg.com/news/articles/2019-12-26/the-corporate-bond-market-s-100-billion-buyer-is-here-to-stay?srnd=premium
Foreign demand seen underpinning U.S. high-grade debt in 2020
Global investors flee $11 trillion of negative-yielding assets
The U.S. corporate-bond market’s $100 billion benefactor isn’t going anywhere in 2020.
Foreign demand will continue to underpin high-grade debt next year as global investors extend their hunt for higher-paying assets in the face of over $11 trillion of negative-yielding securities around the world, according to market watchers.
“There’s simply not enough high-quality income-producing assets to meet the demand,” Mark Kiesel, chief investment officer of global credit at Pacific Investment Management Co., said in an interview. “That’s the reason that credit did so well this year. It wasn’t just the fact that the Fed and other central banks cut rates. The fact is that there’s just that much demand.”
While hardly anyone expects a repeat of 2019, which has seen blue-chip company bonds return more than 14% -- the most in a decade -- many predict solid single-digit gains from a market they readily admit looks expensive by most conventional measures. That’s partly based on the expectation that money managers outside the U.S. will continue to pile in. They’ve bought $114 billion of bonds on a net basis this year through the third quarter, according to Federal Reserve flow of funds data.
Foreign Flows
Dealers have sold more bonds to non-U.S. investors than they've bought
Global central banks have cut interest rates roughly 90 times over the past year, the largest cumulative easing since the financial crisis, according to Canadian Imperial Bank of Commerce data. While the Fed accounted for three of those, taking its policy rate down to a range of 1.5% to 1.75%, that’s still higher than much of the rest of the developed world, including Japan and Europe, where rates are near or even below zero.
“It’s very hard for the average foreign investor to survive -- we’re still at a point now where it’s max desperation,” said Hans Mikkelsen, head of high-grade credit strategy at Bank of America Corp. “Basically there’s only one game in town for foreign investors, and that’s the U.S. corporate bond market.”
A lower fed funds rate also has its advantages. For one, it tends to make it cheaper for international buyers to protect against the risk of currency fluctuations. Three-month dollar-hedging costs based on forward contracts for euro- and yen-based investors have dropped significantly this year.
That’s “a positive for demand from those investors staying pretty strong,” said Barry McAlinden, senior fixed-income strategist for the Americas at UBS Global Wealth Management.
And if rates continue to decline, as some forecasters expect, that will almost certainly bolster demand for relatively higher-paying assets such as U.S. investment-grade company debt, market participants say.
The average U.S. investment-grade corporate bond yields 2.87%, or about 1 percentage point more than Treasuries. In Europe, absolute yields on company bonds sit at just 0.47%, similar to the 0.46% that Japanese corporate debt pays.
That’s why institutional investors like Japan’s Government Pension Investment Fund, the largest of its kind in the world, say they’re preparing to buy more bonds outside local markets.
“They are being pushed out of Japan,” said Tetsuo Ishihara, a U.S. macro strategist at Mizuho Financial Group Inc.’s fixed-income unit in New York, referring to Japanese institutional investors broadly. “There’s nowhere else to go.”
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>>> Apollo and Blackstone Are Stealing Wall Street’s Loans Business
Bloomberg
By Lisa Lee
December 18, 2019
https://www.bloomberg.com/news/articles/2019-12-18/apollo-and-blackstone-are-stealing-wall-street-s-loans-business
Growth of private credit comes at expense of leveraged lending
Apollo sees $200 billion of debt going private over five years
On the surface it was a classic leveraged takeover -- $1.8 billion of debt to fund the acquisition of Gannett Co. And just like hundreds before it, front and center was Apollo Global Management. Except this time, the private equity giant wasn’t the borrower. It was the lender.
The deal is part of a major shift occurring in global finance. Direct lenders, including more and more hedge funds and buyout firms, are preparing to dish out billions of dollars at a time to lure borrowers away from the $1.2 trillion leveraged loan market.
It’s the latest push by alternative asset managers into what was once the exclusive territory of the world’s biggest investment banks. And while Wall Street voluntarily ceded much of its business lending to medium-sized companies in the aftermath of the financial crisis, this time the iron grip it has on arranging the industry’s bigger loans is being pried open, jeopardizing some of its juiciest fees.
“Direct lenders have raised significant capital to allow them to commit to larger deals,” said Randy Schwimmer, head of origination and capital markets at Churchill Asset Management. “It’s an arms race.”
Investment returns from direct lending outpace gains from high-yield loans, bonds
It’s a striking reversal of fortune for syndicated-lending desks that spent the last 10 years luring business away from the high-yield bond market, the original source of buyout financing for big, risky companies. Even as recently as the beginning of the year, deals in excess of $1 billion were largely seen as the private domain of bulge-bracket banks, which arrange and sell them to institutional investors.
Not anymore.
Apollo said last month that it’s looking to do deals in the $2 billion range. Rival Blackstone Group Inc. is actively pitching a trio of billion-dollar financings that it intends to hold entirely itself, according to a person with knowledge of the matter. (The firm declined to comment.) And private-credit standouts including Owl Rock Capital and HPS Investment Partners are also setting their sights on bigger loans.
The $1.8 Billion financing of New Media Investment Group Inc.’s acquisition of Gannett came on the heels of a $1.25 billion direct loan by Goldman Sachs Group Inc.’s private-investment arm -- one of the few of its kind under a Wall Street bank -- and HPS to fund Ion Investment Group’s purchase of financial data provider Acuris.
And in October, a group of about 10 lenders including Owl Rock banded together to provide a $1.6 billion loan to refinance the debt of insurance brokerage Risk Strategies.
“There are bigger pools of capital” now, said Craig Packer, co-founder of Owl Rock, which controls more than $14 billion. “Our holdings of individual loans are therefore larger than was previously available from smaller lenders.”
Fading Fees
Investors have plowed hundreds of billions of dollars into private debt funds in recent years, lured by premiums that are more than five percentage points higher than competing public debt, according to a Goldman Sachs analysis.
Assets under management now exceed $800 billion, based on the most recent data available from London-based research firm Preqin, including over $250 billion of dry power. In contrast, leveraged loan growth has begun to stall, with the size of the U.S. market now hovering around $1.2 trillion, up less than 4% from a year earlier.
Partly as a result of direct lenders increasingly allowing borrowers to bypass the syndication process, compensation for arranging leveraged loans has plunged. Fees are down 29% this year through November, to about $8.5 billion, versus the same period last year, according to Freeman Consulting Services estimates.
The biggest players in the industry say the shift is just getting started.
Apollo predicts as much as 10% of the more than $2.5 trillion high-yield loan and bond market will go private over the next five years, John Zito, co-head of global corporate credit, said at the company’s Nov. 7 Investor Day.
The alternative asset manager sees the privatization of global credit mirroring a similar trend that’s swept equity markets in recent years.
In fact, many say the continued expansion of private equity will only help fuel the growth of direct lending.
“As private equity capacity increases, more deals and larger deals are being done in the private space,” Benoit Durteste, chief executive officer of Intermediate Capital Group, said in a report by the Alternative Credit Council last month. “This is why we are seeing larger and larger deals in private debt and the limits keep on being pushed.”
Growing execution risk in the leveraged loan market is also prompting buyout firms to increasingly turn to private sources of financing, according to market participants.
Loan buyers have been drawing a line and either bypassing or demanding significant concessions to lend to companies that may struggle in an economic downturn. On the flip side, private debt transactions can often be arranged in a fraction of the time it takes for a public-market deal, while limited scope for pricing adjustments provides sponsors with greater cost certainty.
Yet efforts to win deals away from investment banks, along with growing competition among direct lenders looking to deploy more than a quarter-trillion dollars of pent up cash, have some worried about weakening lending standards in the industry.
The club loan to Risk Strategies boosted the company’s leverage multiple to seven times a key measure of earnings, as much -- if not more -- than the issuer would have been able to get away with in the leveraged loan market, according to people with knowledge of the matter. While the financing includes a maintenance covenant, its terms are loose enough that the company would likely already be struggling to meet interest obligations before the safeguard is triggered, said the people, who asked not to be identified because they aren’t authorized to speak publicly.
“We are worried about how much debt has gone there versus going to the public market, and what that means in a downturn because there’s no liquidity” in private credit, said Elaine Stokes, a portfolio manager at Loomis Sayles & Co. in Boston. “That could seep into the public markets, if you end up having people becoming forced sellers.”
For others, the growth of direct lending is simply part of the natural evolution of credit markets.
“It’s part of a broader harmonization,” said Jeffrey Ross, chair of Debevoise & Plimpton’s finance group. “The broadly-syndicated loan market for the past 10 years has evolved to look and trade like high-yield bonds. There’s been a similar convergence between the middle-market and bulge-bracket lenders.”
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>>> Fuzzy Math That Fueled Junk Debt Boom Is Sparking Jitters
Getting creative with earnings adjustments helps sell deals.
Bloomberg
By Davide Scigliuzzo
December 13, 2019
Imagine walking into a bank to borrow money. The loan officer might ask for your pay stubs and tax returns to prove your income, as well as for information about your debts and monthly expenses to determine whether you’re a worthy borrower. If the numbers don’t add up, you’d be out of luck.
But what if you could convince your bankers that your income is higher than your stack of documents indicates? What if you promised some belt-tightening over the next couple of years that included moving to a cheaper neighborhood, getting rid of your gym membership, and cutting back on travel? Would they believe you?
In the mid-2000s—the heyday of “liar loan” mortgages—maybe they would have. But banks learned their lesson about taking too much on faith from consumers. For corporations, though, credit is easy again. Some of the riskiest borrowers, and the private equity firms often behind them, have been massaging a measure known as Ebitda—earnings before interest, taxes, depreciation, and amortization—to appear more creditworthy and take out bigger loans.
Money managers, regulators, and credit rating companies say they’re being vigilant. Even so, the fuzzy numbers may be creating a false perception of safety in the $2.5 trillion market for low-rated corporate debt. That market is a key source of funds for companies with less-than-stellar credit and for private equity firms, which typically load the businesses they acquire with debt to boost returns. Institutional investors have increased their purchases of high-risk loans and bonds over the past decade, as near-zero interest rates made other fixed-income assets less attractive. That demand helped make bigger and riskier loans possible. Matthew Mish, head of credit strategy at UBS Group AG, says even a garden-variety recession in the next year or two could cause earnings for the weaker borrowers to drop by as much as 40% from peak to trough, rivaling the declines seen during the global financial crisis. Such a meltdown of corporate balance sheets could fuel a cascade of defaults and bankruptcies.
Ebitda, which became popular in the 1980s as a tool for corporate raiders to better evaluate potential targets, has become a mainstay of corporate finance. It’s seen as a relatively direct measurement of a company’s ability to generate cash, because it strips out the effects of management’s decisions on capital investments and indebtedness. In theory it provides evidence of how much money the company could have available to service its debt.
Over the past several years, Wall Street lawyers and advisers have worked to squeeze generous adjustments into the Ebitda calculation, helping make purchase prices look smaller and debt loads more manageable. Exela Technologies Inc., a document processing company formed through the merger of SourceHOV and Novitex, relied on several rounds of adjustments to boost Ebitda when it borrowed money to finance the deal in 2017.
After removing interest, tax, depreciation, and amortization, plus some one-time costs, the company arrived at Ebitda of $247 million. In another round of adjustments, Exela counted expected benefits from shutting offices, cutting wrokers, and renegotiating vendor contracts. The resulting “further adjusted Ebitda” showed it pulling in $353 million for the 12 months ended on March 31, 2017. Based on generally accepted accounting principles, the combined company would have lost almost $63 million over that period. In a statement, Exela Chief Executive Officer Ronald Cogburn said it was important for investors to consider both a company’s current financial reporting and the potential beneficial impact of strategic planning on future plans.
In perhaps the most flagrant example of creative Ebitda, office-sharing company WeWork turned a $933 million loss into $233 million of what it called “community adjusted Ebitda” last year, when it issued its debut bond. The widely ridiculed—and since discontinued—metric excluded even basic general and administrative expenses. “We have never seen a net negative adjustment to Ebitda—it only goes up,” says Jason Dillow, CEO of Bardin Hill, a credit investment firm. “It is basically what can you get away with while keeping a semi-straight face.”
Professors Adam Badawi of the University of California at Berkeley and Elisabeth de Fontenay of Duke used a machine learning algorithm similar to those used to identify spam in email traffic to screen more than 4,000 credit agreements filed with the Securities and Exchange Commission from 2011 to 2018. Their study showed wide variation in how companies define Ebitda.
Take Del Frisco’s Restaurant Group Inc., the New York steakhouse chain. The company sought a $390 million loan last year to finance its acquisition of Spanish tapas chain Barteca Restaurant Group. It took Del Frisco 2,723 words to explain what Ebitda means, the most of any borrower included in the study. Its definition included 22 types of adjustments it could use to boost its reported earnings. By contrast, blue-chip companies such as chemical giant 3M Inc. and advertising agency Omnicom Group Inc. used less than 40 words for their Ebitda definitions. The most concise borrower used 10, barely enough to spell out the acronym. The simpler the definition, the less “creative” the Ebitda.
An overly complex definition can weaken protections for buyers of the company’s debt. That’s because key tests to determine if the company can take on additional debt, make investments, or pay dividends are typically calculated with Ebitda. “In instances where you have extraordinarily permissive language, it is much more like a self-certification than anything else,” de Fontenay says.
Ebitda inflation has picked up. In the first quarter of this year, companies issuing leveraged loans for mergers and acquisitions inflated their Ebitda by an average 43%, according to Covenant Review, an independent research firm that analyzes debt documents for investors. That’s the highest of any quarter in the data, which dates to 2015.
Evidence suggests that when companies make optimistic adjustments to Ebitda, disappointments are the norm soon after a deal is done. According to a recent study by S&P Global Ratings, companies involved in a merger or a leveraged buyout in 2015 missed their own earnings projections by an average 29% in the first year following the deal. For deals originating in 2016, the projections were off 35%.
Investors have already had a taste of what happens when things don’t work out as expected. Since 2017, Exela has been unable to improve earnings significantly with cost cuts and other moves, according to Moody’s Investors Service, which in November lowered Exela’s credit rating to Caa3, nine notches below investment grade. Exela’s profit margins have dwindled amid stiff competition, while charges for restructuring costs and goodwill impairment contributed to a net loss of $282 million in the 12 months ended on Sept. 30. Its bonds, meanwhile, dropped to just above 30¢ on the dollar. No reason to panic, though. The company says its further adjusted Ebitda is still growing.
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>>> Super-Rich Families Pour Into $787 Billion Private Debt Market
While banks are pulling back from lending, ultra-high-net-worth individuals are offering direct loans in return for high yields.
Bloomberg
By Kelsey Butler, Benjamin Stupples, and Marianna Duarte De Aragao
December 10, 2019
https://www.bloomberg.com/news/articles/2019-12-10/super-rich-families-pour-into-787-billion-private-debt-market?srnd=premium
Like many members of the global super rich, Monaco-based financier Evgeny Denisenko faces an investing challenge.
Four years ago, he came into a multimillion-dollar windfall when he sold an equity stake to a large Russian pharmaceutical firm. But in an era when central banks are keeping economies on life support with cheap-money policies and negative-yielding bonds, the traditional assets that used to preserve family fortunes are scarcer and less effective. That means the real value of many a nest egg is dwindling, leaving Denisenko to face the challenge of ensuring that future generations of his family are as rich as he is.
The solution, says the 29-year-old Russian, lies in a risky market for lending money to ventures and businesses viewed as too niche or outlandish by banks. “If you get the right deal, it’s one of the best asset classes at the moment,” Denisenko says.
Direct loans to far-flung oil exploration projects, luxury real estate projects, private equity-backed businesses, and cash-intensive tech startups can pay yields more than twice as big as the junk-bond market. That’s lured the likes of the Denisenko family and other members of the global elite such as former Los Angeles Dodgers owner Frank McCourt Jr. Stockholm-based Proventus Capital, which spun off from the family office of Swedish financier Robert Weil, is investing on behalf of wealthy clients, as well as institutional investors, in the market. More commonly, family offices are investing in the private credit market through funds. The Pritzker family, which owns the Hyatt hotel chain, and the Bill & Melinda Gates Foundation Trust have also put money into funds that invest in private distressed debt, tax filings show. Spokesmen for McCourt and the Gates Foundation Trust declined to comment. Requests for comment from the Pritzker family weren’t immediately returned.
Private credit has boomed globally as banks, under pressure from regulators since the global financial crisis to reduce risk, have pulled back from lending to smaller, potentially more vulnerable companies. The private credit market has expanded to $787.4 billion, from just $42.4 billion in 2000, according to London-based research firm Preqin.
Family offices—mini-investment firms set up by the super rich to manage their personal wealth—have poured more and more cash into direct lending, Preqin says.
Denisenko’s family office, known as Apolis, aims to deploy about $50 million per year around the world to companies from sectors such as outsourcing, oil, and real estate. As of October, 393 family offices were active in private debt, up from 129 in 2015, according to Preqin. This year, Axial Networks Inc., which operates an online forum to bring together lenders and borrowers, estimates that family offices on its platform will sign as many as 275 private credit deals in 2019, roughly a 15% annual increase.
The trend is likely to continue, according to findings from the Alternative Credit Council, which represents private credit asset managers globally. Its survey of firms managing $400 billion in private credit assets reported that half expect family offices to keep adding more money to private debt strategies over the next three years.
Tight Competition
There isn’t one playbook for investing in this market. “We like investing in places that are niche-y and capital short,” says Alan Snyder, founder and managing partner of Shinnecock Partners, a Los Angeles-based multifamily office. Shinnecock provides loans of $5 million to $25 million and focuses on such strategies as short-term bridge real estate lending, distressed municipal bonds, and lending against art assets. The art lending fund it set up about 30 months ago has made deals totaling $17 million and is getting more calls from people willing to lock up their artwork in storage as collateral for debt, Snyder says.
In addition to the tempting yields, the entrepreneurial flavor of lending directly to ventures in search of the rewards that come with bigger risks can also add to the appeal for families that became rich running their own businesses. “Appetite is strongest in asset-backed transactions or areas that are close to the family’s existing investments or operations,” says Robert Crowter-Jones, head of private capital at Saranac Partners, a London-based advisory firm for rich individuals and families.
But as the strategy’s popularity with billionaires has grown, competition for private loan deals has ignited. Family offices can move more quickly to sign new business than can bigger institutional peers such as pension funds, says Mark Sotir, president of Equity Group Investments, which manages Chicago billionaire Sam Zell’s money. EGI has loaned money to moving company Sirva Worldwide, oil and natural gas company Penn Virginia, and energy company Par Pacific Holdings, according to its website. “Debt is a tool in the toolbox, and we’re going to use it more in the future for sure,” Sotir says.
As the race to bag deals before rivals can get them intensifies, investors are also swallowing bigger risks when deploying their money, according to Snyder.
So-called middle-market lending, which involves loans of $50 million or larger, is overcrowded. More competition has also started eroding the yields that made direct lending appealing in the first place.
Michael Dean, of family office Bluelaurel, has felt the crush of competition firsthand. Avamore Capital, a property-focused lending company that Bluelaurel backs, initially produced double-digit returns four years ago. Surging interest in private credit has since halved those returns, Dean says. Still, he expects to maintain as much as 80% of his family’s assets in private real estate credit for now. “If the right opportunities arise, we’ll probably do some deployment back into direct real estate,” he says.
There are also liquidity risks. The underlying loans in private debt aren’t widely traded, which means they’re likely to be hard to sell in a crisis when markets turn volatile. In short, investors could find themselves looking on helplessly as their assets become worthless during a crash. Moreover, when investing in a closed-end fund with an asset manager, the capital is locked in with virtually no opportunity to withdraw until the asset matures.
“There’s a real reason the returns are as high as they are,” says Christian Armbruester, the founder of London-based Blu Family Office, who manages an open-end fund that contains more than 3,000 private loans worldwide. “If a borrower defaults, walks away, and the markets freeze up, you’re holding an asset you can’t move.”
But any concerns about deteriorating credit quality, tougher competition, or an impending downturn are failing to dent the popularity of private debt among investors in search of the yields it can pay. Debt will remain a big part of family office portfolios as they expand their footprint in private markets for the foreseeable future, according to Axial Chief Executive Officer Peter Lehrman.
“It’s really the next leg of progress by family offices in terms of their sophistication as direct investors in private markets,” Lehrman says. “I’m not surprised they started off investing in equity. And the fact that they’re increasingly putting capital to work and looking for opportunities in credit is a function of their sophistication.”
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>>> Why Fund Managers Are Scared of Sudden Withdrawals
Bloomberg
By Nishant Kumar and John Gittelsohn
July 10, 2019
https://www.bloomberg.com/news/articles/2019-07-10/why-liquidity-mismatch-is-scaring-the-bond-market-quicktake?srnd=premium
When M&G Plc, a U.K. property fund, announced it was freezing withdrawals on Dec. 4, mom-and-pop real estate investors were introduced to a term that’s already caused pain elsewhere in European bond and equities markets: liquidity mismatch. It’s what happens when funds that promise unrestricted redemptions put money into assets that are hard to sell in a pinch. That contradiction led the head of the Bank of England to warn earlier this year that some funds were “built on a lie.” Some observers compare the situation to a bomb hidden in the markets, ticking away and set to go off come the next downturn.
1. What’s causing mismatches?
For years, mom and pop investors have been pouring their money into mutual funds and exchange-traded products with the promise that they can get their money out anytime they want. At the same time, many funds that traditionally focused on liquid securities have been edging into more rarefied corners of the market to eke out returns in today’s world of low or negative interest rates -- a movement known as “style drift.” But many of those higher-yielding assets are in thin or quirky markets, making them potentially hard to trade. Real estate is perhaps the most illiquid asset of all, often taking months to unload.
2. Why is that such a problem?
Remember bank runs? Before deposit insurance, they were a regular occurrence because of the liquidity mismatch inherent in banks -- institutions that convert customer deposits available on demand into long-term investments. For investment funds, a sudden rush for the exits can create something similar. That can leave them with a choice of selling off assets at fire sale prices, potentially weakening themselves further, or closing the door to redemptions, a step that can erode market confidence more broadly.
3. What prompted these worries?
M&G froze its flagship 2.5 billion-pound ($3.3 billion) U.K. real estate fund after being hit by mounting redemptions. Carney’s comments came in June, after one of Britain’s most famous stock pickers, Neil Woodford, froze withdrawals from his flagship equity fund, and a global macro fund run by H2O, which is backed by Natixis SA, saw billions of dollar’s worth of withdrawals over investments in unrated bonds. Earlier, Swiss asset manager GAM Holding AG, froze redemptions in some funds after its dismissal of star bond manager Tim Haywood led to a rush of withdrawals.
4. Hasn’t this happened before?
Yes. In 2016, property funds stopped investors from taking out their money when withdrawals spiraled after the U.K. voted to exit the European Union. The M&G money pool was one of seven major U.K. funds managing more than $20 billion to halt trading at that time. To fix the problem, U.K. property funds -- which managed 29.3 billion pounds as of the end of October -- have been raising their cash levels. But the real estate market in the U.K. is slowing and the value of malls and stores, in particular, is plunging. That could make it even harder for funds to exit their bets, especially if they’ve offloaded their healthier properties first.
5. What’s driving it?
Something that’s referred to as “the reach for yield” -- and managers have been reaching further and further lately. Returns on safe assets plummeted in the 2008 financial crisis and have stayed low ever since. For example, as time has passed, many relatively straightforward U.S. bond funds have increased their holdings of lower-rated bonds, emerging-market debt and other securities, to juice returns. The trend led Morningstar Inc. to change how it classifies U.S. bond funds to make risk levels clearer. In April, it broke intermediate-term bond funds into two categories. Funds in “intermediate core bond” limit exposure to below-investment-grade assets. The second category is “intermediate core-plus bond.” At least eight of the “core plus” funds tracked by Morningstar reduced their allocation to government AAA rated debt between 2006 and 2018, while allocating more funds to assets rated BBB, the lowest investment grade rating given by Standard & Poor’s.
6. What are regulators doing?
The U.K.’s Financial Conduct Authority said it was working with M&G to ensure that “timely actions” are undertaken in the best interests of all the fund’s investors. The U.S. Securities and Exchange Commission has been concerned about mutual fund liquidity since at least 2015. The SEC now limits fund holdings of illiquid securities to 15%, and the funds are required to provide a confidential breakdown on the liquidity of their holdings to the regulator. As of June, they must also include a discussion on how they manage liquidity risk in annual reports to investors. Mutual funds in the U.K. are allowed no more than 10% of their assets in unquoted securities, a limit that Woodford’s now-frozen fund breached twice, according to the Financial Conduct Authority. On the other hand, the number of U.K. funds that have closed and blocked redemptions so far is relatively small compared with the hundreds of U.S. funds that close annually because of shrinking assets or investment losses.
7. How big a problem is this?
A lot of money is potentially at risk, though there’s debate over how acute the dangers are. Carney cautioned that the problems are “systemic,” with some $30 trillion tied up in illiquid or difficult-to-trade instruments. U.S. Federal Reserve officials have been warning about potential risks in leveraged loans and CLOs (Collateralized Loan Obligations) since 2013. “Widespread redemptions by investors, in turn, could lead to widespread price pressures,” Fed Chairman Jerome Powell said in May, “which could affect all holders of loans.” Others have pointed to liquidity issues with exchange-traded funds that focus on high-yielding loans and with direct lending funds, in which pools of investors make the kinds of loans to mid-sized companies that used to be arranged by banks. Defenders of bond ETFs point to the way they weathered previous bouts of market turmoil. But Michael Burry, an investor whose bet against the subprime bubble was featured in “The Big Short,” warns that “the theater keeps getting more crowded, but the exit door is the same as it always was.”
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>>> Record $2.4 Trillion Bond Binge Is Threatening Investor Returns
Bloomberg
By Finbarr Flynn
November 29, 2019
https://www.bloomberg.com/news/articles/2019-11-30/record-2-4-trillion-bond-binge-is-threatening-investor-returns?srnd=premium
Valuations are tight, little room for error: Aberdeen Standard
Drop in Treasury yields in 2019 helped boost investor returns
An unprecedented frenzy of debt sales around the world is threatening to cool this year’s hot returns on corporate bonds.
Companies have sold a record $2.43 trillion so far this year across currencies, surpassing previous full-year records. Investors rushed to snap up all this debt because they were desperate for yield as central banks cut rates. That has pushed up valuations.
Now, some troubling signs for the direction of those valuations are converging. Recent data suggest that the worst may be over for the global economy, which means many central banks could have less reason next year to guide down borrowing costs. That will all make it harder to top the double-digit returns that some investors scored on corporate bonds this year.
Corporate Debt Bonanza
Companies in 2019 rushed to sell debt across currencies as rates fell
“Valuations are tight in parts of the market, meaning there is not much margin for error,” said Craig MacDonald, global head of fixed income at Aberdeen Standard Investments. There could be “fairly muted positive returns, if you miss the problem credits, rather than the very strong returns of this year,” he said.
There are also some wild cards lurking: the ultimate course of U.S.-China trade talks, for starters. Signs of progress in the negotiations have buoyed financial markets in recent weeks, but political factors in the U.S. and China could make the path to any final agreement harder.
Geopolitical risks including North Korea, which tested more missiles in recent days, could also lead to more volatility.
Any shocks that pushed up financing costs would be of particular concern at weaker companies that have loaded up on debt. There are plenty such borrowers after bond issuance in Asia and Europe marched ahead at record pace this year, and U.S. debt sales remained high.
“The low hanging fruits are gone after a year of strong rally,” said Angus Hui, head of Asian credit and emerging-market credit at Schroder Investment Management (Hong Kong) Ltd.
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>>> Pensions Venture Into Risky Corners of the Market in Hunt for Returns
Wall Street Journal
by Avantika Chilkoti and Caitlin Ostroff
11-7-19
https://www.msn.com/en-us/money/retirement/pensions-venture-into-risky-corners-of-the-market-in-hunt-for-returns/ar-BBWq1Yi#page=2
Some pension-fund managers are venturing further into unusual investment territory as this year’s plunge in bond yields makes it even harder to find decent long-term returns.
Funds are dabbling in riskier asset classes, including private markets, real-estate projects, infrastructure financing and direct lending. Some are making riskier fixed-income bets, buying volatile assets such as 100-year Argentine government bonds. Others are going farther afield, investing in greenhouses and waste management.
“How do we get those types of return in an environment with low interest rates?” said Duncan Hale, a portfolio manager at Willis Towers Watson Investments, which offers insurance brokering, risk management and investment advisory services. He said he looks for tried-and-tested investment avenues that are “slightly outside of where you’ve seen pension funds usually invest.”
The giant pools of retirement money are under pressure to take on more risk following decades of declining interest rates that have chipped away at returns from their traditional bond-heavy portfolios. Those concerns have been exacerbated this year as yields on government bonds dropped sharply and central banks loosened monetary policy to stimulate economic growth.
Pension funds’ allocations to alternative asset classes rose to 26% in 2018 in the U.S., U.K., Japan, Australia, Canada, Switzerland and the Netherlands, from 19% in 2008, according to estimates from Thinking Ahead Institute, a research firm affiliated with Willis Towers. The allocation to bonds has remained steady at around 30%. That trend shows no sign of reversing, investors and analysts say.
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Falling bond yields hurt pensions by lowering a key metric called the discount rate, which measures the current value of a program’s future obligations to retirees. That forces the pensions to boost their assets to satisfy liabilities in coming years.
To help U.K. pensions generate steady returns, Willis Towers is advising its clients to invest in long-term property rental markets and infrastructure projects, as well as buying trains and leasing them to the government, according to Mr. Hale.
His fund backs a company that purchased land in eastern England for the construction of two greenhouses with a combined size of roughly 47 soccer pitches. Those will be leased out for 20 years to tomato growers and others, and are projected to generate annualized yields of more than 6% over the period.
Another project backed by the fund involves investing in a company that collects waste from London boroughs to be burned, helping generate electricity through turbines. Local authorities pay for the waste collection, while the electricity is sold back into the grid, according to Mr. Hale. The returns are expected to be more than 5% annually over 20 years, he said.
Some pension funds are moving into emerging-market debt—which can be volatile and sensitive to political headwinds—or less-liquid assets such as real estate.
One U.K. pension-fund client placed a sliver of its assets in the 100-year Argentine bond sold in 2017, according to Con Keating, head of research at Brighton Rock Group, an insurance provider for pensions. The bond currently offers a 27.712% yield, according to FactSet. In August, the value of those ultralong bonds fell by nearly half because of political uncertainty.
“This stuff really doesn’t belong in a pension fund,’’ said Mr. Keating. Because of the search for better returns, “you see all sorts of deals being done for all sorts of credit that wouldn’t ordinarily be touched,” he said.
The need to boost returns prompted Nest, a £8.5 billion ($10.9 billion) workplace-pension fund manager backed by the U.K. government, to make its first foray into private markets.
The firm is financing infrastructure projects such as toll roads and airports, and lending to commercial real-estate projects and buying collateralized mortgage-backed securities, through investments managed by Amundi SA and BlackRock Inc.
“It’s going to just become harder to eke out any returns from public markets,” said Stephen O’Neill, Nest’s head of private markets. With the new investments, “the main motivation is to try to pick up a private-credit premium—or liquidity premium—over the comparable bonds in the public market,” he said.
For pension funds in the Netherlands, the shrinking yields are a growing headache as they are required to surpass—and not just meet—estimated liabilities. Those that fall short must submit a recovery plan within a specified time frame.
APG, which has €440 billion ($486.9 billion) under management and oversees investments for the Netherlands’ largest pension fund for government and education employees, has less than 40% of its portfolio in fixed income, said Thijs Knaap, a senior strategist at the asset manager. Another 34% is in equities, 10% in real estate and 17% in alternative investment classes such as hedge funds and infrastructure. The firm, like many other pension funds, insurers and large investors, sees bonds as a crucial part of its portfolio because they can quickly be converted into cash, even if the returns are negligible.
“You have to work harder for your money,” said Mr. Knaap. “This means we’re taking on risk rather than the old situation of putting everything in bonds.”
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>>> This Red Alert Is Now Flashing on the Bond Trader’s Radar Screen
Bloomberg
By Liz McCormick
November 9, 2019
https://www.bloomberg.com/news/articles/2019-11-09/this-red-alert-is-now-flashing-bright-on-the-bond-trader-s-radar?srnd=premium
Last time this happened was during biggest sell-off since 2009
Longer maturity bonds in crosshairs as reflation trade builds
A bond-market warning light that glowed green for years is suddenly flashing red. The bad news for bondholders is that the last time this happened, it was accompanied by the biggest sell-off since the aftermath of the global financial crisis.
That indicator is the term premium, which, for both Treasuries and German bunds, has snapped back from last quarter’s record lows. The U.S. gauge is now on track for the biggest three-month increase since late 2016.
After a stellar rally through August, global bonds have pulled back in recent weeks as thawing trade tensions lightened the global economic gloom, sapping demand for the safety of sovereign debt. Rebounding term premiums now signal the sell-off has further to run -- the measure of extra compensation for holding longer-term debt versus simply rolling over a short-tenor security for years is in an uptrend that investors and strategists say has only just begun.
Term premium rebound adds fuel to Treasury yields' rise
The 10-year Treasury yield, a benchmark for world markets, climbed Thursday to a three-month high as investors’ animal spirits were sparked by the ebbing of the biggest headwind to global growth -- the U.S.-China trade war. That came as its German counterpart surged to levels unseen since mid-July and those in France and Belgium climbed back above 0%. The Japanese equivalent jumped Friday to its highest since May.
Investor are increasingly worried about holding longer-term debt as easing economic anxiety raises the prospect of a capital flight out of haven assets into riskier ones. Such a trend is already driving up yields, which, combined with the Federal Reserve’s signal that it will hold interest rates steady for the time being, is boosting term premiums. In Europe, a still-accommodative policy is bolstering inflation prospects, adding to the upward pressure on the gauge.
“Term premium was extremely depressed due to trade uncertainty, Brexit and you name it,” said Roberto Perli, a partner at Cornerstone Macro LLC. “These risks have abated so there is room for about a 50 basis point move higher in term premium. And given the Federal Reserve is on hold -- with no chance of lifting rates - there’s a lot of incentive for investors to take risk.”
Ten-year Treasury term premium has climbed about 42 basis points since the end of August, on track for the biggest three-month increase since 2016, according to the widely followed New York Fed ACM model created by Tobias Adrian, Richard Crump and Emanuel Moench. It rebounded this week to as little as minus 0.84% -- from a record low of minus 1.29% in August, the least for NY Fed data provided back back through 1961.
Understanding the trend in term premium isn’t just an academic exercise for bond wonks as it also helps gauge what’s driving debt yields and valuations. That margin of safety is one of three components that make up the yield of any given bond, according to former Fed Chairman Ben S. Bernanke -- the other two being market expectations for monetary policy and inflation. Basically, it’s an extra cushion against risk over the security’s relatively long lifetime.
READ MORE:
U.S. Yields Soar to Three-Month High as Bets on Fed Cuts Slashed
Bond Yields Start to Turn Positive Again as Trade Outlook Clears
Japan Bond Yields Climb to Five-Month High With 0% on Horizon
Havens Crushed as End-of-the-World Trade Implodes (2)
To be sure, a resolution to the U.S.-China trade spat still looks far, with President Donald Trump downplaying Friday the amount of progress made in negotiations.
In Germany, the 10-year term premium began a swoon in mid-2014 after ranging from 100 to 250 basis points back since the euro was introduced in 1999, according to estimates by UniCredit SpA strategist Luca Cazzulani, using the methods as in the ACM model.
The gauge for bunds slumped to a record minus 100 basis points at the end of September before rising to minus 88 in October, according to UniCredit data updated at the end of each month. It has likely risen further this month.
“We have seen a continuation of upward in bund yields this month, and that should be related mostly to higher term premium,” Cazzulani said.
Long-term debt has a higher duration that those with shorter tenors. That means that for each move up in yield, prices will fall more sharply than for its short-term counterparts, increasing the risk of being in long-maturity debt.
QE Effect
The European Central Bank’s resumption of fresh bond purchases this month will exert marginal downward pressure on bund term premium, yet won’t be “a game changer,” according to Cazzulani. He estimates that quantitative easing will cause only a five basis point setback in the gauge, which would be too little to counter forces pushing it upward.
After cutting rates and unveiling debt-buying plans last month, the ECB has been pushing for governments to add budgetary support for growth. The prospects of fiscal stimulus along with an ongoing push for more European banking integration bode for more upside for term premium and yields in the region, according to Ronald van Steenweghen, a fund manager at a portfolio manager at DPAM.
Lagarde Eyes Dozen Euro Members With Precious Room to Spend More
“Term premium was driven to levels that were difficult to explain unless you think the economic outlook is very dire, which we don’t agree with,” DPAM’s van Steenweghen said during an interview at the firm’s Brussels office. “And the potential positive feedback loop on the economy of fiscal stimulus is very, very high. This, with stable ECB policy, improving growth and reduced uncertainty all will work to push yields higher.”
The 10-year bund yield is on course to rise from about minus 0.26% to between 0.50% and 1% over the next one to three years, predicted van Steenweghen.
That leaves him “more confident with having a shorter duration stance.”
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>>> Calls Persist for Negative U.S. Yields Even as Fed Signals Pause
Bloomberg
By Vivien Lou Chen
November 3, 2019
https://www.bloomberg.com/news/articles/2019-11-03/calls-persist-for-negative-u-s-yields-even-as-fed-signals-pause?srnd=premium
Belly of curve could go below zero by 2021: BofA’s Braizinha
Moody’s Analytics also raises prospect of sub-zero yields
The Federal Reserve may be hinting at a pause in its policy easing, but Bruno Braizinha at Bank of America Corp. sees a risk that yields on some Treasuries will go negative by 2021 as the U.S. central bank cuts rates all the way to zero.
While that may seem like a remote scenario to some, the strategist says the market can’t ignore the possibility that 5- and 7-year yields -- both presently within a few basis points of 1.60% -- could fall below zero. He says now’s the time to hedge against that prospect.
Braizinha wrote about the risk of sub-1% yields in the U.S. just ahead of August’s historic Treasuries rally, which drove 10-year yields as low as 1.43% on Sept. 3. That rate has since rebounded to around 1.71%, but his central view is that the benchmark yield will go even lower -- to around 1.25% -- in the next three months. In addition to that, he also sees the Fed being forced to return to near-zero rates amid a deterioration in the American economy and an eventual realization by investors that a U.S.-China trade deal won’t be a panacea.
Yields in belly of Treasury curve have fallen over the past year
“It’s important to acknowledge those risks and not overlook these scenarios,” he said by phone. “All the positive sentiment on trade is fading, and what’s changed now is that it’s more likely that at some point the Fed is going to have to cut again.”
A day after the Fed signaled a pause on Oct. 30, yields plummeted across the curve. In Braizinha’s view, the moves reflected a bias that permeated the bond market based on expectations for worsening economic data, lower yields and a flatter curve.
Yields regained some of that ground on Friday amid stronger-than-expected American jobs data and positive developments on the U.S.-China trade relationship, although a poor reading on the Institute for Supply Management’s factory gauge created a slightly more mixed view.
To get to negative yields in the belly of the curve, Braizinha says the Fed would need to push its target to around zero -- from 1.50% to 1.75% currently -- like it did a decade ago in the midst of the global financial crisis. Rates on Treasuries out to around three years would then be “anchored around 10 basis points to 15 basis points” in his view, while demand for dollar duration would send 5- and 7-year yields negative.
The Bank of America analyst, who recommends betting on 30-year Treasuries in anticipation that yields will go much lower, is not alone in contemplating negative Treasury yields.
Ryan Sweet, head of monetary policy research at Moody’s Analytics, said he also sees a risk that Treasury yields could go below zero if the U.S. falls into recession. And, according to him, this could happen even if the Fed doesn’t cut its target below zero.
In the options market, meanwhile, some traders have been hedging in the past month against the possibility of U.S. policy rates heading to zero or even negative levels.
Bank of America currently expects one additional Fed rate cut in the first quarter and “there are still many hurdles to get to negative interest rate policy in the U.S.,” according to Braizinha. One of these is that “it is not clear that it worked as it was intended” in other economies.
“What I find more likely is that we reach a policy exhaustion point where the Fed cuts down to near zero, which requires only six 25-basis-point moves, and the curve continues to be pressured by lower long-term inflation expectations and global duration demand,” he said.
<<<
>>> Fed’s Plan to Buy Treasury Bills Could Be an Expensive Ordeal
Bloomberg
By Alex Harris
October 11, 2019
https://www.bloomberg.com/news/articles/2019-10-11/fed-s-plan-to-buy-treasury-bills-could-be-an-expensive-ordeal
Bank to buy $60 billion of 5- to 52-week securities per month
Short-term investors may be reluctant to part with securities
The Federal Reserve’s attempt to keep U.S. funding markets calm by rebuilding its cache of bank reserves could be expensive.
The Fed said Friday it will begin buying $60 billion of Treasury bills per month -- with maturities ranging from five weeks to a year -- at least through the second quarter of 2020 to improve its control over the benchmark rate it uses to guide monetary policy. It’s the central bank’s latest measure meant to prevent a repeat of the mid-September turmoil that rocked money markets.
But the Fed may have to pay up to convince people to part with the securities since investors are clamoring to hold bills. Money funds’ holdings of them topped $1 trillion in September, according to Peter Crane, president of Crane Data LLC. “Funds love them,” Crane said.
Debbie Cunningham, chief investment officer of global money markets at Federated Investors Inc., said if the company started to sell Treasury bills, it may be from shorter-dated holdings that it can easily invest in the market for repurchase agreements.
“That will be the exception rather than the norm,” Cunningham said in an interview. “They’re going to have to be buying them from other participants.”
Money-market funds continue to see inflows
Money-market reforms from 2016 spurred record inflows into government funds, driving demand for assets like repurchase agreements, Treasury bills and short-term agency debt. Regulations also require daily and weekly liquidity thresholds for money-market funds, and T-bills can satisfy those requirements.
“Everybody’s got bills somewhere, but it’s shaking those out in size that the Fed wants,” said Blake Gwinn, strategist at NatWest Markets. “I’m wondering what kind of premium the Fed is going to have to pay to get them.”
Even though primary dealer holdings of Treasuries are about $190 billion, their T-bill levels are quite low by comparison: around $7 billion. There’s not enough bills to buy just from the primary dealers, and so the Fed is going to have to convince other investors -- like money funds or corporations -- to part with their T-bills.
However, money markets -- particularly the government ones -- need the Treasuries, both as an investment vehicle, but also because they satisfy fund liquidity requirements. Fed purchases could drive yields down. If a money manager’s objective is to generate as much yield as possible for investors, why sell to the Fed at a lower rate? All that’s going to happen is the fund has to reinvest it in bills at a lower rate, reducing the yield the fund offers investors.
In addition to the Treasury bill purchases, the central bank said Friday that it will continue to conduct overnight and term repo operations through January, if not longer. The Fed has done liquidity injections like these since Sept. 17, and they’ve helped calm this vital funding market.
<<<
>>> QE, or Not QE? Impact of Fed Bond-Buying Will Depend on Treasury
Bloomberg
Rich Miller
October 11, 2019
https://www.bloomberg.com/news/articles/2019-10-11/qe-or-not-qe-impact-of-fed-bond-buying-will-depend-on-treasury?srnd=premium
Shift in Treasury sales to bills might depress long-term rates
Powell insists Fed not undertaking quantitative easing
The Federal Reserve insists its planned hoovering-up of Treasury securities is a “technical” measure that isn’t quantitative easing and won’t meaningfully impact the economy. But that may depend on how the Treasury Department responds to the central bank’s plan.
If the Treasury reacts by stepping up its issuance of Treasury bills and cutting back on sales of longer-dated securities, that would tend to put downward pressure on long-term interest rates -- which is exactly what the Fed’s crisis-era QE programs were intended to do.
But if the Treasury keeps its issuance plans the way they are now, then the Fed’s massive buying risks squeezes in the bills market that could push up prices.
“The impact the Fed’s purchases have is dependent on what the Treasury Department does with issuance,’’ Drew Matus, chief market strategist for MetLife Investment Management, said in an email.
“If they boost bill issuance and cut note and bond issuance, it could have a stimulative effect on the economy,’’ said Matus, who once worked on the New York Fed’s open market desk that implements the central bank’s interest-rate intentions.
Fed to ramp up purchases of Treasury bills, but is it QE?
The interplay between the politically-independent Fed and Treasury highlights the difficulties of carrying out monetary policy in a world where rates are low and central banks are more dependent on asset purchases to manage their economies.
A Treasury spokesman declined to comment on what the department intends to do. The Treasury is slated to announce its quarterly refunding plans on Oct. 30, a few hours before the Fed concludes a policy meeting.
The Fed said on Friday that it will begin buying $60 billion of Treasury bills per month to improve its control over the benchmark interest rate it uses to guide monetary policy after turmoil rocked money markets in September.
Purchases will continue “at least into the second quarter of next year,’’ the central bank said in a statement.
“If you stretch purchases into the second quarter, that amounts to at least $400 billion,’’ said Thomas Costerg, senior U.S. economist at Pictet Wealth Management in Geneva.
In foreshadowing the Fed’s decision earlier this week, Chairman Jerome Powell repeatedly maintained that any planned securities buying would not be a resumption of QE.
Not QE
“In no sense is this QE,’’ Powell told the National Association for Business Economics conference in Denver on Oct. 8.
Under quantitative easing, the Fed bought bonds to lower long-term borrowing costs and boost stock prices and the economy during and after the financial crisis.
Powell argued that the Federal Open Market Committee was not out to spur the economy by resuming growth of its balance sheet, as was the case under its crisis-era buying campaign.
Fed to buy $60 billion of Treasury bills per month
Instead, it is responding to last month’s strains in short-term money markets by supplying more liquidity in the form of bank reserves.
As if to hammer that message home, the Fed is creating those reserves through purchases of bills with a maturity of one year or less, rather than buying longer-term Treasury debt, as it did under QE.
“The committee’s apparent concern with how the public would perceive today’s announcement seems heightened enough to conclude that it was a primary consideration in deciding which sector of the Treasury market they would purchase,’’ Michael Feroli, chief U.S. economist for JPMorgan Chase & Co., said in a note on Friday.
Trump Attacks
Some of that concern may also be political. President Donald Trump has repeatedly accused the Fed of keeping monetary policy too tight and at various points has urged it to resume asset purchases.
Some Fed watchers concur with Powell’s assessment of what the Fed is up to.
“This is not QE or even QE lite,’’ Krishna Guha, vice chairman of Evercore ISI, said in an Oct. 8 note. “The central bank is responding to market demand for central bank reserves with minimal duration as it did before 2007.’’
The September scramble for reserves was triggered by a combination of corporate tax payments and the settlement of Treasury debt sales that temporarily sent the rate on overnight securities repurchase agreements as high as 10%.
Wrightson ICAP LLC chief economist Lou Crandall said that a lot depends on how the Treasury responds.
“If they cut coupon issuance, then guess what, this is QE,’’ he said. If the Treasury doesn’t, then it runs the risk of spawning turmoil in the bills market.
“I don’t know which of their allergies give them the worst rash,’’ he said in discussing the Treasury’s options.
<<<
>>> Top Two Threats to the Treasury Market’s Big Year Are Converging
Bloomberg
By Emily Barrett
October 12, 2019
Sell-off puts best Treasuries performance since 2011 at risk
Yields may climb with progress on trade talks, Brexit
https://www.bloomberg.com/news/articles/2019-10-12/top-two-threats-to-the-treasury-market-s-big-year-are-converging?srnd=premium
Two serious threats to this year’s stellar performance in Treasuries are closing in on the market: steps toward a U.S.-China trade deal and a light at the end of the Brexit tunnel.
Treasury yields took flight this week on hints of a partial trade pact, and late Friday President Donald Trump said he and his counterpart Xi Jinping could sign an accord as soon as next month. Prospects for a deal between the U.K. and European Union also looked firmer, as the EU’s chief negotiator signaled readiness to delve into the details of an Oct. 31 exit.
All year, investors have known that the case for Treasuries largely hinged on these major geopolitical quandaries. Now, credible progress on both could catch Treasury bulls seriously offside, and derail a market on track for its best annual return since 2011.
If a worst-case scenario is no longer in play, global growth could improve, the Federal Reserve could be less inclined to ease, and yields in major government bond markets could have more scope to rise.
“There was a decent long in the market that is going to get tested,” said Gary Cameron, portfolio manager at Garda Capital. “I don’t think we have a bear market, but the buy-dips environment we’ve been in since last September is late stage.”
Cameron expects that if this week’s positive signals are sustained, the U.S. 10-year yield could hit 1.90%. The benchmark ended Friday at 1.73%, after rising 20 basis points this week, its second-biggest sell-off this year. Moreover, traders in futures markets have been paring back their wagers on further Fed easing. Pricing of fed fund contracts show that the odds of a cut this month have gone from near-certain to close to a coin flip.
Investors will get plenty of live feedback from central bankers on how they’re viewing the geopolitical landscape next week. Highlights will be toward the back end, with speeches from New York Fed President John Williams and Vice Chairman Richard Clarida, who’s signaled openness to a further easing this year. Both have emphasized the Fed’s data-dependent stance.
Foremost among the potentially market-moving economic reports on the way is retail sales, which investors will watch for confirmation that consumption can continue to support U.S. growth. Economists are looking for Wednesday’s report to show a 0.3% monthly increase in spending for September, slowing from 0.4% the prior month.
“Retail sales will be pretty important,” said Cameron, adding that “the U.S. is the last bastion of reasonable growth it seems in the world right now.”
What to Watch
Monday is Columbus Day, a recommended holiday for the U.S. bond market.
Here’s the economic calendar:
Oct. 15: Empire manufacturing
Oct. 16: MBA Mortgage applications; retail sales; NAHB housing market index; business inventories; Federal Reserve Beige Book; Treasury International Capital flows
Oct. 17: Building permits; housing starts; Philadelphia Fed business outlook; initial jobless claims; industrial/manufacturing production and capacity utilization; Bloomberg consumer comfort; Bloomberg economic expectations
Oct. 18: Leading index
Fed speakers are prevalent:
Oct. 15: St. Louis Fed’s James Bullard; Atlanta Fed’s Raphael Bostic; Kansas City Fed’s Esther George; San Francisco Fed’s Mary Daly
Oct. 16: Chicago Fed’s Charles Evans; Dallas Fed’s Robert Kaplan; Fed Governor Lael Brainard
Oct. 17: Evans, Governor Michelle Bowman; New York Fed’s John Williams
Oct. 18: Kaplan; George; Vice Chairman Richard Clarida
Here’s the Treasury auction schedule:
Oct. 15: $45 billion of 3-month bills; $42 billion of 6-month bills
Oct. 17: 4- and 8-week bills; $17 billion 5-year TIPS reopening
<<<
>>> A $40 Billion Pile of Leveraged Loans Is Battered by Big Losses
By Katherine Doherty
October 9, 2019
https://www.bloomberg.com/news/articles/2019-10-09/a-40-billion-pile-of-leveraged-loans-is-battered-by-big-losses
Sudden drops reflect growing distaste for shakier issues
Energy leads list of losers with $12 billion of loans affected
Barely noticed in a corner of the financial markets, leveraged loans originally worth about $40 billion are staging their own private meltdown.
Loans tied to more than 50 companies have lost at least 10 percentage points of face value in just three months, according to data compiled by Bloomberg. Some have dropped a lot more, with lenders lucky to get back just two-thirds of their investment if they tried to sell.
The list is growing as lenders and credit raters lose patience amid the slowing economy with borrowers that took on mountains of debt to fund private equity buyouts, dividends and other transactions that didn’t improve earnings.
The companies range across sectors, from energy to health care to communications. The biggest losers as of Tuesday included Amneal Pharmaceuticals LLC, whose $2.7 billion loan due 2025 has sunk to about 80 cents on the dollar, and Seadrill Operating LP, whose $2.6 billion loan maturing in 2021 fetches around 53 cents. The biggest losses in terms of total value included Deluxe Entertainment Services Group Inc., whose first-lien loan dropped as much as 77 cents in three months to 12.5 cents -- more than $600 million.
Cuspy Corporations
It’s hardly a full-blown apocalypse for the junk-rated leveraged loan market, which totals $1.2 trillion. But it does reflect a shift in sentiment, and perhaps a latent market risk, as speculation about a recession spurs investors to flee shaky names.
“People want the well-performing loans, and are more wary of taking chances on the situations that have turned negative,” said Andrew Sveen, co-director of bank loans at Eaton Vance Management.
Energy is the hardest-hit sector on the list, with more than $12 billion of loans falling more than 10 cents on the dollar. Consumer and health care follow, comprising around $8 billion and $5 billion of loans outstanding, respectively.
Leveraged Losers
Some of the drops track the slide in a borrower’s financial fortunes, and some were made worse by downgrades to the CCC bucket by ratings firms.
In turn, the downgrades can trigger selling by money managers who are limited from holding such names once they fall below a certain ratings threshold. This includes collateralized loan obligations, groups of loans that asset managers package into bonds. Most CLOs can’t hold more than 7.5% of their portfolios in loans rated CCC.
The CLO market has mushroomed in recent years as investors have clamored for higher yields, and CLOs are the biggest holders of loans to junk-rated companies. Concerns are mounting about how the structures owning so much of corporate America’s debt will react if a recession hits and more downgrades hit.
When now-bankrupt Deluxe Entertainment was looking for a loan to keep it afloat, its lenders, comprised mostly of CLOs, were prohibited from providing the company with more capital because of legal limitations. Their hands were tied after the company was downgraded three notches to CCC- by S&P Global Ratings. Deluxe wound up in Chapter 11 bankruptcy.
<<<
>>> Repo Market Is Telling Washington That Deficits Still Do Matter
Bloomberg
By Liz McCormick and Saleha Mohsin
October 8, 2019
https://www.bloomberg.com/news/articles/2019-10-08/mmt-is-all-the-rage-but-repo-spike-shows-deficits-still-matter?srnd=premium
Bond dealers choke on Treasuries as U.S. goes deeper into red
‘There’s no down time on the supply front,’ FTN’s Vogel says
These days, you’d be hard-pressed to find many people in Washington who are all that worried about the U.S. budget deficit. Republicans seem more interested in tax cuts, Democrats have ambitious spending plans for everything from health care to infrastructure, and Modern Monetary Theory, a manifesto for free-spending governments, is all the rage in progressive circles.
But on Wall Street, bond dealers provided a small, but pointed reminder that, just maybe, debt and deficits do matter after all.
It came in the form of a sudden spike in interest rates for repurchase agreements, or repos, a normally obscure part of finance that keeps the global capital markets spinning. Plenty of factors helped cause liquidity to dry up, but one that’s getting more attention is concern that dealers are starting to choke on Treasuries as the U.S. government goes deeper into the red.
The argument goes like this: Primary dealers, which are obligated to bid at U.S. debt auctions, have absorbed more and more Treasuries to finance the Trump administration’s tax cuts as investor demand has waned. Typically, they rely on repos to fund those purchases by putting up the debt as collateral.
The problem is that with the financial system already inundated by over $16 trillion of Treasuries, banks constrained by crisis-era rules have fewer incentives to participate in repo. Simply put, there was too much new debt flooding the financial system and not enough money, causing lenders to jack up repo rates. The Federal Reserve has moved to inject much-needed cash on a temporary basis, but if left unchecked, the flood of supply in coming months and years could ultimately result in higher borrowing costs for the U.S.
“There’s no down time on the supply front,” said Jim Vogel, a strategist at FTN Financial who’s been following debt markets for over three decades.
The Treasury’s next slate of debt sales comes this week, with a combined $78 billion of 3-, 10- and 30-year auctions starting Tuesday. Yields on the benchmark 10-year note are currently at 1.52%.
Of course, supply wasn’t the only issue. The situation was compounded by corporate tax payments that also siphoned cash out of the banking system.
And to be fair, nobody is suggesting the U.S. faces any imminent problems financing itself. Everywhere you look, government borrowing costs in bond markets around the world are at historic lows. The dollar remains the world’s reserve currency, and with the global economy showing signs of weakness, investors are still likely turn to Treasuries for safe harbor.
Economists Worry That MMT Is Winning the Argument in Washington
Nevertheless, the mid-September repo upheaval is a clear sign there might actually be limits on just how much debt the U.S. can take before triggering more frequent disruptions. Deficits aren’t exactly new, but they do add up. Since the crisis, the market for Treasury debt has roughly tripled in size.
And the fiscal balance has only gotten worse under President Donald Trump. The deficit surpassed $1 trillion in the first 11 months of the fiscal year, which just ended last month. And the Congressional Budget Office forecasts the shortfall this fiscal year will exceed $1 trillion. That all means the Treasury will need to keep increasing its debt auctions to fund the budget shortfalls.
In the coming decade, debt as a percentage of the gross domestic product will reach 100%, CBO estimates show. That would be greater than any time since just after World War II. Before the financial crisis, debt-to-GDP was about 40%.
The growth was more than manageable in the years after the crisis because the Fed bought significant amounts of Treasuries (from dealers post-auction) with its quantitative easing, or QE. Some argue the Fed used QE to “monetize” the debt, which pumped trillions of dollars worth of cheap cash into the banking system and kept U.S. funding costs artificially low. Whatever the case, there’s little doubt the buying helped dealers clear their inventories.
That started to change in late 2017, when the Fed began to gradually unwind those purchases, reduce the size of its balance sheet and drain the excess cash held in bank reserves. The Fed now holds roughly $3.9 trillion in assets, down from $4.5 trillion in January 2015. More than half of the total is in Treasuries.
Without the Fed, which was arguably the biggest buyer of U.S. debt during the QE era, dealers have had to pick up the slack. In May, primary dealers’ outright positions in Treasuries reached an all-time high of almost $300 billion -- more than double what they were the previous year.
What’s more, post-crisis rules have led banks to prefer cash over Treasuries, which contributed to the liquidity issues in repo markets, according to Michael de Pass, head of Treasuries trading at Citadel Securities.
“The Fed has shrunk its balance sheet in a meaningful way, resulting in reduced reserves in the system,” he said. The cash squeeze has “been further exacerbated by increased issuance, resulting in high levels of Treasury collateral settling into the market.”
Dealers aren’t getting as much help from foreign investors to soak up all that additional supply. Big creditors like China and Japan have slowed their buying of Treasuries in recent years. Overall, the share of foreign official holdings has shrunk to just over 25% this year, from a high of about 40% in 2008.
Foreign holders' share of U.S. debt pile has been falling
That waning appetite been reflected in the amount of bids investors submit versus the actual amount sold, known as the bid-to-cover ratio.
According to an analysis by John Canavan, Oxford Economics’ lead analyst, the ratio for 3-, 10- and 30-year debt sold each month has fallen to 2.39. That’s down from 2.89 times in January 2018, just before the Treasury began boosting its sales, and far lower than a high of 3.48 times in December 2011.
So-called auction tails, which occur when yields on debt issued at auction exceed prevailing levels in the market at the time of sale, have become more common as well. In layman’s terms, it’s a sign investors need to be paid more to take on new debt. That’s been true especially for longer-maturity debt, like the 10-year note and the 30-year bond.
“The debt has become more difficult to digest as the rise in Treasury issuance is outpacing the rise in demand, and overall there’s been a decline in recent years in foreign demand,” Canavan said.
Ratio of bids relative to amount sold at auction has waned
There’s little to suggest the U.S. will suddenly decide to embrace fiscal restraint, either under Trump or a Democratic administration.
So for many market watchers, the most likely near-term solution to the supply problem is for the Fed to start increasing its debt purchases in a systematic way once more. (Following the recent repo turmoil, the Fed has been providing repo financing on a temporary basis.)
Historically, pumping lots of cash into the system has come with the risk of spurring too much inflationary pressure. But after a decade of ultra-low inflation, that isn’t much of a concern today. The purchases would not only replenish bank reserves and help dealers off-load Treasury collateral, but it would also keep a lid on funding costs as the U.S. runs up the deficit.
Former Fed officials Joseph Gagnon and Brian Sack say the central bank should buy enough Treasuries to build up a buffer of extra reserves, with outright purchases totaling $250 billion over the next two quarters.
“More Fed buying may finally give some relief to the supply issues that the market so needs,” Vogel said.
Fed's pile of Treasuries to rise even faster in balance sheet expansion
When it comes to financing America’s deficit though, it’s not the Fed that Julius Baer’s Markus Allenspach is worried about.
“There’s going to be saturation by investors at some point,” said Allenspach, head of fixed-income research and a member of the firm’s investment committee. “Yes, there is a global search for yield, but we believe we may be past the peak of this hunt for safe assets.”
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>>> CLOs Stuffed Full of Private Debt to Risky Companies Are Booming
Bloomberg
By Lisa Lee
October 2, 2019
https://investorshub.advfn.com/secure/post_new.aspx?board_id=31578
Middle-market collateralized loan obligation assets hit record
Some warn lack of transparency, liquidity puts buyers at risk
It’s a marriage between two of Wall Street’s hottest products.
Collateralized loan obligations -- typically chock-full of broadly-syndicated debt -- are increasingly being stuffed with private loans made to highly leveraged medium-sized companies with limited access to bank financing. Known as middle-market CLOs, the asset class has ballooned to $57 billion, from just $20 billion six years ago. Five new entrants this year -- including Owl Rock Capital and PennantPark Investment Advisers -- suggest issuance is only set to increase.
The frenzied growth is another example of how banks, insurance companies and pension funds continue to reach for higher-paying securities in the face of almost $15 trillion of negative-yielding debt around the world. Middle-market CLOs can offer premiums of as much as 200 basis points versus their garden-variety peers, in part due to the reduced liquidity that comes with direct lending, which bypasses traditional capital markets. Analysts say the products could saddle investors with even steeper losses if credit conditions sour.
“Some investors want the excess return to take on the illiquidity of the underlying middle-market loans,” said Michael Herzig, a portfolio manager at THL Credit. “You can’t trade a middle-market CLO the way you can broadly-syndicated ones. You really have to be diligent and careful when you structure.”
Reaching New Heights
Outstanding U.S. middle-market CLOs have surged to a record $57 billion
About $10.4 billion of new middle-market CLOs have priced this year, according to data compiled by Bloomberg, near last year’s pace, which was the fastest since the financial crisis. Still, that’s dwarfed by about $80 billion of traditional CLO issuance. The $57 billion of middle-market CLOs outstanding compares to more than $600 billion of the conventional variant.
There are plenty of distinctions between middle-market and more typical CLOs that pool syndicated loans. For one, the firms that make the private loans are also the ones that oversee the securitizations. The combination of origination, underwriting and management fees is a potentially lucrative setup.
But the arrangement also means they’re forced to keep a slice of the securities they offer in what is known as risk retention. These are rules intended to align lender and investor interests -- largely to prevent a repeat of the subprime mortgage fiasco.
“In a middle-market CLO versus one in the broadly-syndicated market, the active management isn’t centered on discretionary trading of the loans within the portfolio,” said Vivek Mathew, head of asset management and funding at Antares Capital, one of the largest middle-market lenders with $26 billion of assets. “It’s originating the loans and actively managing the underlying assets from a credit perspective, including working them out if they begin to struggle.”
Major Players
Middle-market loans also tend to carry more safeguards -- known as covenants -- than broadly-syndicated loans, where investors have recently started to push back against some of the riskiest financings.
Only about 30% of middle-market debt is covenant lite, versus 70% to 80% for loans sold to investors, according to Michael Boyle, a managing director at Bain Capital Credit.
On the other hand, the underlying debt in middle-market CLOs tends to be smaller in size, as many borrowers have annual earnings of $100 million or less. That makes the debt significantly less liquid compared to traditional loans. In addition, it makes the CLO bonds themselves harder to sell.
“If you decide you don’t like what the CLO manager is doing, you’ll pay a higher price to exit the position,” said Dave Preston, a CLO analyst at Wells Fargo.
The anatomy of a CLO: A look inside the deals funding corporate America
Many of the new entrants issuing middle-market CLOs are already major players elsewhere, including business development company FS KKR Capital and conventional CLO manager THL, which sold its first middle-market securitization in March.
The A rated chunk of Bain Capital’s middle-market collateralized loan obligation from August pays an interest rate of 3.6% over the London interbank offered rate, according to data compiled by Bloomberg. The similar-rated tranche of its most recent conventional CLO from September yields 2.85% over the benchmark. Corporate bonds with comparable rankings pay an average of about 2.64%, according to Bloomberg Barclays index data.
Still, some are steering clear of middle-market CLOs given the difficulty conducting due diligence on the underlying companies. Investors have good reason to be wary, according to Jason Merrill, an investment specialist at Penn Mutual Asset Management, which oversees about $28 billion, largely on behalf of insurers.
“One of the lessons we were supposed to learn from the financial crisis is that it’s important to understand the collateral and understand the risks,” Merrill said. “We do deep analysis when we look at credits, and that’s harder to do with middle-market CLOs,” he said, adding that it has “caused us to shy away from the middle-market space.”
That’s why it’s critical for investors to choose a firm whose lending and management approach aligns with their own, according to Bain Capital’s Boyle.
“There’s less collateral overlap than in the broadly-syndicated market,” said Boyle. “Finding the right asset manager really matters.”
For now, there’s little sign of a supply slowdown anytime soon. Middle-market lenders say CLO issuance is an increasingly popular source of term financing as they seek to expand their private-credit business. And fundraising for North America-focused direct lending is booming.
New money reached $6 billion in the third quarter, bringing this year’s total to $22.6 billion, according to London-based research firm Preqin. That compares to $16.2 billion a year ago. Fundraising typically jumps in the fourth quarter, and cash raised may come close to the record $36.3 billion of inflows in 2017.
“There’s been more competition but there’s still growth opportunity in direct lending,” said Craig Packer, co-founder of Owl Rock, which manages $13 billion of assets. We’ve seen investor appetite for our CLOs, and we expect to do more.”
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>>> Wall Street Falls in Love Again With Companies Loaded Up on Debt
Bloomberg
By Sarah Ponczek and Molly Smith
September 29, 2019
It’s a victory of sorts for the Fed as officials cut rates
Inexpensive financing will help most indebted companies
https://www.bloomberg.com/news/articles/2019-09-29/wall-street-falls-in-love-again-with-companies-loaded-up-on-debt?srnd=premium
The Federal Reserve’s new round of interest-rate reductions just might be working. At least, that’s what one obscure, but key, stock market indicator suggests.
For the first time since 2016, companies with fragile balance sheets are outperforming their sturdier peers and the broad market, a pair of Goldman Sachs indexes show. That’s a clear sign that the rate cuts are shoring up investor confidence in heavily indebted companies -- the segment of corporate America that’s perhaps most at risk to any downturn that hits the U.S. economy.
The outperformance is so stark that a pure measure of leverage is the top equity factor this year among 10 styles tracked by Bloomberg. It’s a big turnaround for traders who had recently pushed relative valuations for financially solid firms to a 16-year high.
The change in heart comes as the Fed seeks to stoke growth by reducing borrowing costs, reacting to signals that the U.S. economic expansion is slowing. With long-term Treasury yields reaching a record low last month, investors may be betting that all that inexpensive debt financing will help those companies expand and drive future earnings growth.
“Money is a lot cheaper to borrow and close to free in some cases,” said Sylvia Jablonski, the head of capital markets at Direxion, which manages $13 billion. “As long as that goes into the investment of the firm and helps the firm grow and increases capex in a positive way, then I think it could be something that’s positive for those firms.”
Companies with weak balance sheets have outperformed sturdier peers
Take the performance of Edison International and Carmax Inc., for example, members of the S&P 500 Index with some of the highest ratios of net debt to earnings, according to data compiled by Bloomberg. Both are up more than 30% this year, trouncing the S&P 500’s 18% return.
That’s not to say there’s hasn’t been a ton of hand wringing about soaring corporate debt levels and the fallout to come when things go south. Even the Fed’s rate cut, while helpful in the short term, runs the risk of merely delaying the reckoning that will surely arrive for overzealous borrowers.
Goldman Sachs pointed out that net leverage -- which measures how much companies owe for every dollar of earnings after subtracting cash on hand -- for the median company in the S&P 500 spiked to a record in the second quarter. JPMorgan also flagged growing debt levels this month as a risk, saying leverage metrics are worsening.
But rather than fret, equity investors are taking a chance on riskier firms. A Goldman Sachs basket of companies with weak balance sheets has bested a gauge of strong balance sheet firms for four straight months. Up 20% year-to-date, the group of firms with more fragile finances is on track to beat the S&P 500 for the first time since 2016.
The U.S. economy is growing at a pace above interest rate levels
One reason for the faith? Extremely low borrowing costs. A divided Fed cut interest rates for the second time in two months on Sept. 18, reducing its federal funds target by a quarter percentage point to a range of 1.75% to 2%.
Interest rates in the U.S. aren’t high compared to the pace of economic growth, a dynamic that means companies should be able to easily meet debt payments, according to Joseph LaVorgna, the chief economist for the Americas at Natixis.
“If yields remain under nominal activity, a broad-based pickup in corporate defaults is unlikely,” he wrote to clients this month.
Companies have been on a refinancing tear in September, issuing bonds with lower interest rates and buying back more expensive securities. The U.S. investment grade market, with about $155 billion priced this month, has already surpassed last September’s total, and more companies are looking to refinance with borrowing costs still low.
Of course bond investors are still being selective. In recent weeks, riskier companies have been forced to either offer higher interest rates or dangle sweeteners to drum up demand. At least four planned sales this month have been yanked from the market entirely.
Investment-grade and high-yield corporate borrowing costs near record lows
The latest bout of strength in highly levered stocks may also be evidence of a trade gone too far instead of any particular love for finance chiefs who have borrowed a lot.
Earlier this year, valuations of firms with healthy finances versus those of their weaker peers had reached some of the highest levels since 1980, and Goldman Sachs said the phenomenon was due for a reversal amid more accommodative monetary policy.
And of course not all investors are keen on highly leveraged stocks. Sandy Pomeroy, manager of the Neuberger Berman Equity Income Fund, is sticking to companies with “squeaky clean” balance sheets. Whittier Trust, with $13.5 billion of assets under management, has a bias toward high quality growth shares.
“Leverage is not a winning stock picking attribute,” Sandip Bhagat, Whittier Trust’s chief investment officer, said in an interview at Bloomberg’s New York headquarters. “The higher the leverage, the lousier the fundamentals, the lower quality the company is depicting. Don’t get tricked by it.”
But Barbara Reinhard, head of asset allocation for multi-asset strategies at Voya Investment Management, and Michael Kelly, global head of multi-asset at PineBridge Investment, both pointed to a thawing of trade tensions between the U.S. and China as supportive for highly indebted companies.
“A more predictable trade environment will lead to better business conditions, so you have some deeper pockets of credit and the stock market finding buyers,” said Kelly, whose firm manages $97 billion. “It’s a little safer to wander out in the waters.”
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>>> Why I'm Worried About the Repo Market
It’s hard to predict how the financial system will handle shocks.
Bloomberg
By Narayana Kocherlakota
September 25, 2019
https://www.bloomberg.com/opinion/articles/2019-09-25/why-i-m-worried-about-the-repo-market
(Narayana Kocherlakota is a Bloomberg Opinion columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.)
The recent unrest in money markets, which briefly caused short-term interest rates to get out of the Federal Reserve’s control, won’t undermine the central bank’s ability to achieve its longer-term economic goals. That said, it does signal that something’s very wrong with the financial system.
To understand what’s going on, let’s return to a simple model. Suppose there’s only one big bank. It has a choice of what to do with most of its assets: It can keep them on deposit at the Fed, earning the interest rate that the central bank pays on excess reserves; or it can take more risk and earn more return by investing in securities or loans. In this world, all the assets earn the same “risk-adjusted” return, which the Fed effectively determines by setting the interest rates on excess reserves.
Now let’s take a step closer to reality. There are two groups of banks, “tight” ones that hold few excess reserves, and “flush” ones that hold a lot. Flush banks can lend reserves to tight banks in the federal funds market, a focal point of the Fed’s monetary policy. As long as this lending happens freely, all assets will still have the same risk-adjusted return, and the one-bank model will still be a good indicator of how the many-bank world will respond to the Fed’s policies and to various shocks.
In recent days, though, that crucial free-lending condition hasn’t held. On the contrary, a convergence of events -- a deadline on corporate-tax payments and the settlement of a big Treasury auction -- created a sudden and severe shortage of reserves. As a result, interest rates diverged sharply in markets where they should be the same. In the repo market, where participants borrow and lend against the collateral of Treasuries and other securities, they shot up above 5%. And in the federal funds market, they breached the upper bound of the Fed’s 2%-to-2.25% target range.
The deeper issue is that, since the 2008 crisis, regulatory reforms -- such as requirements that banks hold a certain amount of liquid assets, and maintain a minimum leverage ratio (equity capital as a percent of total assets) -- have constrained the ability of flush banks to lend, and of tight banks to borrow. Such constraints interact in complicated ways with financial market conditions. For example, European banks must report their leverage ratios as of the last day of each quarter, so they reduce their repo activity to make those ratios look better. As a result, even when excess reserves seem abundant, funding costs for banks may exceed the interest rate that the Fed controls.
This isn’t necessarily a problem for the Fed’s monetary policy, because the central bank can inject cash into various markets to bring interest rates into line. That’s precisely what the Fed has been doing in the repo market. And it can make the fix more permanent by creating what’s called a standing repo facility, which means the Fed will inject sufficient funds every day, as needed, to ensure that the federal funds rate stays in what it deems the appropriate range.
What’s harder to understand is how money markets will respond to future shocks. As the experience of the past couple weeks has shown, the simple single-bank model no longer works. Reserves are siloed in the flush banks, so the financial system is acting more like it has $1.3 billion in excess reserves than the actual $1.3 trillion. The design of regulation has disrupted some of the system’s most basic functions. The people who oversee it all should be far from sanguine about what the repercussions might be.
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>>> Repo Market’s Liquidity Crisis Has Been a Decade in the Making
Bloomberg
By Liz McCormick, Matthew Boesler, and Craig Torres
September 22, 2019
https://investorshub.advfn.com/secure/post_new.aspx?board_id=31578
It sounds crazy: even National Public Radio is talking about repo rates.
In normal times, not even Wall Street thinks too much about the arcana of short-term money markets.
But over the past week, the Federal Reserve has had to work unusually hard to rein in a key policy rate after overnight repo lending dried up. Suddenly, everyone is asking the same question: what does it mean?
The answer is sobering. Despite assurances by the Fed and others to the contrary, the stress in the market for repurchase agreements, or repos, has exposed some fundamental weaknesses in the nation’s financial system which have been a decade in the making. While they don’t pose a significant problem during good times, the risk is clear: without a permanent fix, sudden cash shortages could lead to broader financial market turmoil in a downturn.
“The machine of liquidity management is just not oiled anymore,” GLMX Chief Executive Officer Glenn Havlicek, who runs a trading platform for repo securities and has four decades of experience in funding markets.
The repo market is important because it serves as the grease that keeps the global capital markets spinning. In a repo, firms borrow cash from each other by putting up securities like Treasuries as collateral. When the agreement expires, the borrower “repurchases” the collateral and returns the cash, though in practice repos are often rolled over day after day.
Hedge funds often use repos to finance purchases of higher-yielding assets, while dealers that are obligated to bid for Treasuries at U.S. debt auctions use them as a way to avoid putting up their own capital.
Participants point the finger at two structural changes that have drained too much cash from the system and made the repo market more prone to seizing up: crisis-era monetary policies and financial regulations designed to curb risk-taking. They contend that those two forces, rather than a mere confluence of technical factors, are what’s really behind this past week’s disruptions.
The first has to do with the unwinding of the Fed’s quantitative easing program, or QE. Simply put, after buying trillions of dollars of bonds to pump cheap money into the banking system, the Fed reversed course and started reducing its holdings (and thus draining cash) in October 2017 as the economy strengthened. It stopped altogether last month.
Fed was forced to temporarily expand balance sheet after 1.5-year unwind
The problem is that, in reducing the asset side of its ledger, the Fed has also had to shrink its liabilities to balance its balance sheet. Those liabilities consist of currency in circulation, which has naturally increased with the economy, and bank reserves, which have fallen.
Of course, that in itself wouldn’t be enough to cause a scarcity of cash in the banking system since firms in aggregate still have over a trillion dollars in reserves. But because of post-crisis rules such as Dodd-Frank and Basel III, banks have been forced to set aside much of those same reserves to meet the more stringent requirements, putting a strain on the available cash they can use. What’s more, capital constraints have made taking large positions in short-term money markets far less lucrative.
“The Fed wanted the market to restructure to a new equilibrium and institutions to figure out how to fund themselves,” said Julia Coronado, president of Macropolicy Perspectives. But “if you have an excess reserve system, you are by definition a primary source of liquidity. And when you squeeze funding markets, you are usually squeezing hedge funds and other investors that may have to cut positions which can spark broader volatility.”
JPMorgan CEO Jamie Dimon summed up the conundrum last week, saying that “banks have a tremendous amount of liquidity, but also have a tremendous amount of restraints on how they use that liquidity.”
The swelling U.S. deficit caused by President Donald Trump’s tax cuts hasn’t helped matters. For one, the money that investors and dealers lend to the government in the form of bond purchases takes money out of the banking system. For another, dealers at Treasury auctions have increasingly turned from lenders to borrowers in the repo market to absorb the additional supply. This year, net issuance will reach roughly $1.2 trillion, after $1.3 trillion last year, according to JPMorgan. In 2017, it was less than half that.
Growing budget deficit pushed inventories of Treasuries to record highs
Those liquidity constraints came into full view over the past few days when corporate tax payments, big Treasury auctions and maneuvers by financial firms to manage their capital requirements prior to quarter-end drained cash available for repo transactions. The overnight lending rate quickly shot up to 10% and the Fed temporarily lost control of its benchmark rate.
In the past, the Fed has disputed the idea that its balance-sheet unwind left bank reserves in short supply. And at his post-policy news conference on Sept. 18, Fed Chairman Jerome Powell sidestepped questions about whether he felt bank regulations were a catalyst for the market turmoil.
Instead, the Fed has opted for a temporary fix. On Friday, the New York Fed announced a series of overnight and term operations over the next three weeks to boost short-term liquidity. That follows four straight days of repo transactions, something it hasn’t done in a decade.
A number of investors, strategists and at least one former Fed official have come out to warn that more may need to be done.
“Maybe we have gotten some hints that reserves are no longer ample,” said Michael Feroli, JPMorgan’s chief economist. “The longer the Fed goes without making changes, the more often you might have these type of incidences.”
Earlier this year, TD Securities’ Priya Misra predicted the Fed would have to resume its bond purchases as a permanent solution. She says this past week’s events have convinced many of her skeptical clients to come around to the idea. They are now asking her “how much” the Fed will need to buy.
While no decisions have been made, Boston Fed President Eric Rosengren acknowledged last week that permanently expanding the Fed’s balance sheet is one option on the table and the one he personally prefers. (The other two being continued ad-hoc interventions or a so-called standing repo facility, which would make cash loans available on a daily basis.)
Growing the balance sheet might also be the easier one, particularly after the New York Fed stumbled out of the gate as it tried to come to the rescue on Tuesday, says GMLX’s Havlicek.
“The repo market isn’t used to being prime time,” in terms of liquidity management, he said. And, the Fed is “out of practice.”
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Back to QE - >>> Potter Warns Fed May Have to Buy More Debt to Calm Market
Bloomberg
By Matthew Boesler and Alex Harris
September 20, 2019
https://www.bloomberg.com/news/articles/2019-09-20/potter-said-to-warn-fed-may-have-to-buy-more-debt-to-calm-market?srnd=fixed-income
Former head of NY Fed’s trading desk speaks with BofA clients
Recommendations go beyond New York Fed’s announcement Friday
A former top Federal Reserve official, who oversaw the U.S. central bank’s trading desk, has warned that the type of actions taken so far to quell this week’s turmoil in money markets may not be enough to keep conditions calm and fresh debt purchases may be needed.
Simon Potter, the former New York Fed executive, made the remarks during a conference call that Bank of America hosted for its clients, according to three people who listened.
Potter cautioned that policy makers may have to expand the central bank’s balance sheet through outright purchases of U.S. Treasury securities, to ensure stable liquidity conditions at the end of the quarter as well as at year-end, said the people, who declined to be named because the call was private.
The recommendation follows a week of intense upheaval in money markets during which short-term interest rates spiked and pulled the Fed’s policy benchmark rate outside its target range. It also goes beyond what the New York Fed has promised so far to keep the situation in check going forward.
A spokeswoman for the New York Fed declined to comment on Potter’s remarks. Potter and Bank of America also declined to comment.
The reserve bank announced later Friday that it would offer so-called term repurchase agreements over the upcoming quarter-end, which would allow financial institutions to borrow cash from the Fed either overnight or for two-week periods, secured by Treasury collateral.
Potter was abruptly dismissed in May by New York Fed President John Williams, who assumed the top post at the bank in June 2018. The departure of Potter, a 21-year veteran of the institution, raised concerns about Williams -- a widely-respected monetary economist -- because of his relative lack of experience with financial markets. The New York Fed has yet to announce Potter’s successor.
The New York Fed was forced to intervene in money markets with overnight cash loans for the first time in a decade on Tuesday, Wednesday, Thursday and Friday to contain short-term interest rates. Surges in the rate on overnight repo loans normally occur only at quarter-end and sometimes month-end.
This mid-month jump was attributed to a confluence of events that knocked cash reserves in the banking system out of balance with the volume of securities on dealer balance sheets: a corporate tax payment date, settlement of last week’s Treasury auctions, and last week’s bond-market sell-off, in which investors sold securities back to dealers.
From the beginning of last year to July, the Fed partially unwound the $4.5 trillion portfolio of bonds it had amassed in the years following the financial crisis. The reduction drained cash reserves from the banking system.
This week’s turmoil raised questions about whether the Fed went too far in removing cash from the financial system, and focused attention on when the central bank would begin resuming balance-sheet expansion to keep pace with the needs of a growing economy.
“We’re going to be very closely monitoring market developments and assessing their implications for the appropriate level of reserves and we’re going to be assessing, you know, the question of when it will be appropriate to resume the organic growth of our balance sheet,” Fed Chair Jerome Powell told reporters Wednesday after the central bank cut interest rates for a second time this year.
“It is certainly possible that we will need to resume the organic growth of the balance sheet earlier than we thought,” Powell said.
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>>> Get a Grip. The Fed Can Handle the Repo Market
The central bank has plenty of options.
Bloomberg
By Bill Dudley
September 20, 2019
https://www.bloomberg.com/news/articles/2019-09-20/how-the-fed-can-handle-the-repo-market?srnd=premium
Chill out.
Bill Dudley is a senior research scholar at Princeton University’s Center for Economic Policy Studies. He served as president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee. He was previously chief U.S. economist at Goldman Sachs.
One of the world’s most important interest rates has had a tumultuous week. Thanks to a sudden shortage of dollars in a separate market, the federal funds rate – the focal point of the U.S. Federal Reserve’s monetary policy – briefly breached the 2%-to-2.25% range that the central bank was targeting.
The aberration has generated a lot of concern. My advice: Don’t worry, the Fed can handle it.
Let’s start with what happened. The cash crunch occurred in a large and central piece of the financial system -- the “repo” market, where participants borrow and lend money against the collateral of various securities. Banks, hedge funds and other investors use it as a source of funds to buy U.S. Treasuries and other assets. Corporations and money-market funds use it as a safe place to park cash and earn a return.
Early this week, a confluence of events threw the repo market out of whack. First, until last month, the central bank had been paring down the securities portfolio it built up after the 2008 crisis, and this process had been soaking up the cash reserves that banks keep on deposit at the Fed. Second, a September 15 deadline for paying corporate taxes further depleted reserves. Finally, the settlement of a large Treasury auction created added demand for cash to pay for the government securities. When the cash flows into the Treasury’s account at the Fed, this drains reserves from the banking system. The imbalance of supply and demand caused repo rates to spike above 5% on Tuesday, more than double the level of the previous week. This, in turn, affected rates in the federal funds market, where banks lend reserves to one another.
The incident is not a harbinger of deeper market problems or a larger crisis. Rather, it provides a useful signal for the Fed, which has been seeking the right level of reserves for the smooth functioning of financial markets. For a long time, this wasn’t an issue: The Fed’s securities purchases, known as quantitative easing, had ensured that the supply of cash was always more than needed. Now, though, as the central bank has reduced its holdings, it’s discovering that various changes have increased the amount of reserves that banks want to hold. These include liquidity regulations, which require banks to hold more cash-like assets, and the Fed’s decision to pay interest on reserves, which makes it less costly for banks to leave cash parked at the central bank.
So what should the Fed do? It has a number of options, some of which will take longer than others to implement.
The primary short-term fix is what the Fed has already been doing: providing the cash that the market needs. Specifically, the New York Fed’s open market desk has increased the supply of reserves by lending money against securities in the repo market. This is one way that the desk can help ensure that the federal funds rate stays within its target range. The Federal Open Markets Committee in Washington D.C. sets the target, and the New York Fed is supposed to hit it. When this doesn’t happen, that’s a problem. I experienced this first hand when I was the System Open Market Account Manager during the financial crisis.
Another short-term fix is to reduce the rate that the Fed pays on reserves. On its own, this won’t address the imbalance in the repo market. But it will help prevent the pressure on repo rates from pushing the federal funds rate above the top end of the Fed’s target range. The Federal Open Markets Committee did this on Wednesday, when it lowered the interest rate on reserves by 0.30 percentage point - 0.05 percentage point more than it lowered its target for the federal funds rate.
One longer-term fix is for the Fed to boost its securities holdings more permanently, thereby increasing the supply of reserves to a level somewhat above the underlying demand from banks. Chairman Jerome Powell hinted at this on Wednesday, and I expect the central bank to announce something in the near future. There probably wasn’t sufficient time to prepare a detailed proposal this week, given that the pressure in the repo market wasn’t evident until Monday. And officials will have to communicate carefully, so the move won’t be confused with quantitative easing. Although the Fed’s balance sheet grows in both cases, the intent is completely different. To signal this, the Fed could focus on adding shorter-term obligations such as Treasury bills, as opposed to the longer-duration assets typically involved in QE.
Fourth, the Fed will likely consider a standing facility for the repo market – in which the central bank would stand ready to lend against Treasury or agency securities at a rate generally above the market and the federal funds target. This would provide a safety valve to mitigate upward pressure on repo rates. Fed officials have been exploring such a mechanism for some time. This week’s events should increase support for putting it in place.
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>>> Fed Injects Cash for Third Day as Calm Returns to Funding Market
Bloomberg
By Liz McCormick and Alex Harris
September 18, 2019
https://www.bloomberg.com/news/articles/2019-09-18/fed-plans-to-intervene-in-repo-market-for-a-third-straight-day?srnd=premium
Thursday’s $75 billion dose followed similar amount Wednesday
Fed’s actions this week are easing pressure in a key market
The Federal Reserve added a third dose of liquidity to a vital corner of the funding markets Thursday, helping rates retreat further as investors warn that fresh bouts of stress remain possible in the weeks ahead.
The New York Fed injected another $75 billion Thursday through an overnight repo operation. That followed a dose of the same size on Wednesday and $53.2 billion on Tuesday. The operations, commonplace in pre-financial crisis times, temporarily add cash, with the Fed taking government securities as collateral.
The latest addition of liquidity -- with the Fed making clear it’s ready to do more as needed -- follows the Federal Open Market Committee’s move Wednesday to reduce the interest rate on excess reserves, or IOER, by more than their main interest rate -- all attempts to quell money-market stresses.
The operations have calmed the funding market, with repo rates declining to more normal levels after jumping to 10% Tuesday, four times where it was last week. Overnight general collateral repurchase agreement rates continued to retreat Thursday, trading around 2%, according to ICAP. Still, most investors say more Fed action is needed for a permanent fix, with gauges of dollar funding costs measured through the current swaps market showing pressures building again given disappointment over the steps the central bank took.
The effective fed funds rate was set at 2.25% as of Wednesday. It was at 2.30% Tuesday, above the top of the Fed’s target range of 2% to 2.25% before policy makers lowered their benchmark rate on Wednesday.
“We expect these episodes of funding stresses to become more frequent with demand for funding and U.S. Treasury supply forecast to increase heading into year-end and the Fed’s reserve levels likely to drop further,” Jerome Schneider, head of short-term bond portfolios at Pacific Investment Management Co., wrote in a note Wednesday with his colleagues.
Given the added supply, banks’ holdings of Treasuries have risen and are increasingly being financed by money market funds investing in repo, which leaves “U.S. funding markets more fragile,” Schneider wrote. He said this adds to other reasons why the Fed needs to do more to engineer a long-term fix.
After policy makers wrapped up a two-day meeting Wednesday, Fed Chairman Jerome Powell said the central bank will keep doing these repo operations if that’s what it takes to get markets back on track. He spoke hours after the effective fed funds rate busted through the central bank’s cap, evidence Powell and his colleagues were losing their grip on one of their most important levers for controlling the financial system.
Fed’s First-in-a-Decade Intervention Will Be Repeated Wednesday
With Repo Market Still on Edge, Fed Preps Second Blast of Cash
‘This Is Crazy!’: Fed’s Repo Madness Sends Wall Street Reeling
Fed Injects Liquidity Into Markets as Key Rate Busts Through Cap
Powell also said the Fed would provide a sufficient supply of bank reserves so that frequent operations like the ones they’ve done this week aren’t required.
The only way “to permanently alleviate the funding stress is to rebuild the buffer of reserves in the system,“ according to Morgan Stanley strategist Matthew Hornbach.
Relying on repo operations doesn’t resolve the issue of reserves declining as the Treasury rebuilds balances, Hornbach wrote in a note. Having regular operations will also increase market uncertainty as the Fed could halt purchases at any time, while the size of its buying will have to expand over time as reserves drop, he said.
“It is certainly possible that we’ll need to resume the organic growth of the balance sheet sooner than we thought,” Powell said, referring to the central bank potentially buying securities again to permanently increase reserves and ensure liquidity in the banking sector.
Many strategists had predicted the Fed would take even more aggressive measures to reduce the pressures. One idea that’s gotten a fair amount of attention is something called a standing fixed-rate repo facility -- a permanent way to ease funding pressures, as opposed to the ad-hoc operations the Fed has used this week. Many analysts even predicted a Wednesday announcement that the Fed would start expanding its balance sheet.
That didn’t happen. However, with the Fed apparently ready to keep injecting liquidity whenever it’s needed, “it’s enough for now,” said Jon Hill of BMO Capital Markets.
“This week’s dramatic moves in the short-term funding markets serve as a case in point for the need to carefully consider liquidity in the financial system,” Rick Rieder, global chief investment officer of fixed income at BlackRock Inc., wrote in a note.
“All of this funding market gyration points to the increasingly obvious fact that the end of Fed reserve draining is insufficient to stabilize these markets,” he said.
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>>> A Divided Fed May Be Reluctant to Forecast More Cuts
Bloomberg
By Steve Matthews
September 18, 2019
https://www.bloomberg.com/news/articles/2019-09-18/divided-fed-reluctant-to-forecast-more-cuts-decision-day-guide?srnd=premium
FOMC expected to lower rates but dots may send hawkish signal
Oil-price spike reinforces sense geopolitical risks are rising
Under pressure from Wall Street and President Donald Trump, the Federal Reserve is widely expected to reduce interest rates on Wednesday for a second straight meeting, but its sharply divided policy panel may be reluctant to forecast further cuts.
The Federal Open Market Committee is likely to lower rates a quarter percentage point to insure against risks from a global slowdown and uncertainty over Trump’s trade policies, while forecasting no more reductions this year, according to economists surveyed by Bloomberg.
The meeting comes a day after the Fed’s New York branch injected billions of dollars in cash to quell a surge in short-term rates that was pushing up its benchmark rate, threatening to drive up borrowing costs for companies and consumers. The spike, while not suggestive of an imminent financial crisis, highlighted how the Fed was losing control over short-term lending.
The policy statement and updated quarterly forecasts will be released at 2 p.m. in Washington and Chairman Jerome Powell will brief the press 30 minutes later.
“It is a very divided group,’’ said Carl Tannenbaum, chief economist with Northern Trust Corp. in Chicago. “If participants are not seeing a deterioration in growth, how far are they willing to push? It is not a sure thing they will do more.’’
Markets have priced in nearly 1% point of cuts over the next year
The median interest-rate projections in the “dot plot’’ -- which displays the forecasts of the 17 Fed policy makers -- is likely to be unchanged for December after Wednesday’s expected cut, according to the Bloomberg survey. By contrast, investors are projecting another quarter point reduction by the end of this year.
Kansas City Fed President Esther George and Boston’s Eric Rosengren are likely to dissent, as they did against the rate cut in July, favoring no move. Another possible dissenter is St. Louis Fed President James Bullard, who may favor a half-point cut in the face of rising uncertainties.
What Bloomberg Economists Say
“Bloomberg Economics expects policy makers to cut rates in steady 25 basis-point increments until the yield curve is no longer inverted. We believe this means rate cuts in September, October and December -- although officials may hesitate to fully telegraph such intentions.”
-- Carl Riccadonna, Yelena Shulyatyeva, Andrew Husby and Eliza Winger
That said, most economists surveyed by Bloomberg expect the FOMC statement to stick with language that signals a bias to continued easing, probably via references to uncertainty over the outlook and a commitment to “act as appropriate” to sustain the expansion.
Division at the Fed
After a period of quiet and consensus, FOMC dissents are on the rise
“There are two fundamentally different views of the economy,’’ said Lindsey Piegza, chief economist at Stifel Nicolaus & Co. Inc. in Chicago. That will be reflected by a “growing in the dispersion of the dots and increasingly muddying the policy message for investors.’’
A small cut won’t be applauded by Trump, who last week said the Fed’s “boneheads’’ should reduce rates to zero or lower.
Read more: Key Trump Quotes on Powell as Fed Remains in the Firing Line
Volatility in oil prices after attacks on key Saudi Arabian facilities over the weekend reinforces the growing risks in the global economy, though the FOMC may be reluctant to adjust views to fast-changing events.
The committee could ratify the view that rates will be lower for longer by edging its estimate of the so-called neutral rate which neither spurs nor brakes the economy. It has fallen to 2.5% from 4% in early 2014 amid a global decline in borrowing costs that’s seen them slip into negative territory in Europe and Japan.
Falling Rates
FOMC median estimate of long run or neutral funds rate has steadily dropped
Statement Language
FOMC divisions make drafting the statement a challenge. Recent data have supported its forecasts for more than 2% economic growth this year, and some reports have surprised to the upside. Yet U.S. payroll growth has slowed and manufactured contracted in August for the first time in three years.
“They have been using boilerplate language ‘solid’ in describing the labor market, but that’s becoming harder to support and could be downgraded,” said Neil Dutta, head of U.S. economics at Renaissance Macro Research. Market measures of inflation expectations could also be downgraded, he said.
FOMC may tweak message after jobs slowdown last month
Powell, who in July referred to the rate cut as a “mid-cycle adjustment’’ rather than a long string of cuts, is likely to be asked about Trump’s call for zero rates and ex-New York Fed President Bill Dudley’s recent controversial column suggesting his former colleagues don’t cut rates to avoid enabling the trade war.
IOER, Balance-Sheet Tweaks
The Fed may announce a couple of technical adjustments to its balance sheet and the interest it pays banks on reserves after a sharp rise in money-market rates led the New York Fed to take action on Tuesday via its first overnight injection of cash in a decade.
It could make another adjustment to the interest rate it pays on excess reserves by reducing it by more than amount it cuts the fund rate. IOER is currently at 2.1% and the Fed may lower that by a bit more than the amount it cuts the target range for its benchmark federal funds rate -- currently 2% to 2.25% -- to better anchor money market rates.
Read more: Fed’s First-in-a-Decade Intervention
Separately, following the Fed’s decision in July to call an early halt to the gradual shrinking of its balance sheet, it may also say it is going to start allowing it to grow again to keep pace with growth in the economy, said Jonathan Wright, a professor at Johns Hopkins University and former Fed economist. The Fed has previously discussed this in terms of a process that could begin further down the road.
A third option to reduce pressure in money markets could be a new tool called a standing overnight repo facility. Such an instrument has been previously discussed and the FOMC was briefed on it in June, though minutes of the meeting showed that policy makers wanted more work done to figure out what it would do and how it would work.
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>>> Fed Injects Liquidity Into Markets as Key Rate Busts Through Cap
Bloomberg
By Alex Harris and Liz McCormick
September 18, 2019
https://www.bloomberg.com/news/articles/2019-09-18/overnight-u-s-funding-rate-at-2-8-elevated-for-a-third-day?srnd=premium
The Fed will buy up to $75 billion of securities later Wednesday morning.
U.S. money markets showed some signs of calm as the Federal Reserve injected another $75 billion of liquidity and key rates pulled back from troubling levels.
Although the U.S. money-market interest rate remained elevated for a third straight day -- after spiking to a record 10% Tuesday -- it came back down to 2.8% early Wednesday even before the Fed accepted billions of dollars worth of Treasuries and other securities.
Now attention turns to this afternoon’s Federal Open Market Committee decision to see what, if any, further action policy makers take to calm the overnight lending business and ensure higher rates don’t harm other parts of the economy.
They’ll likely have to do something because the New York Fed said Wednesday that the effective fed funds rate busted through policy makers’ 2.25% cap the day before, coming in at 2.3%. That’s bad because it shows the Fed losing its grip on short-term interest rates, undermining its ability to guide the financial system.
“These money markets are a very powerful part of the financial system and everything flows through,” said John Herrmann at MUFG Securities in New York. “What the Fed has been doing so far to address the issues is like being a fire department chasing the fire instead of sort of installing fire hydrants through facility. They need to do more.”
The Fed dose of cash Wednesday follows a $53.2 billion liquidity injection Tuesday, the first in a decade and an attempt to restore order within the underpinnings of U.S. markets.
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>>> Fed’s First-in-a-Decade Intervention Will Be Repeated Wednesday
By Liz McCormick and Alex Harris
September 17, 2019
https://www.bloomberg.com/news/articles/2019-09-17/new-york-fed-announces-operation-to-ease-money-market-rates?srnd=premium
Central bank is taking action after a key lending rate spiked
Turmoil signals the Fed is losing control of short-term rates
The Federal Reserve took action to calm money markets, injecting billions in cash to quell a surge in short-term rates that was pushing up its policy benchmark rate and threatening to drive up borrowing costs for companies and consumers. The central bank also said it’s willing to spend another $75 billion Wednesday.
While the spike wasn’t evidence of any sort of imminent financial crisis, it highlighted how the Fed was losing control over short-term lending, one of its key tools for implementing monetary policy. It also indicated Wall Street is struggling to absorb record sales of Treasury debt to fund a swelling U.S. budget deficit. What’s more, many dealers have curtailed trading because of safeguards implemented after the 2008 crisis, making these markets more prone to volatility.
Money markets saw funding shortages Monday and Tuesday, driving the rate on one-day loans backed by Treasury bonds -- known as repurchase agreements, or repos -- as high as 10%, about four times greater than last week’s levels, according to ICAP data.
More importantly, the turmoil in the repo market caused a key benchmark for policy makers -- known as the effective fed funds rate -- to jump to 2.25%, an increase that, if left unchecked, could have started impacting broader borrowing costs in the economy. Because that’s at the top of the range where Fed officials want the rate to be, they are likely to make yet another tweak to a key part of their policy tool set -- something called the interest on excess reserves rate -- to try to get things back on track when they meet Wednesday to set their benchmarks.
But the central bank didn’t wait until then to do something, resorting to a money-market operation it hasn’t deployed in a decade. The New York Fed bought $53.2 billion of securities on Tuesday, hoping to quell the liquidity squeeze. It appeared to help. For instance, the cost to borrow dollars for one week while lending euros retreated after almost doubling Monday.
Late Tuesday, the New York Fed said it would conduct another overnight repo operation of up to $75 billion Wednesday morning.
For repo traders, hedge funds and others that rely on that market for financing, the intervention came none too soon.
“There’s been a sea change in markets, and it’s one the Fed needed to respond to,” said Lou Crandall of Wrightson ICAP. “In the current market environment, there is just not enough elasticity in the repo market to handle the big seasonal swings of the banking system. The Fed needed to come in now and alleviate the immediate problem, while it is also working on long-term solutions.”
The central bank has considered introducing a new tool, an overnight repo facility, that could be used to reduce pressure in money markets. No decision has been announced. Another long-term remedy would be growing the Fed’s balance sheet again to permanently increase reserves in the banking system. But for now, if the rate remains elevated, expect more temporary liquidity injections, Crandall said.
The New York Fed declined to comment on the events of this week.
Actions like the Fed took Tuesday were once commonplace, but stopped being so when the central bank expanded its balance sheet and started using a range of rates to implement its policy in the aftermath of Lehman Brothers’ 2008 collapse.
Securities eligible for collateral in the Fed operation include Treasuries, agency debt and mortgage-backed securities. In an overnight system repo, the Fed lends cash to primary dealers against Treasury securities or other collateral.
Surges in the repo rate normally occur only at quarter-end and sometimes month-end. This mid-month surge was attributed to a confluence of events that knocked cash reserves in the banking system out of balance with the volume of securities on dealer balance sheets: a corporate tax payment date, settlement of last week’s Treasury auctions, and last week’s bond-market sell-off, in which investors sold securities back to dealers.
Fed adds liquidity to keep fed effective below its target range
“This is certainly painful for firms that have to fund positions,” said Thomas Simons, an economist at Jefferies LLC. “So it’s difficult for the dealer community. But it’s not systemically threatening.”
Beyond the technical forces driving the spike in repo rates, the move is also a sign that excess reserves in the banking system are dwindling, according to Tom di Galoma, managing director of government trading and strategy at Seaport Global Holdings LLC.
“This made the repo market ripe for dislocation,” he said.
>>>
>>> Unhinged Money Markets Trigger Fed Action to Alleviate Stress
Bloomberg
By Elizabeth Stanton
September 17, 2019
https://www.bloomberg.com/news/articles/2019-09-17/new-york-fed-announces-operation-to-ease-money-market-rates?srnd=premium
N.Y. Fed takes $53.2 billion of securities in repo operation
Surge in funding rates led to New York Fed’s Tuesday move
The Federal Reserve Bank of New York injected funds into the banking system via an overnight repurchase-agreement operation for the first time in a decade, amid a rare mid-month surge in U.S. money-market rates.
The operation to keep the fed funds rate within its target range closed at 10:10 a.m. New York time, for $53.2 billion, the New York Fed said in a statement. The operation was initially canceled because of technical difficulties. Securities eligible for collateral included Treasury, agency debt and mortgage-backed securities.
In an overnight system repo, the Fed lends cash to primary dealers against Treasury securities or other collateral. The operation was “commonplace before the expansion of the Fed’s balance sheet in 2009,” according to a research note by Wrightson ICAP, which became its primary tool for implementing monetary policy.
The New York Fed declined to comment.
The interest rate for overnight loans collateralized by Treasury securities, which normally stays in the vicinity of the Federal Reserve’s target for the federal funds rate, spiked on Tuesday to a record level above 8%. It then settled back down around 2.5%, according to BMO. The squeeze pushed the effective fed funds rate up to 2.25%, in line with the top of the Fed’s target range of 2% to 2.25%.
Surges in the repo rate normally occur only at quarter-end, sometimes month-end. The mid-month surge was attributed to a confluence of events that knocked cash reserves in the banking system out of balance with the volume of securities on dealer balance sheets: a corporate tax payment date, settlement of last week’s Treasury auctions, and last week’s bond-market selloff, in which investors sold securities back to dealers.
“This is certainly painful for firms that have to fund positions,” said Thomas Simons, an economist at Jefferies LLC. “So it’s difficult for the dealer community. But it’s not systemically threatening.”
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>>> King Dollar Is Left, Right and Center of Emerging-Market Malaise
By Constantine Courcoulas
August 31, 2019
https://www.bloomberg.com/news/articles/2019-08-31/king-dollar-is-left-right-and-center-of-emerging-market-malaise?srnd=premium
Trade-weighted dollar index hit an all-time high in August
Dollar strength makes search for local-currency carry futile
The prospect of ever looser U.S. monetary policy is little consolation for emerging-market investors grappling with a resurgent dollar.
Rather than weaken, the world’s reserve currency has strengthened against all but one major emerging-market peers since the Federal Reserve cut interest rates in July. Earlier this month, the trade-weighted dollar index touched an all-time high, pushing past a peak seen in 2002.
Meanwhile, speculation that China may be using the yuan as a tool in the trade spat with the U.S. is bolstering havens, a sign that the worst for emerging-markets probably isn’t over.
Never before has the dollar been as strong vs major trading peers
The dollar’s ascent undermines the modus operandi for investors in the developing world. Borrowing where rates are low to invest in higher-yielding emerging-market assets is futile if the dollar’s strength wipes out gains. And it creates headwinds for large swaths of debtors in the developing world, where companies and governments rely on foreign funding for growth.
“My big concern is about the dollar. At the moment, when people want certainty, when they want a safe haven they tend to go to the dollar,” said Paul McNamara, a London-based fund manager who helps oversee $9.4 billion in assets at GAM UK, in Bloomberg TV interview on Tuesday. “That tends to be a tough environment for emerging markets.”
Traders who went long local-currency government debt in the developing world after the Federal Reserve’s decision at the end of last month will have have suffered a more than 2% loss, according to a Bloomberg Barclays index, even as global bond markets rallied.
READ MORE:
Falling EM Currencies Herald End of Renaissance for Carry Trade
Investors Slam on Brakes in Emerging Markets as Risks Escalate
Dollar Rising Into a Possible U.S. Recession Could Be a Bad Omen
Dr. Copper Has Ominous Prognosis for Emerging-Market Currencies
Dollar Demand
The market has now fully priced another 25 basis-point cut by the Fed in September, yet the dollar’s unwavering strength reflects the special status America enjoys at times of heightened global unease: it issues U.S. Treasuries, the biggest and most liquid market for safe government debt.
“It’s hard to argue against the dollar in the short term,” said Chris Turner, the head of foreign-exchange strategy at ING in London. “With so many event risks, such as trade escalation and European politics, we suspect investors will increasingly focus on capital preservation rather than the search for yield.”
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>>> U.S. Yield Curve Steepens as Mnuchin Considers Longer-Term Bonds
Bloomberg
By Emily Barrett and Masaki Kondo
August 28, 2019
https://www.bloomberg.com/news/articles/2019-08-28/u-s-yield-curve-steepens-as-mnuchin-endorses-longer-term-bonds?srnd=premium
30-year yield reversed drop that sent it to a record low
Treasury is yet again considering 50- and 100-year debt
The U.S. yield curve steepened after Treasury Secretary Steven Mnuchin said the government is seriously considering extending its debt profile well beyond the current three-decade maximum.
The gap between five- and 30-year Treasury yields widened to 59 basis points, from 56 basis points just before the news broke late Wednesday. The ultra-long bond’s rate climbed to 1.97%, reversing a decline that had driven it to a record low of 1.90% earlier in the day.
Thirty-year yield shoots up as Mnuchin's comments hit wire
The Treasury Department revealed two weeks ago that it was yet again mulling 50- and 100-year bonds, which would let the government lock in historically low rates for longer. “If the conditions are right, then I would anticipate we’ll take advantage of long-term borrowing and execute on that,” Mnuchin said Wednesday in a Bloomberg News interview in Washington.
“There was no need for Mnuchin to make remarks that could prompt selling of Treasuries,” said Hidehiro Joke, a bond strategist at Mizuho Securities Co. in Tokyo. “He might have tried to lift long-dated yields given that the yield curve inversion is seen as a sign of recession and cools sentiment.”
Read More: Mnuchin Says Ultra-Long Bonds Under ‘Very Serious Consideration’
Heavy buying of the 30-year bond has driven the sharpest monthly decline in that yield since 2011, as investors have sought safety from global market volatility in one of the few major government markets offering positive yields.
The idea of ultra-long bonds fell flat when it was last floated in 2017, but this may be an auspicious time to revisit it. The world’s spreading pile of negative-yielding securities -- which stands at about $16 trillion -- is driving investors further out global yield curves, in part to finance retirees’ longer lifespans.
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Muni Bonds - >>> ‘It’s Just Dirt’: Anything Goes in Today’s Muni Bond Market
Bloomberg
By Amanda Albright
August 21, 2019
https://www.bloomberg.com/news/articles/2019-08-21/muni-bond-buyers-are-desperate-risky-borrowers-are-cashing-in?srnd=premium
Yields on riskiest muni-debt drop to 4%, the lowest on record
That is pushing investors into increasingly exotic deals
Last month, a risky, new deal hit the municipal-bond market. It came from a small borrower in Colorado that was looking to finance the construction of 1,200 luxury homes in the foothills of the Rocky Mountains.
It was an odd time for such a project. Denver’s decade-long housing boom was beginning to show signs of cooling and, moreover, rival developers had already raised record sums to turn vast tracts of land into new communities. “There’s no houses to see,” said Nicholas Foley, a municipal-bond fund manager at Segall Bryant & Hamill in Denver. “It’s just dirt.”
No matter. The buy orders poured in anyways and, in the end, about $20 million worth of bonds had been sold for yields as low as 4.75% on 30-year maturities -- similar to the rates that investors once only reserved for relatively risk-free market behemoths like California or New York.
The Federal Reserve’s decision to lower benchmark borrowing costs is keeping the U.S. awash in cheap credit. That has fueled a surge in corporate borrowing, bankrolled takeovers of debt-laden companies and, increasingly, sparked concern that some of those leveraged loans have become too risky. That angst has also seeped into the $3.8 trillion market for municipal bonds, a corner of the financial world that traditionally has served as a refuge for individual investors seeking steady, low-risk returns.
With the steep drop in yields wiping out the tax advantages of some tax-exempt securities, investors are hunting for higher payouts. That’s driven yields on the riskiest tax-exempt securities down to about 4%, the lowest since at least 2003, and in turn spurred an increase in sales from the most default-prone segments of the market. Shopping malls, centers for novel health-care treatments, factories seeking to turn trash into fuel and speculative real-estate developments like the one outside of Denver -- all have recently sold tax-exempt debt through local government agencies.
Yields on high-yield muni bonds have reached record lows
At the same time, investors are receiving less return for the risk, with the gap between yields on top-rated and junk-grade debt holding near where they stood at the end of 2007.
“There is so much money coming in -- even if 90% of the market rejects it, if 10% wants to buy, they are able to get it done,” said Dan Solender, a partner at Lord, Abbett & Co.
The municipal-debt market remains one of the world’s safest, with only 0.16% of those rated by Moody’s Investors Service defaulting between 2009 and 2018, compared with 6% of corporate bonds. Yet many of the riskiest deals aren’t rated and could leave investors -- including those with stakes in mutual funds -- exposed to potential losses if the economy stalls.
During the 2008 credit crisis set off by the last recession, the municipal junk-bond market was roiled as the slowdown rippled through the economy. More than $8 billion of debt issued through state and local government agencies defaulted that year, the most for any year dating back to 1980, according to Richard Lehmann & Associates. When funds unloaded the riskiest securities, high-yield municipal bonds tumbled, saddling investors with a loss of 27% until the market rebounded in 2009.
The lowest-rated municipal securities have rallied this year, delivering gains of nearly 10%, as plunging yields worldwide leave investors hunting for ways to get higher returns. Mutual funds focused on high-yield tax-exempt debt have pulled in cash every week since early January, with about $384 million added in the week ended Aug. 14, according to Refinitiv’s Lipper US Fund Flows data.
That has increased demand for new issues, driving down the extra yields that the riskiest borrowers pay and allowing some to weaken the protections given to bondholders in the securities contracts.
AMG Vanadium LLC sold $307 million of debt through an Ohio agency to build a factory that will turn waste into a product that’s used in the production of steel. The company, which is responsible for paying on the debt, didn’t give bondholders a mortgage on its property in the event it defaults, as is commonly done. The sale was oversubscribed anyway, allowing the underwriter to price the 30-year securities for a yield of 4.28%. The bonds continued to climb after they were sold.
Investors bought up $1.75 billion in unrated municipal bonds for Virgin Trains USA’s private rail project in Florida. A California factory seeking to create a wood alternative has tapped the market more than once. The new sales-tax-backed debt issued this year by Puerto Rico has gained, pushing the price above full face value, even though the island was rocked by protests that forced the resignation of the governor and has yet to emerge from a record bankruptcy.
“It is a very aggressive market -- but to say that it is frothy means that this is the end of it, and I don’t know,” said Matt Fabian, a partner with Municipal Market Analytics, an independent research firm. “A year from now, we might be yearning for the discipline of 2019.”
Some money managers have started to pull back. Vanguard Group Inc. has cautioned against taking too much risk as the economy’s record-long expansion makes a recession look overdue. Goldman Sachs Group Inc. earlier this year shifted a record amount of its high-yield municipal fund into investment grade debt, anticipating that some of the projects financed by the securities may run into distress.
Through July, about 33 municipal bond issues defaulted, the fastest pace since 2015 and up from 21 during the same period in 2018, according to Fabian’s firm. That included a California plant that converts medical waste into hot gases, recyclable metals and glass, just years after issuing the unrated debt in 2016 and 2017.
But with the market still delivering outsize gains, mutual funds have a powerful incentive to stay put, given that they’re judged by the performance relative to their peers.
Guy Davidson, chief investment officer of municipal investments at AllianceBernstein, said he’s grappled with the performance of the company’s so-called high-income municipal fund. It’s up 9.7% this year, beating nearly 90% of its peers. “You go, gosh, is it time to take money off the table?” he said.
He hasn’t, anticipating that the high-yield market will be supported by the still-growing U.S. economy. “A bubble implies it’s supposed to pop,” he said. “Fundamentally, it doesn’t feel like there’s things that are going to make it pop.”
Foley, the Denver-based portfolio manager, was once a big buyer of tax-exempt bonds issued to build new housing developments in his booming state, but he has since stopped amid signs that the market has gotten frothy.
Last year, such Colorado land districts sold $1.3 billion in bonds, the most since at least 2005. The securities, which are typically unrated, are repaid by assessments levied on homeowners and offer few protections to investors if the housing market goes south. In the case of the Castle Rock, Colorado development, even if the district skips interest or principal payments, it won’t count as a default, limiting bondholders’ legal power to recoup some of what they’re owed.
Real-estate backed bonds were hit hard by the housing bust over a decade ago, when a wave of them defaulted in Florida. That also happened in California in the 1990s and in Colorado the decade before.
Colorado’s real estate market has boomed over the past decade, leaving Denver’s higher above their pre-recession peak than any other major metropolitan area, according to ATTOM Data Solutions. But there have been some signs that the frenzy is slowing down, as it has elsewhere: in June, only about 12% of homes had competing offers, down from half a year earlier, according to Redfin. And the number of homes on the market rose 28%, according to a local realtors report.
The Castle Rock debt used a limited-tax structure, meaning that failing to levy the property tax pledged to the bonds triggers an event of default.
That security pledge helps ensure that investors eventually get paid on their investments, said Sam Sharp, a managing director at D.A. Davidson & Co., which underwrites the majority of Colorado dirt bonds. The use of surplus funds also provides protections, he added.
“The structuring we do is mindful of how cyclical the real estate market can be,” he said.
Foley said it helps that his firm doesn’t run a high-yield municipal-bond fund and can instead move in and out of securities when they reach “irrational” points.
“If you make a real call against the high-yield market, you’re making a big call that can cost you your job if it doesn’t go right,” Foley said. “The easy thing to do is keep buying more and more high-yield.”
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>>> World's First 30-Year Bond With Zero Coupon Flops in Germany
Bloomberg
By John Ainger
August 21, 2019
https://www.bloomberg.com/news/articles/2019-08-21/germany-sees-anemic-demand-for-30-year-bond-sale-at-zero-coupon?srnd=premium
Nation sells 824 million euros versus 2 billion euro target
‘It is technically a failed auction,” says Danske’s Sorensen
Germany Sees Anemic Demand for First 30-Year Bond at Zero Coupon
The world’s first 30-year bond offering a zero coupon struggled to find buyers, signaling that negative yields across Europe may finally be taking their toll on investor demand.
Germany failed to meet its 2-billion-euro target ($2.2 billion) for the auction of notes maturing in 2050, selling only 824 million euros. It’s another sign that the global bond rally may be coming to a halt now that more than $16 trillion of securities around the world have negative yields.
German 30-year bond yields have plunged into negative territory
“This shows that there is less demand for 30-year bonds at negative yields,” said Marco Meijer, a senior fixed-income strategist at BNP Paribas SA. Still, Meijer doesn’t “see yields rising a lot in Europe.”
The whole of Germany’s yield curve is now below zero -- the first major market exhibiting such a trait -- meaning the government is effectively being paid to borrow out to 30 years. That’s a reflection of dwindling expectations for inflation and growth over the coming years, while the European Central Bank is widely forecast to introduce a new wave of monetary stimulus next month.
The sale comes as Germany is priming the pumps for extra spending should an economic crisis hit. While the nation is confined to strict laws on running a fiscal deficit, Finance Minister Olaf Scholz suggested Germany could muster 50 billion euros ($55 billion) should a recession hit. The economy contracted in the second quarter.
German 30-year yields rose three basis points to -0.12% as of 1:20 p.m. in London. Those on 10-year securities climbed two basis points to -0.67%.
The auction was at a record-low average yield of -0.11%, while the Bundesbank retained nearly two-thirds of the debt on offer. The real subscription rate -- a gauge of demand that accounts for retentions by the Bundesbank -- fell to 0.43 times against 0.86 times at the previous sale of similar maturity bonds on July 17.
Commerzbank AG had expected demand to come from life insurers and macro investors before the sale, despite the yield curve flattening in recent weeks. Long-dated German bonds are still attractive for U.S. investors, when hedged for currency swings, offering around a 2.6% yield, relative to around 2% on a 30-year Treasury.
“It is technically a failed auction,” said Jens Peter Sorensen, chief analyst at Danske Bank AS. “I am not all worried about this -- as investors can always just buy in the future and do not need to participate in auctions.”
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>>> U.S. Weighs Selling 50- and 100-Year Bonds After Yields Plummet
By Alex Harris and Emily Barrett
August 16, 2019
https://www.bloomberg.com/news/articles/2019-08-16/u-s-treasury-to-do-market-outreach-again-on-ultra-long-bonds-jzejo2qu?srnd=premium
Treasury conducting an outreach on ultra-long debt issuance
Announcement follows slide in 30-year yield to record low
With interest rates on 30-year U.S. debt hitting all-time lows this week, the government is once again considering whether to start borrowing for even longer.
The U.S. Treasury Department said Friday that it wants to know what investors think about the government potentially issuing 50-year or 100-year bonds, going way beyond the current three-decade maximum.
The government stressed that no decision has yet been made on ultra-long bonds, explaining that it’s looking to “refresh its understanding of market appetite.” The idea was broached before, back in 2017, but was shelved after receiving a less-than-warm reception.
“This comes up every now and again,” said Gennadiy Goldberg, U.S. rates strategist at TD Securities. “Every time the takeaway is, there simply isn’t enough demand at that tenor, or at least there hasn’t been in the past.”
The announcement follows a plunge in the 30-year yield to a record low this week below 2%, and also comes in the wake of many other nations opting to extend their borrowing profiles with so-called century bonds. Investors have snapped up 100-year bonds issued by the likes of Austria, although the experience of Argentina underscores some of the potential pitfalls of buying such long-maturity debt.
The yield on America’s current benchmark 30-year bond spiked to its highs of the day and the curve steepened following the Treasury announcement. The 30-year rate climbed as much as 8 basis points on the day to 2.05%, before ending the session at around 2.03%. The yield spread between the U.S.’s longest-maturity debt and its two-year note widened the most in five weeks on Friday.
30-year Treasury yields sank to a record low
The Treasury’s group of market consultants, the Treasury Borrowing Advisory Committee, has long been unenthusiastic on the prospect of an ultra-long issue, said Bruno Braizinha, director of U.S. rates research at Bank of America.
The challenge for the Treasury would be to offer a yield attractive enough for the typical investor base of pension funds and institutions, while keeping a lid on the cost of borrowing for U.S. taxpayers.
By Braizinha’s estimates, the yield on a 50-year issue would be expected to come in around 10-30 basis points above the 30-year rate.
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>>> A Decade of Low Interest Rates Is Changing Everything
Cheap money has transformed the world of borrowers, savers, bankers, money managers, and retirees.
Bloomberg
By Liz McCormick
July 23, 2019
https://www.bloomberg.com/news/articles/2019-07-23/a-decade-of-low-interest-rates-is-changing-everything?srnd=premium
It’s hard to wrap your head around just how low U.S. interest and bond yields are—still are—a decade after the Great Recession ended. Year after year, prognosticators said that rates were bound to go back up soon: Just be ready. That exercise has proved to be like waiting for Godot.
In 2018, Jamie Dimon, chief executive officer of JPMorgan Chase & Co., put Americans on alert to the likelihood of higher interest rates. He said the global benchmark for longer-term rates, the yield on a 10-year Treasury bond, could go above 5%. Right now it’s just a hair above 2%. Thirty-year mortgage rates are a fraction of long-run averages, and companies too are paying very little to borrow. All that cheap money has been helping the economy along. On the other side of the ledger, bank depositors are getting paid only a fraction of 1% on their savings.
The longevity of low rates has upended long-standing assumptions about money and reshaped a generation of investors, traders, savers, and policymakers. The Federal Reserve has tried to push the U.S. into a higher-rate regime, raising rates nine times since 2015, when the key short-term rate was near zero. But now the central bank appears ready to reverse course and start cutting again when it meets at the end of July. “This is the new abnormal,” says David Kelly, chief global strategist at JPMorgan Asset Management, which oversees $1.8 trillion. “Normally when you are in this phase of an expansion, you have a rising inflation problem, a Federal Reserve overtightening to slow the economy, and businesses that can’t afford to borrow. None of that is true right now.”
Investors are betting that a quarter-percentage-point rate cut is all but certain, according to prices in the futures market. Fed Chair Jerome Powell reinforced those views with remarks to Congress on July 10 and 11. He cited rising global risks, low inflation, and weakening business investment and manufacturing. Depressed U.S. rates come as other central banks, including the European Central Bank, have turned more dovish—even with their rates already set below zero.
relates to A Decade of Low Interest Rates Is Changing Everything
Fed chairman Jerome Powell.PHOTOGRAPHER: ANDREW HARRER/BLOOMBERG
Anne Walsh, chief investment officer of fixed income at Guggenheim Partners, says there’s been “a paradigm shift of epic proportion for investors.” Not only are short-term rates low, but long-dated bond rates are minuscule, too, suggesting that investors see little likelihood of rates—and the economic conditions they reflect—changing anytime soon. (Bonds’ yields fall as their prices rise.)
Borrowers of all kinds have been clear benefactors of this sea change, with many nations and companies locking in low rates for as long as a century. Belgium and Ireland have sold 100-year bonds, as did Austria this year at a yield of 1.171%. In 2015, Microsoft Corp. sold 40-year bonds and the University of California issued 100-year debt. Subdued rates have also buffered the U.S. Treasury from rising interest costs on the federal debt.
For banks, the squeeze in long-term rates isn’t ideal. That’s because they tend to fund long-term investments with short-term debt, so they prosper when long-run rates are significantly higher than short ones. In the U.S., banks have still been able to profit, with the top five firms cracking $30 billion in quarterly earnings for the first time. But some big commercial banks have warned that lower interest rates are weighing on their outlooks for revenues from lending.
Individuals have had to get used to earning paltry rates. The national average rate on savings accounts is 0.10%, little changed from four years ago and down from 0.30% in 2009, according to data from Bankrate.com. In 2000, well before the financial crisis, the rate was 1.73%. “We never got to the would-be promised land with respect to higher rates,” says Mark Hamrick, senior economic analyst at Bankrate.com. “This has been the difference for savers between having more money and not.”
The problem is the same for institutions that manage savings on behalf of others. Pension funds, overseeing trillions in retirees’ future cash, have been ratcheting down return expectations. The 30-year Treasury bond, a favored debt security, yields about 2.5%—compared with an average 6.5% since the 1970s. Even a record rise in stock prices hasn’t solved the low-return problem for pension funds, because many of them cut their allocations to equities after the financial crisis. Ben Meng, chief investment officer of the California Public Employees’ Retirement System, said in June that the expected return for his pension portfolio over the next 10 years would be 6.1%, down from a previous target of 7%.
Where low rates really bite isn’t in current returns but in the future gains investors can reasonably expect. Interest rates set a kind of baseline for the return on all assets. As they fall, bond values rise and stocks often do, too. But once rates have settled at or near rock bottom, there’s less room for that kind of price appreciation.
All this has sent investors looking under every available rock for more return—even if it means taking more risk. The fear is this could lead to the formation of bubbles and eventually destabilize the financial system. “Institutional investors are out there in the great truffle hunt for yield,” says Walsh, at Guggenheim. “This is particularly true of large institutions, like banks and insurance companies and pension funds. These firms are searching for yield and potentially taking on unintended risk because that is what they need to do.”
It’s a global phenomenon. Japan Post Bank Co., the banking unit of Japan Post Holdings Co., a publicly traded company that’s majority-owned by the government, held $577 billion in bonds outside its low-yielding home market in March. Norinchukin Bank, a cooperative that invests the deposits of millions of Japanese farmers and fishermen, has $69 billion in collateralized loan obligations—essentially, loans to companies with less-than-stellar credit—in the U.S. and Europe.
While some Fed officials wish they could get back to more-normal rates, so they have more room to ease again in the future if they need to fight a downturn or fresh financial crisis, they seem to have their hands tied. For all the problems low rates may cause, policymakers see them as a stimulant to growth. Although unemployment rates are very low, the economy took an agonizingly long time to recover from the financial crisis. And now a slowdown in global growth and headwinds from Trump’s trade war have made risks to U.S. output too strong to ignore.
This has some wondering if we’ve been thinking about the economy all wrong. “The traditionalist views on monetary policy and monetarism are really being questioned,” says Mark Haefele, chief investment officer at UBS Global Wealth Management, referring to to the notion that central banks always have the ability to juice the economy—or put the brakes on it—when needed. “That has led to a wide range of alternative theories including Modern Monetary Theory, and just how to re-stimulate growth.” According to MMT, for example, government policymakers should be willing to run bigger deficits, at least until a boom in demand causes inflation to kick in.
The surprising persistence of low rates has even quietly reordered the hierarchy on Wall Street. Hedge fund managers may still be glamorous on shows like Billions, but in real life they’ve had to fight to retain clients. Partly that’s because many hedge fund managers thrive on volatility, and in a world where the dreaded spike in interest rates has never arrived, there’s been too little of that for them. The long fall in rates has made it easier so far to earn money with simple investments such as stock and bond index funds. Meanwhile, cheap financing costs and rising asset values have been a boon for private equity firms. Investors have committed about $4 trillion to them in the last decade, according to data from research firm Preqin Ltd.
In 2009, bond powerhouse Pacific Investment Management Co. saw all this coming, when they dubbed their multiyear investment outlook “the new normal” and predicted lower long-term yields. They saw the same issues the Fed and central bankers around the world are grappling with now: slow growth, a combination of technological innovation and low-cost global labor that eases inflationary pressure, and a glut of savings as the populations of rich countries age. Looking ahead, with many of those 2009 factors remaining, “the new wrinkle is concern around global trade and countries looking more inward,” Pimco Group Chief Investment Officer Dan Ivascyn says. “Yields can absolutely go a lot lower.”
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>>> How ‘Transition Bonds’ Can Help Polluters Turn Green
Bloomberg
By Tom Freke
July 14, 2019
https://www.bloomberg.com/news/articles/2019-07-14/how-transition-bonds-can-help-polluters-turn-green-quicktake?srnd=premium
It makes sense that green bonds are meant for green companies. But there aren’t that many of them -- not enough to meet the rising demand from investors who want their money to have a positive impact on the environment. So what if some of that money went to finance green activities by less-than-green firms, such as oil companies, coal miners and agricultural businesses? A new concept that’s gaining traction, dubbed for now as transition bonds, could vastly expand the green credit field, and could help cut pollution where it needs to be cut. The risk is that they could provide cover for companies not fully committed to shifting quickly away from their carbon-spewing ways.
1. What would one be like?
A new class of bonds, transition bonds would finance projects aimed at helping the seller switch to a cleaner way of doing business, particularly if they help the climate. For example, an energy company could use them to finance efforts to capture and store its carbon emissions or to move from coal to gas-fired power plants. There’s no consensus yet on what types of commitments companies would need to make, though it’s expected that borrowers would need to sign up to specific targets, as well as broader sustainability goals. Investors would demand transparency, adding further pressure on companies to make public their impact on the environment and detail measurable ways in which they plan to bring their businesses in line with goals set in the Paris Agreement on climate change.
2. How is that different from a green bond?
It’s different because rather than focusing solely on the use of the proceeds or the profile of the issuer, a transition bond is about an issuer’s behavior: are they committing to becoming greener? By contrast, a green bond is restricted to financing for projects that are environmentally friendly. A focus on behavior is an approach that’s already taken off in the loan market. There, a new product called sustainability-linked loans allows borrowers to win a reduction in interest costs by hitting certain targets, such as cutting pollution or reducing food waste. They are one of this year’s fastest-growing debt asset classes.
3. Why aren’t green bonds an option?
The rules don’t prohibit oil producers and coal miners from selling green bonds, but it’s not a great option because some investors doubt those bonds are really green. Investors and banks are increasingly taking a company’s overall profile and commitment to reducing their carbon footprint into account when considering anything labeled “green,” while distancing themselves from non-renewable investments. In 2017, the first green bond sale by a major oil company, Spanish firm Repsol SA, divided the green-bond industry and the securities weren’t included in major green bond indexes. Better, say advocates of transition bonds, for those companies to have their own separate asset class.
4. What’s are the next steps?
There needs to be a wide-ranging discussion between banks, investors, policy makers and companies to decide whether it’s a good idea and how to proceed. In an effort to jump-start the conversation, Axa Investment Managers in June published proposals for transition bonds, arguing that they should be structured similarly to green bonds and be accompanied by a high level of transparency by issuers. French bank BNP Paribas SA has said it supports the the idea. Last year a body representing some Canadian companies also published proposals for transition bonds.
5. What are the challenges?
The suggestion comes at a time when the question of what makes a green bond is still being debated. There is still no single standard for green bonds, although the European Union recently published proposals for a code, potentially superseding the well-followed green bond principles used by trade body ICMA. With skepticism persisting about green bonds, getting people to trust that a transition bond is a solution, not just a marketing trick, may be tough. To avoid accusations of greenwashing -- making misleading claims about how effective at tackling climate change a project is -- there would need to be well-defined criteria for eligible projects and transparent reporting requirements.
6. What’s at stake?
An average of as much as $3.5 trillion worth of investments are needed every year through 2050 to build the necessary clean energy infrastructure to keep global warming in check. This could be the moment when green bonds go mainstream. But currently they only make up a small fraction of the market, with a cumulative $698.5 billion of green bonds sold, according to research by BloombergNEF. If more firms can seek financing based on environmental goals and more big investors swing behind the asset class, transition bonds could see growth similar to that seen in sustainability-linked loans.
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>>> The Black Hole Engulfing the World's Bond Markets
Bloomberg
By John Ainger
July 13, 2019
https://www.bloomberg.com/news/articles/2019-07-13/the-black-hole-engulfing-the-world-s-bond-markets-quicktake
It is growing.
There’s a multitrillion-dollar black hole growing at the heart of the world’s financial markets. Negative-yielding debt -- bonds worth less, not more, if held to maturity -- is spreading to more corners of the bond universe, destroying potential returns for investors and turning the system as we know it on its head. Now that it looks like sub-zero bonds are here to stay, there’s even more hand-wringing about the effects for mom-and-pop savers, pensioners, investors, buyout firms and governments.
1. Why invest in a bond that will lose you money?
Typically, bonds are the safest assets on the market, so many investors seek them out at times of heightened market stress, say a U.S.-China trade war or tensions in the Persian Gulf. A bond can have a modestly positive coupon when issued by a government, institution or company, but once it starts trading, high demand by investors can push its price up -- and therefore its yield down -- to such an extent that buyers no longer receive any payment. Some funds track government bond indexes, meaning they must buy the bonds regardless of the yield. And some investors can still make positive returns on these bonds when adjusted for currency swings.
2. How much is being bought?
Negative-yielding debt topped $13 trillion in June, having doubled since December, and now makes up around 25% of global debt. In Germany, 85% of the government bond market is under water. That means investors effectively pay the German government 0.2% for the privilege of buying its benchmark bonds; the government keeps 2 euros for every 1,000 euros borrowed over a period of 10 years. The U.S. is one of the few outliers, with none of its $16 trillion debt pile yielding less than zero, but across the world, strategists are warning that the problem may get worse.
3. Why is this reason for worry?
Negative rates are at odds with basic principles of the global finance system. “One important law of financial logic –- if you lend money for longer, you should see a higher return –- has been broken,” wrote Marcus Ashworth, a Bloomberg Opinion columnist covering European markets. “The time value of money has essentially disappeared.” (Has it ever: The so-called century bonds issued by Austria two years ago, which mature in 2117 and initially offered a 2.1% return, now yield about 1.2%.) All this can push investors into riskier bets in the hunt for returns, raising the chances of bubbles in financial markets and real estate.
4. Who benefits from negative rates?
Governments, for one. The incentive to borrow money is never greater than when you are being paid to do so. Germany, for example, is being subsidized to issue debt over the next 20 years, though that does not necessarily mean it will boost spending. Companies that issue bonds also reap the benefits of record-low borrowing costs. So do private-equity firms, which typically use leverage to acquire companies and see greater opportunities when (and where) capital is cheap. Homeowners with variable-rate mortgages also have reason to celebrate.
5. Who gets hurt?
Pension funds and insurers, traditionally big investors in government bonds, are in a particular predicament: Their liabilities grow steadily as clients age, but often they are required not to take on big risks. Banks see their margins squeezed. They’re earning next to nothing from lending but still need to offer depositors a rate above zero to keep their business. In Germany, the ECB has come under political pressure for hurting the returns of savers. Central banks could run into the problem of hitting the so-called “reversal rate” -- the point at which low borrowing costs start to harm rather than help the economy, should banks start to restrict loans. That could deepen any slowdown.
6. How did we get here?
Several of Europe’s central banks, otherwise unable to spur growth in the aftermath of the 2008-2009 financial crisis, cut interest rates below zero in 2014. Japan soon followed. The idea was to spur lending by charging financial institutions, rather than rewarding them, for parking money that otherwise could be put to use in the real economy. Since 2016, the ECB’s benchmark rate has been -0.4%, meaning banks lose 4 euros to store 1,000 euros there. The sub-zero rates were supposed to be temporary but have endured. Traders are betting that the ECB will push its deposit rate ever more negative this year, driving record levels of bond yields below zero.
7. Why have negative rates lasted so long?
More than a decade on from the credit crisis, inflation is still scarce, with wages increasing only modestly despite large drops in unemployment. The ECB, for example, isn’t expected to get to its close-to-2% inflation target over the next decade, according to a market-derived measure. And the yield difference between U.S. three-month bills and 10-year Treasuries is inverted, an indication that an economic contraction may be coming. Aside from the U.S. Federal Reserve, few central banks that slashed interest rates during the credit crunch have managed to raise rates, meaning that during the next downturn they are likely to head further into negative territory.
8. Where’s all this heading?
In Europe, there are fears that the continent is following the path of Japan’s so-called lost decade, where policy makers struggled to revive anemic growth and inflation. Central banks have been keen to iterate that they still have tools in their locker to combat any slowdown, including rate cuts and more quantitative easing. For markets, waning volatility is bad for trading. Geopolitical tensions over trade, and Britain’s exit of the European Union will keep driving investors into the safest assets, meaning demand will remain high for negative-yielding debt. But the push to find juicier returns with riskier bets raises the prospect of further fund failures or a new crisis.
The Reference Shelf
Why buyers of negative-yielding debt aren’t necessarily fools.
QuickTakes on negative interest rates, yield curve inversion and central bank independence.
Bloomberg Opinion columnist Marcus Ashworth delved into the implications of "this tectonic shift in fixed income."
The crisis at Danske Bank illustrates the full extent of damage from negative rates.
An ECB paper on negative rates not being unproductive once they reach the zero lower bound.
Pimco are among a growing clamor of voices that Europe is becoming “Japanified.”
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>>> Jerome Powell Just Locked in a July Rate Cut
If he had any inkling to hold steady this month, his testimony needed to shake bond traders from their 100% certainty about easing. Instead, he only added to their resolve.
Bloomberg
By Brian Chappatta
July 10, 2019
https://www.bloomberg.com/opinion/articles/2019-07-10/jerome-powell-leaves-no-doubt-about-fed-rate-cut-in-july?srnd=premium
The question now is whether the central bank stops at just one.
Federal Reserve Chair Jerome Powell had a chance Wednesday to push back against both over-aggressive bond traders and Trump administration officials who were pounding the table for interest-rate cuts. He had the cover of not just a strong rebound in the U.S. labor market but also the backing of regional Fed presidents like Patrick Harker and Loretta Mester, who had already advocated this month for keeping the central bank’s lending benchmark unchanged.
Instead, in prepared remarks to U.S. lawmakers, he told the bond market and the president that a quarter-point rate cut is a sure thing at the end of the month.
Rather than highlighting the strength of the U.S. economy, Powell seemed to make every effort to note all the possible risks and where it’s falling short. Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott, noted that in his description of the current economic situation and outlook, Powell wasted no time brushing off the first-half performance:
The economy performed reasonably well over the first half of 2019, and the current expansion is now in its 11th year. However, inflation has been running below the Federal Open Market Committee's (FOMC) symmetric 2 percent objective, and crosscurrents, such as trade tensions and concerns about global growth, have been weighing on economic activity and the outlook.
This is more or less a snapshot of Powell’s stance throughout the remarks. They’re far more pessimistic than expected, focusing on trade tensions and the slowing global economy and what that sort of uncertainty might mean for the U.S. “There is a risk that weak inflation will be even more persistent than we currently anticipate,” he said. That’s an abrupt change of tune. So much for those “transitory” factors subduing price growth that the Federal Open Market Committee saw just two months ago. Or that the latest reading of the consumer price index is still to come this week.
In a way, this is what markets expected all along. The odds of a quarter-point interest-rate cut have been stuck right around 100% since last week’s jobs data. But Powell’s unambiguous move toward the dovish contingent of the Fed, which thinks an “insurance cut” is necessary, is nonetheless new information. To be clear, this was not a “hint” of a July rate cut. It was a declaration.
In No Uncertain Terms
Powell chooses not to preserve the option to hold interest rates steady this month
As I wrote last week, Powell had a real opportunity with this testimony to shake bond traders from their 100% conviction. In fact, he was probably the only Fed member who could do it. My Bloomberg Opinion colleague Conor Sen and I recently discussed this idea of what it would take to break through the 100% mark, imagining this sort of conversation among two traders heading into Powell’s testimony:
Trader 1: I really don’t think the Fed will cut rates this month. I should bet on that.
Trader 2: Of course the Fed will cut. Markets have priced in a 100% chance. They’ve never disappointed in that scenario and they won’t this month either.
Trader 1: But the jobs numbers were strong, other Fed officials have signaled they’re not fully on board with a cut, inflation is still decent and stocks are at all-time highs.
Trader 2: Yes. Still, the markets have priced in a 100% chance of a cut. They’ve never disappointed in that scenario and they won’t this month either.
Trader 1: But…
Trader 2: The markets have priced in a 100% chance of a cut. They’ve never disappointed in that scenario and they won’t this month either.
Trader 1: OK, you’re right. I’ll just wait to see if the odds fall below 100% before betting.
Obviously, with those sorts of conversations on trading desks around the world, no one ends up taking the first step toward pricing out an interest-rate cut. That sort of inertia requires someone like Powell to break it. It didn’t happen, and that was by design.
It’s hard to pinpoint what precisely persuaded Powell capitulate to easing sooner rather than later. Some will probably cite his comments that “an ounce of prevention is worth a pound of cure” as evidence that he was leaning toward lowering rates in July all along. That wasn’t my read, and I wasn’t alone. Bloomberg Economics and Bank of America Corp. were among those expecting the Fed to hold steady this month, and Citigroup Inc. this week reiterated that a July interest-rate cut wasn’t a done deal.
It will be worth watching how Powell answers questions about the central bank’s independence and its ability to withstand political pressure. There’s simply no escaping the fact that the Fed is about to lower interest rates after months of President Donald Trump demanding it do so, all the while chiding policy makers for being clueless and suggesting he has the power to fire or demote Powell. This White House views the stock market as a referendum on its economic policies, and, thanks to Powell, the S&P 500 reached another record on Wednesday, eclipsing 3,000 for the first time.
The debate on lowering interest rates in July is over. Now, traders will move on to ponder whether the Fed can really do just one for insurance, or whether this is the beginning of an extended easing cycle that will once again bring U.S. yields back toward all-time lows.
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