Relief for Memorial Day drivers

US gasoline prices have been on the rise, as peak diving season approaches while a number of refineries have been undergoing scheduled and unscheduled maintenance. The price increases have been particularly acute in the Midwest.

Source IEA, May 24th, 2013

EIA: - Higher gasoline prices in the Midwest largely reflect supply constraints stemming from decreased refinery runs and lower-than-normal gasoline inventories. Refinery utilization in the

Midwest has fallen steadily since the start of 2013, and is now about 83 percent of capacity, below the U.S. average of 87 percent. As of May 17, Midwestern gross refinery inputs were averaging 279,000 barrels per day (bbl/d) lower than at the start of the year. The reduction in runs reflects a combination of routine seasonal turnaround and maintenance activity, unplanned outages, and longer-term upgrading initiatives

But it seems that in spite of these constraints, price increases - at least at the national level - have stopped.

Source: Gasbuddy.com

This is the result of a recent surprisingly sharp increase in the national gasoline stocks, with supplies now running above the 5-year range for this time of the year. And that should provide some relief for Memorial Day drivers as prices stabilize or even decline.

Source: DB

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From our sponsor:

The Eurozone's economy could surprise to the upside

This may be an unpopular suggestion, but those with a contrarian view of the world will surely appreciate the logic here. The chart below from Goldman shows the consensus economic forecast for 2013 GDP growth of the large Eurozone nations. Again, this is not the actual GDP, but a forecast over time.

Source: GS

It shows that the "herd" of forecasters following each other in the realization of how dire the recession has been across the area. But keep in mind that these are some of the same forecasters that 18 months ago were calling for a "shallow" downturn in these nations (see discussion). Many weren't even talking about a possible recession. And now they are continually downgrading their predictions - after the fact?

Today we got the latest PMI numbers from the Eurozone. France is clearly struggling and Germany's growth has been slower than many had hoped - due primarily to global economic weakness. But take a look at the rest of the Eurozone. While still in contraction mode, it shows an improving trend.

Spain printed a trade surplus last month (surprising some commentators), which may be a signal to rethink how valid some of these forecasts really are. Nobody is suggesting we will see Spain or Portugal all of a sudden begin to grow at 5%. But given the extremely pessimistic sentiment of many economists (a contrarian indicator), it is highly possible we are at or near the bottom of the cycle. People should not be surprised if we start seeing some positive growth indicators - especially in the periphery nations - in the next few quarters.

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Shareholder activism may be negative for credit

Equity investors might find it a bit surprising that the rating agencies are not necessarily all that excited about the recent wave of stock investor activism. In fact some view such aggressive investor involvement as risk to corporate credit. Instituting strong corporate governance is certainly a positive, but equity investors will also continue to insist that companies do something with their cash (see discussion), including paying dividends or buying back shares. That ends up helping shareholders in the short run but increases net leverage - which is not ideal for credit investors. And certain structural, management, and board changes that result from shareholder activism will conflict with the needs of corporate debt holders.

Fitch: - The unprecedented level of shareholder activism seen across the energy space has increased the tail risk of future unexpected shareholder-friendly actions for credit in the space, according to Fitch Ratings.

Activist campaigns and/or proxy-related issues have flared up widely across the energy sector this year at several key names including Hess, Nabors, Transocean, Chesapeake, and Occidental Petroleum. The net result of these campaigns has been a wave of changes on the corporate governance, financial, and operational levels.

... Financial changes such as new shareholder-friendly distributions include new or expanded buyback programs and new or expanded dividend payouts while operational changes include accelerated restructuring plans and asset sales.

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From our sponsor:

Hawkish comment from Bernanke hit stimulus-dependent asset valuations

It took one sentence to send shockwaves through the financial markets.

Bernanke: - We’re trying to make an assessment of whether or not we have seen real and sustainable progress in the labor market outlook. If we see continued improvement and we have confidence that that is going to be sustained, then we could in -- in the next few meetings -- we could take a step down in our pace of purchases.

US equity and fixed income markets declined sharply in response. To understand just how much asset prices depend on this stimulus from the Fed, consider the move across the treasury curve today. The increase in the 10yr yield was larger than in the 30yr. The Fed does not hold much in the long bond type durations relative to those that are 10yr and shorter. The long bond is therefore not as exposed to the Fed slowing its purchases as the 7-10yr notes.

The central bank's balance sheet - not the fundamentals - has been driving bond pricing and is the key determinant of the treasury curve's shape. Today was just a hint of how the eventual exit from QE may ultimately play out. This does not bode well for other asset classes (such as high-dividend shares which sold off sharply) whose valuations have become dependent on this stimulus rather on fundamentals.

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In an attempt to avoid more controversy, banks are pegging LIBOR to CD rates

As predicted back in October (see discussion), dollar LIBOR is now being priced (roughly) off certificate of deposit (CD) rates. Imagine being a bank's treasurer responsible for submitting LIBOR quotes to the BBA. If you can't justify how you obtained your rate and someone accuses you of LIBOR manipulation (see post), it could cost you your job and more. The sources of LIBOR rates were supposed to be quotes on interbank loans. But unsecured interbank lending volumes have been suppressed since the financial crisis. In fact current levels are similar to what they were in the 80s (see chart below). And most of the activity is in the overnight markets with very little transacted at maturities of one month or greater. (Note: some confuse the sources of LIBOR rates, such as interbank lending, with products that price using LIBOR rates, such as interest rate swaps. Here we are discussing the sources.)

With little to go by in the way of actual quotes, setting these rates becomes a real headache for banks. By pricing LIBOR off something that's highly transparent, like CD rates, makes the quotes easier to justify. After all, a CD rate is where a bank is willing to borrow money for a fixed term - which is what LIBOR is supposed to be. That's why LIBOR has been fixed at a fairly constant average spread to CD rates. The 3-month LIBOR is now roughly 7 basis points above the 3-month CD rate (note that the CD average here includes retail quotes - larger term deposits yield more and the spread of those large CDs to LIBOR is even tighter).

Ironically CD volumes are declining as well (see discussion). But as long as banks continue to openly quote the full CD term structure (across different maturities), banks will use the CD curve as a guide to set LIBOR rates.

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From our sponsor:

Headed for euphoria

On its risk appetite index, Credit Suisse views the index value of 5 as "euphoria". And we are headed there, as markets embrace risk.

Source: Credit Suisse

This is not surprising given where credit markets are trading. As an example, the Merrill European High Yield Index average yield is now below 4.5% (4.46% to be precise). Keep in mind this is sub-investment grade debt mostly from European issuers. The yield on these bonds is now less than half what it was just a year ago.

Not much else to say here other than enjoy it while it lasts.

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From our sponsor:

Corporate cash balances still growing - and so is debt

Corporate treasurers' risk tolerance remains low as they prefer to hold record amounts of cash on their balance sheets.

Source: JPMorgan

This is taking place at the time when companies have issued record amounts of debt to take advantage of ridiculously low rates. Increasingly however the proceeds of those bond sales and other borrowings sit in cash. The difference between total and net debt in the chart below is cash (above).

Source: JPMorgan

Markets are betting that some of this cash will ultimately turn into stock buybacks or dividends. Shareholders are certainly demanding it. Over time that will leave some of these firms more leveraged, and unless they "grow into" this debt, more vulnerable to downturns.

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From our sponsor:

BOJ says party on - in the long run we are all dead

Japan's monetary experiment is truly unprecedented, both in size and scope. Not only is the overall central bank balance sheet growth accelerating, but the assets purchased are not just government securities.

Total Assets (source: BOJ)

The Bank of Japan is buying up REITs and stock ETFs to prop up both asset classes. The amounts are still relatively small, but the buildup is quite rapid.

BOJ's holdings of ETFs

BOJ's holdings of REITs

And with Keynesian economists cheering the BOJ on (see post), the policy is rapidly achieving the desired result. Japanese authorities are ecstatic - dollar-yen just broke 103 as the yen "printing presses" quickly debase the currency. Japan will quickly have a competitive advantage over South Korea, Germany, and in some cases even China. Japan's exporters are popping the Champagne corks ...

Yen per one dollar; source: Investing.com

The nation's stock market is now up over 75% over the past year as investors celebrate the massive stimulus, BOJ's direct purchases of ETS and REITs, and a rapidly depreciating yen.

Source: Ycharts

Japan's economy is quickly responding to this aggressive policy, with analysts frantically revising growth forecasts.

Goldman: - Strong Q1 growth, technical upward revision to our FY2013 forecast Jan-Mar real GDP growth came in at +3.5% qoq annualized, substantially outpacing the market consensus forecast of +2.7%. Consumption was the driver rising +3.7%, while exports turned positive for the first time in four quarters.

We raise our FY2013 real GDP forecast to 2.8% growth, from 2.5%, based on the strong GDP numbers for Jan-Mar.

The Bank of Japan's biggest achievement of course is pulling the nation out of the prolonged deflationary spiral. Market-implied inflation expectations have risen sharply over the past year, quickly approaching those in the United States.

5y inflation expectations (source: JPMorgan)

This is a great lesson for central banks around the world. If much needed structural changes fail or competitive pressures become too great, let you central bank resolve the situation. Just as the ECB "saved" the EMU with its OMT bond backstop policy, Japan is showing that highly aggressive central bank actions can work beautifully in the short term. But what happens in the long run some may ask? Don't worry about that, because as Keynes famously pointed out, "... this long run is a misleading guide to current affairs. In the long run we are all dead."

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