Monday, December 31, 2012

US credit expansion driven by corporate lending

2012 was marked by significant credit expansion in the US, as loans and leases on domestic banks' balance sheets hit a new post-recession high. Here is a quick overview of recent lending trends.

Loans and leases in bank credit; domestically chartered commercial banks; seasonally adjusted (source: FRB)

A great of that expansion has been driven by corporate loans, where credit expansion started in early 2011. Although the Fed doesn't break down this measure by company size, anecdotal evidence suggests that this credit growth is concentrated in large company lending. Small business loan growth has apparently been much more modest.

Commercial and industrial loans; domestically chartered commercial banks; seasonally adjusted (source: FRB)

Commercial real estate lending remained subdued as CMBS pools have been hitting their maturity wall (see discussion). It seems however that commercial loan balances are stabilizing.

Commercial real estate loans; domestically chartered commercial banks; seasonally adjusted (source: FRB)

Residential mortgages held by banks grew in 2012, although most have been sold to the US government (GSEs). The recent spike is likely to be temporary as the newly originated loans await sales into the agency pools.

Closed-end residential real estate loans; domestically chartered commercial banks; seasonally adjusted
(source: FRB)

Consumer credit did not expand except for student loans (although auto loans saw some growth), as Americans held back on using credit cards.

Consumer loans: credit cards and other revolving plans; domestically chartered commercial banks; seasonally adjusted (source: FRB)

One area where credit contraction continued unabated is in home equity loans. This has been driven by low home equity values, tighter credit requirements, and lack of demand from homeowners.

Revolving home equity loans; domestically chartered commercial banks; seasonally adjusted (source: FRB)
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China's economic stabilization is now reflected in the equity market

China's business surveys continue to show stabilization in economic activity. The ISI Group's seasonally adjusted MNI Survey index (see discussion) shows some recent improvement. The survey is fairly balanced, with 75% from manufacturing and 25% from services.

Source: ISI Group

MNI: - Business conditions continued to expand after the lows of mid-summer, when they dropped to levels not seen since the height of the global financial crisis in late 2008 and early 2009. Key sub-indicators softened but mostly remain a few points into expansionary territory, still vulnerable to any external or domestic setbacks. Expectations for the future continued to improve in December at a faster pace but for the most part they too have not recovered very far into expansion.
Similarly the HSBC Manufacturing PMI (final measure from this morning) shows the bottoming out of manufacturing activity.

Source: Markit

HSBC/Markit: - Output at manufacturing plants in China expanded in December, and for the second month in a row. Although the rate of expansion was modest, it was the fastest in 21 months. Total new orders also increased but at a faster pace than in November, the quickest since January 2011. Exactly 15% of panellists noted increased order volumes, a number of which attributed growth to increased client demand. Meanwhile, new export orders fell slightly following a modest increase in November. Just over 12% of firms reported lower new export orders in the latest survey period. Fewer export sales were linked to weak demand in Europe, Japan and the US.
In response to these positive indicators, some of China's institutions and money managers continue to come into the equity market that was abandoned by the retail sector. The Shanghai Composite is up for the year after a 15%+ rally in December. Even in China the retail capitulation signaled the bottom (see this post on Nov 30th). It is important to note however that China's economic stabilization is still quite tenuous and heavily dependent on economic activity in the US (see discussion).

Shanghai Composite (source: Yahoo Finance)
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Fiscal uncertainty undermining the muni markets

The US fiscal negotiations are putting pressure on the muni bond markets.
ETF Trends: - The tax hoopla has depressed municipal bonds, with high-grade 10- and 30-year munis comparably yielding as much as taxable Treasury securities at 1.79% and 2.73%, respectively, writes Randall W. Forsyth for Barron’s.

According to reports from trading desks, bids have become more scarce as a greater number of investors are sitting on the sidelines and waiting it out as the fiscal cliff goes down to the wire.

Congress has reportedly proposed levies on high-income investors in munis as part of of the deficit plan.

More pessimistic muni observers are wondering if taxes could be imposed retroactively on tax exempt securities. George Friedlander of Citi, though, believes this is a “pernicious concept” that could destroy confidence in the federal government’s ability in the capital markets.

“The fact that there’s support on both sides of the table is what freaked people out,” said George Friedlander, managing director and chief municipal-bond strategist at Citigroup...
Fund flows into munis have slowed to a trickle.

Fund flows (source: GS)

Once again some zealous politicians who wish to "tax rich people" are simply going to transfer funds from municipalities to the federal government (in an inefficient manner).
ETF Trends: - Friedlander has also pointed out that if there were a limit to the value of tax-exemption on munis to up to a 28% cap, yields would rise 0.4% to 0.6%, which would devalue munis by $200 billion. Looking at the recent correction in muni ETFs, the potential tax hikes may have already been priced in.
Indeed the market has corrected from the peak reached at the end of November, as the chart for NY munis shows.

SPDR Nuveen Barclays Capital NY Muni Bd  (INY)

Ultimately whatever politicians decide to do, they need to get it done soon in order to return some certainty into this market. Otherwise they simply end up hurting municipalities around the nation who rely on this market for funding.
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Sunday, December 30, 2012

More hard evidence for fiscal negotiations impacting consumer sentiment

Some analysts remain doubtful that the fiscal impasse in Washington is having a material impact on the US consumers (as discussed here). But once again we see the uncertainty showing up in consumer survey numbers. Last week's Conference Board confidence index exhibited a considerable decline.

The same analysts argue that this decline is small in comparison to the Eurozone crisis-induced drop in confidence a year ago (discussed here). But one should consider two factors that make the latest confidence numbers a cause for concern.

1. The number came in some 5 points below expectations - a surprise to many economists:

Source: Econoday

2. The most compelling evidence is the divergence between consumer "expectations" and "present situation" (as the chart from Goldman shows). Consumers view the current conditions as the best since the start of the recovery, yet are extremely uneasy about the future.

Source: GS

Econoday: - The consumer confidence report shows hard evidence that the fiscal cliff is hurting the consumer's assessment of economic conditions. The index fell 6.4 points this month to 65.1 with weakness centered in the post-cliff outlook, that is the expectations component which plunged nearly 15 points to 66.5. The assessment of the present situation actually is up, rising nearly 5-1/2 points to 62.8 which is by far the best reading of the recovery!
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Egypt's central bank running "dangerously low" on foreign reserves

Egypt is learning the hard way that free elections by themselves do not produce a democratic state (see discussion). Nor do free elections necessarily translate into prosperity. With the new constitution in place and Muslim Brotherhood consolidating power, capital is flowing out of the country. The Egyptian pound (EGP) is under pressure as it hits new lows, while the central bank is spending foreign reserves to keep the pound from collapsing. It's becoming a losing battle.

EGP per one dollar (EGP weakening)

BBC: - Egypt is grappling with a crippling budget deficit and dwindling foreign reserves. The central bank has spent more than $20bn in foreign reserves to support the pound since a revolution against former President Hosni Mubarak in 2011.
With hard currency reserves running tight, the central bank is now imposing currency controls.

BBC: - The central bank also forbid corporate clients from withdrawing more than $30,000 in cash per day ...
Reuters: - Egypt has banned travellers from carrying more than $10,000 in foreign currency in or out of the country, as officials worry over pressure on its pound currency and a rush by Egyptians to withdraw their savings from banks.

Political turmoil over the past month has raised fears among ordinary citizens and investors that the government - which has pushed back talks to seal IMF funding till January - may not be able to get its fragile finances under control.

The uprising drove away tourists and foreign investors alike, freezing growth, pushing the state budget deficit into double digits as a percentage of national output and worsening its balance of payments.
Egypt has asked the IMF for a $4.8bn loan to keep its government and currency afloat.
BBC: - Egypt will soon resume talks with the International Monetary Fund over a crucial $4.8bn (£3bn) loan to shore up the economy, the prime minister says.

Talks were suspended because of political turmoil over a new constitution.

PM Hisham Kandil was speaking as the Egyptian pound reportedly fell to a record low against the US dollar.

The central bank said the country's foreign reserves have dropped to "critical" levels.
It's not clear at this stage if the IMF will provide the funds needed or whether it will be enough to keep the currency from collapsing. The big concern of course is that weakening currency will exacerbate food inflation (Egypt imports some 40% of its food and nearly two thirds of its wheat consumption), causing further civil unrest.
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Negative rates on deposits would force Eurozone core banks to repay their LTRO funding

There is concern among some Eurozone banks that the ECB may push the deposit rates on excess reserves into negative territory next year. In fact the 12-month EUR OIS rate (the so-called EONIA swap rate), which is the market expectation of where the overnight rates will be next year, briefly dipped below zero recently.

Source: euribor-ebf

If that were to happen, banks would in effect be penalized for holding excess reserves at the ECB. Such action would force those who are able (more likely the core banks) to pay down their borrowings from the ECB (otherwise they are paying 1% for the LTRO funding and then paying again for depositing the cash at the ECB).
JPMorgan: - There has been renewed speculation that the ECB will set a negative rate on its deposit facility. Indeed, the EONIA curve, which tracks the deposit facility, dipped into negative territory for the first time last week. Negative interest rates on deposits are like safe deposit charges – the idea is that they should incentivize banks to lend out money rather than suffer an erosion of capital.
Core banks are more susceptible to negative deposit rates. The first response by core banks would be to repay back most of the extra funds they borrowed via the 3y LTROs, which they can do from January 30th. We previously argued that core banks could repay €100bn of 3y LTRO funds as yield compression makes carry trades less attractive. But an ECB deposit rate cut to -25bp could induce them to pay back perhaps all of the €140bn they borrowed on net via the 3y LTROs.
In preparation for this potential event, banks have been paying down the shorter term LTRO balances (not all LTRO is 3 years). In fact the ECB is showing a gradual but consistent decline in LTRO funding provided to the euro area banks.

LTRO funding by the Eurosystem to MFIs

According to JPMorgan, the effect of a negative deposit rate on excess balances would help the Eurozone periphery by pushing capital out of the core.
JPMorgan: - ... an ECB rate cut to -25bp could accelerate that process [of paying down LTRO]. In trying to avoid negative carry, the resulting search for yield and increase in the velocity of reserves, i.e. passing on the “hot potato”, within the euro area banking system is likely to improve capital flows back to peripheral banks and reduce TARGET2 imbalances, especially now that the ECB has back-stopped the system with OMT. From this perspective, negative deposit rates could be a useful policy tool to induce financial re-integration in the Euro zone and ultimately allow the periphery to reduce its reliance on the ECB.
Of course one of the reasons the Fed hasn't followed this path is a potential disruption to the money markets. Even the recent drop to zero rate on deposits by the ECB has caused havoc for euro denominated money market funds (see discussion). A negative rate would force money market firms to simply kick the existing depositors out, forcing them into periphery government paper or periphery banks - which of course is the idea behind negative rates.
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Saturday, December 29, 2012

Monti to face two key challenges in his bid for re-election

Mario Monti's decision to run in the next Italian election is a positive development for the future of Italy and the stability of the Eurozone. At this stage the last thing the global economy needs is the return to fears of the euro area breakup, particularly if it's driven by Italy. Those who profess that Italy should consider exiting the union simply don't comprehend the impact such an event would have on the global financial system. And Monti has been instrumental in bringing credibility to Italy's commitment to stay in the union.
Bloomberg: - Italian Prime Minister Mario Monti said he will lead a coalition of centrist political parties that support his agenda of fiscal rigor and pro-European policies in February elections, marking a de-facto bid for a second term.

Monti’s announcement, made at an impromptu press conference in Rome yesterday, takes his political role in the upcoming vote a step further after the former European commissioner said Dec. 23 that he would consider leading a group of parties supporting his agenda.

“A new political movement is being formed,” Monti told reporters in Rome. The 69-year-old economist is heading a coalition that includes small parties led by Catholic politician Pier Ferdinando Casini and Luca Cordero di Montezemolo, the Ferrari SpA chairman, who formed a new movement in an attempt to lure Monti into the race.
However Mario Monti will face two key challenges in his attempt to remain Italy's prime minister.

1. Italy's consumer recession is worse than it was in 2008. There is no question that a portion of the voters will blame it on Monti's policies, which were inevitable in order for the Italian government to remain solvent. Italy in effect has undergone its version of the "fiscal cliff".

Source: Markit

2. Berlusconi will continue to undermine Monti's efforts. He will level accusations and spread rumors in order to vilify the current prime minister. His recent approach is to label Monti as a "leftist" (even though Italy's business community generally supports Monti).
Reuters: - Silvio Berlusconi said on Saturday that outgoing Prime Minister Mario Monti was plotting with the left in his centrist alliance's bid to win Italy's national election in February, but centrist leaders denied any secret accord.
Speaking to reporters at Milan Central railway station, Berlusconi said Monti wanted to help the left secure power after the February 24-25 election so he could continue his austerity agenda of tax hikes and spending cuts.

"This grouping has been formed to favor the left - also the harmony with the left's programme they have celebrated heads in this direction," he said, after earlier describing Monti as "the spare wheel" of the PD in an interview with Vista TV.
But it doesn't take much to see what Monti has been able to accomplish during his short tenure. The yields on Italian government paper are now the lowest in over 2 years. Clearly at least some of that should be credited to the ECB, but this would have been an impossible task if Berlusconi was still in power. Italian voters, who (for now) don't have to worry about their deposits and pensions being converted to lira, understand this and are likely to support Monti's bid for re-election.

Italy 10y gov. bond yield (source: Bloomberg)
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Washington forcing investors into the options market

Back in July we discussed the mispricing of equity risk that was visible in the low levels of the VIX (implied volatility) index (see post). Making money by shorting equity options and riding the decay became fashionable after Draghi put in a backstop for the Eurozone periphery and the Fed started taking volatility out of the market (see discussion). But those shorting options got punished today. Demand for short-term equity options spiked, driven by the dysfunction in Washington. VIX (and VIX futures) jumped some 17% in a single day.


WSJ: - Late-day fiscal cliff news out of Washington Friday provoked the biggest one-day percentage gain in the market’s so-called fear since gauge November 2011.

With just three days remaining to reach a budget agreement to advert the year-end tax increases and spending cuts known as the fiscal cliff and no solution in sight, the Chicago Board Options Exchange’s Volatility Index Thursday jumped to the highest level since June.
Investors don't trust Washington to get a resolution any time soon and are willing to pay a high premium to protect themselves. The risk-on trade is on.
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Thursday, December 27, 2012

With all the Fed activity, there has been no QE in 2012

By definition, any policy of "quantitative easing" involves the expansion of bank reserves (by outright purchases of securities) and ultimately the monetary base. Neither has been expanded by the Fed in 2012.

Reserve balances with Federal Reserve Banks: Wednesday level (source: FRB)

Source: St Louis Fed

Clearly, given the latest announcement by the Fed (see discussion), 2013 should see both measures spike sharply. But there has been no "money printing" in 2012.
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The yen lost its status as a "safe haven" currency

As discussed earlier, the yen is no longer acting as a "safe haven" or "risk-off" currency. This is difficult for some in the FX community to accept, but it's the new reality. The recent drop in the US equity market coincided with declines in the yen. In the past the yen would typically move in the opposite direction of the "risk-on" assets such as equities and commodities, but that relationship no longer holds.

S&P500 futures
(the big drop is the Republican rejection of the Boehner proposal)

Yen per one dollar (yen weakening)

Much of this is driven by Japan's fundamentals. The new government will ride the Bank of Japan (BOJ) to make sure it ramps up QE to unprecedented levels. The goal is to "print" so much yen that inflation rises from negative levels (where it is currently - chart to the left) to some fixed positive target such as 2%. Any semblance of independence BOJ had is now gone.
The Telegraph: - Mr Abe has said that he will pick someone who agrees with his views on the need for bolder monetary easing to succeed governor Masaaki Shirakawa when his term expires in April next year. 
"At this month's policy meeting, the BoJ said it would examine (setting an inflation target) at its next meeting" in January, he said on television on Sunday.
The strategy may in fact help Japan's exporters in the long run, as the weaker yen makes their goods cheaper. For now however the fundamentals remain weak and the traditional relationship between global risk assets and the yen no longer holds.
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Wednesday, December 26, 2012

US investors exiting equity mutual funds

2012 was another rough year for equity mutual funds business. In spite of relatively strong stock market performance, retail investors continued to pull their money out. This trend has been in place for quite some time (see discussion), but has accelerated this year. The outflows from US equity mutual funds were roughly $154bn this year.

Source: ISI Group
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Sunday, December 23, 2012

The 2012 winner for the best performing currency against the US dollar

The table below shows the world's top performing currencies against the dollar. Poland, which was somewhat shielded from the Eurozone by its ties with the big neighbor to the east (considerable capital inflows from Russia and elsewhere in Europe) has been the best performer among the mainstream currencies. In fact Poland, together with other EU nations who stayed out of the euro area - such as Sweden, and the UK - have seen their currencies appreciate.

As of 12/21/12 (source: WSJ)

There is one currency however that has outperformed all of these by a long shot, but you won't find it on the list. The currency is called Bitcoin (ticker symbol BTC) and it more than tripled this year.

Dollars per one Bitcoin (source:

It's not issued by a country, nor is it a precious metal or a rare-earth. Bitcoin is an electronic currency that can be exchanged for some goods and services, particularly online. The currency is not controlled by a central bank. Instead it is maintained by a global registrar and managed via a private network of participants who get paid to "rent" their computing power to the network. The "rented" machines are used to maintain the integrity of Bitcoin transactions and act as a virtual decentralized registrar.

The network "node" providers (called miners) of course receive their payment in Bitcoin, with the overall currency amount growing gradually over time (current value of Bitcoins in circulation is about USD 140mm). The gradual growth in the "monetary base" is designed to prevent inflation. This is done via a complex algorithm that requires rapidly increasing computing power by the network providers to get paid the same amount. The number of Bitcoins paid to participants is halved periodically. At some point in the future the amount of Bitcoin will become fixed, with network providers relying fully on transaction fees rather than newly "minted" Bitcoins.

For more background on Bitcoins see this story from Wired Magazine (Wikipedia does a terrible job describing this process). It is a brilliant scheme to create a global currency that is separate from governments and central banks. The network however has had its share of growing pains due to hacker activities (specifically on a major Bitcoin currency exchange - not the network itself) and regulators. But it has survived.

The whole premise of this type of private network is to create anonymity online (see TOR Project). That means it is impossible to trace an online transaction. And therein lies the flaw of the Bitcoin concept: transaction anonymity attracts illicit activity. As an example, a website called Silk Road (you won't find it on the internet, since it lives on this private network) sells all sorts of things (paid only in Bitcoin), including illegal drugs. The site is estimated to have made some $22mm in the first half of 2012 but has received all sorts of scrutiny from law enforcement (for more on the site and the market, see the research paper from Carnegie Mellon).

So why has the currency tripled this year? A number of rumors have been circulating in the online forums trying to explain the rally. Unfortunately one explanation that stands out is the increased demand for illicit drugs online. Quite sad actually. Another explanation is the fact that the number of newly minted Bitcoins has been halved again in November, reducing the available supply.

Nevertheless Bitcoin is the 2012 winner for the best performing currency against the dollar.
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Park Geun-hye wants South Korean companies to get back to the business of making money

South Korean new president-elect, Park Geun-hye, surprised the world by promising - as part of her campaign - to increase the KOSPI (the country's benchmark stock market index) by some 50% over the next five years. Many dismissed this as an unrealistic campaign rhetoric. The South Korean government clearly does not have that much control over the stock market, given the nation's large export sector that is dependent on external factors. But is targeting a strong equity market necessarily a bad government policy - particularly if the government wishes to accomplish this without directly interfering in the market? Many would feel that it is, simply because such a policy would be viewed as benefiting the wealthy. But in order to lift the equity market, one needs to make significant improvements to the overall economy. And taking for example the relationship between the US jobless claims and the S&P500, it is not difficult to see how Park Geun-hye's campaign promise may have resonated with South Korea's citizens - even those who are not shareholders.

Source: Ycharts

So what's wrong with such a pro-business government policy? Clearly it means that South Korea's largest firms (chaebol) will continue business as usual - which is a concern for many (due to semi-monopolistic structure of some of these firms). But if companies "get back to the business of making money", the nation's economy is likely to benefit from better overall business environment.
Reuters: - Victory for Park Geun-hye, the 60-year old daughter of South Korea's former military ruler, in the election means the top chaebol - five of whom control assets worth 57 percent of gross domestic product in the world's 14th largest economy - can get back to the business of making money.
KOSPI may not grow by 50% in the next 5 years. But there is something to be said for promoting policies that improve the nation's business environment, ultimately leading to growth in jobs and incomes. Why not then target the stock market? It is after all a "real time" independent judge of a nation's economic health.
ISI: - It’s quite interesting to see how a pro-business president [a new concept for many] approaches his/her job.
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Saturday, December 22, 2012

AUD remains vulnerable; 75bp in rate cuts expected next year

There are clearly a number of reasons that "non-commercial" short positions on the Australian dollar have been cut (see discussion) by investors. But the Australian dollar remains vulnerable to the downside - particularly now that the net non-commercial CME position is near record highs. Investment-related portfolios are positioned long.

CME non-commercial net (source: CME)

What many fail to realize is that the Australian government is in a belt-tightening mode as it tries to address its budget shortfall (AUD 2.6bn). The fiscal tightening is expected to be a drag on the economy, pushing the RBA (in spite of its hawkish stance) to cut rates in 2013. Goldman is predicting another 75bp worth of cuts next year, taking the overnight rate to record lows.
GS: - With the fiscal contraction now extending into the FY14 year and coinciding with the ongoing income shock and the transition of the mining investment cycle to being a drag on growth, we believe the rationale for further easing remains in place. We continue to expect 75bp of rate cuts in 2013.
That does not bode well for AUD next year, and investors got a taste of the currency's vulnerability on Friday (in the "risk-off" trade).

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Argentina's policies culminate in looting outbreak

As looting broke out across Argentina, political analysts scrambled to find the reason for the outbreak. Is it the unions? The opposition? The sad reality is that these events are simply the culmination of horrific government policies, including the recent theft of foreign property (see discussion). The belligerent approach to foreign relations (see post) for a nation whose growth had depended heavily on exports has backfired.
WSJ: - Thousands of people in several Argentine cities ransacked supermarkets for a second day in the latest challenge to President Cristina Kirchner, who is struggling to revive a weak economy and maintain her control over the ruling Peronist Party.

What started with a raid Thursday afternoon of a supermarket in the Patagonian resort town of Bariloche quickly spread to other parts of the country, with thousands of looters attacking supermarkets and shops in the cities of Rosario, Campana and Zárate. In the central city Rosario, two people were killed during the incidents and 137 people arrested.
Source: Reuters

Kirchner's government single-handedly drove the nation's economy into the ground. Here are just a couple of economic data points from Q3: construction spending and private consumption.

What makes this situation extreme is the out-of-control stagflation. Despite such severe economic weakness, inflation is running at 25% yoy, as the currency weakens further (and the government continues to lie about the actual inflation level - see discussion).

Of course Argentina's government (which now relies on children's vote to stay in power - see discussion) is attempting to deflect the blame for the mess it has created.
WSJ: - Mrs. Kirchner's cabinet chief Juan Manuel Abal Medina accused Mr. Moyano's truckers union and other union bosses of organizing the latest looting this week.

"These are isolated incidents that are clearly organized and structured. In none of them did people seek food. They took televisions and drinks," he said.
It seems Mrs. Kirchner wants to be congratulated for the fact that the nation, rich in natural resources and the world's 5th largest wheat exporter, is not yet in full starvation mode.
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Washington derailing nascent economic recovery

US consumer confidence took a hit in December, as the madness emanating from Washington is taking its toll.
Reuters: - U.S. consumer sentiment slumped in December as Americans were rattled by on-going negotiations to avert the tax hikes and spending cuts set to come into effect in the new year, data showed on Friday.

The Thomson Reuters/University of Michigan's final reading on the overall index on consumer sentiment tumbled to 72.9 from 82.7 in November, worse than forecasts for 74.7.

It also came in under December's preliminary figure of 74.5.

Talks to avoid the so-called fiscal cliff were thrown into disarray on Thursday evening when Republican lawmakers failed to back an effort by House of Representatives Speaker John Boehner that was designed to extract concessions from President Barack Obama.

The latest surveys indicate that this worsening sentiment will translate into declining holiday sales.
Reuters (different article from the one above): - About 17 percent of the 1,514 Americans who participated in a Reuters/Ipsos poll conducted December 17-20 said the impending "fiscal cliff" was making them spend less this season.
This comes at a time when the US economy was just beginning to stabilize and could be poised for a decent 2013. Manufacturing seems to have found a bottom (see discussion), home prices and sales have been improving, and income growth is showing positive signs.

Source: Econoday

CNBC's video below is fairly representative of the blame game going on in Washington at the expense of spending, business investment, and ultimately jobs. It is inexcusable.
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Thursday, December 20, 2012

US consumer developing a taste for ever-falling mortgage rates

US homebuyers have come to expect constantly declining mortgage rates. After all, any recent increases in mortgage rates have been fleeting - just waiting a month or two would generally result in a lower rate. That expectation of cheaper mortgages has resulted in higher sensitivity to rate fluctuations. And now that the 30-year rate has stopped declining (see discussion), some buyers are sitting back and waiting for the rate to go lower.
Reuters: - Applications for home mortgages fell to their lowest level since early November last week and the purchase index fell after a five-week climb, an industry group said on Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, fell 12.3 percent in the week ended December 14.

The MBA's seasonally adjusted index of refinancing applications fell 13.8 percent, while the gauge of loan requests for home purchases, a leading indicator of home sales, fell 4.8 percent, dropping from its high point on the year.
Many had expected that the Fed's latest action will push rates even lower, but that wasn't the case.
Econoday: - Higher mortgage rates in the December 14 week cooled activity at mortgage bankers where purchase applications fell 5.0 percent, a drop that ends five straight weeks of gains. The report notes that rates increased, not decreased, following the Fed's decision last week to buy an additional $45 billion of Treasuries per month. MBA specifically cites the increase in rates, up three basis points in the week for 30-year conforming mortgages to 3.50 percent, for a big 14 percent drop in refinancing applications.
Ironically, the fiscal cliff negotiations is the one factor that could push mortgage rates lower by threatening to derail fragile US economic recovery and lowering treasury yields. But if by some chance Washington reaches a decisive resolution, mortgage rates declines may be over for now.
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Tuesday, December 18, 2012

US corporate credit market looking extraordinarily rich

One of the "side effects" of the Fed's monetary expansion is all the capital flowing into spread products, particularly corporate credit. Corporate bond yields are hitting record lows across the ratings spectrum. An average junk bond in the Merrill HY index now yields some 6.3%.

Merrill HY Index effective yield (source: St. Louis Fed)

Even emerging markets corporate HY bond yields are near all-time lows.

Merrill Emerging Markets Corporate HY Index effective yield (source: St. Louis Fed)

In fact credit looks highly overpriced relative to US equities. And equities are not exactly cheap at this stage, particularly given some 2% GDP growth expectations in the US. Goldman's relative value model now shows corporate credit at the richest levels in at least three decades.

Source: GS
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Demand for commercial real estate loans on the rise

Investors seem to be showing a great deal of interest in US commercial real estate. The Fed's survey of loan officers is showing rising demand for commercial real estate loans, which has recovered dramatically. Some of this increase is driven by renewed activity in the CMBS market, as search for yield has created more opportunities for property loan securitization. According to JPMorgan, interest-only loans (equivalent to "balloon" mortgage) are on the rise and average loan coupon has been declining.

Source: JPMorgan
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Monday, December 17, 2012

30y mortgage rates have stopped declining

As discussed a couple of weeks back (see post), the primary dealers had built up quite a position in MBS (mostly agency paper) - in what started to look like a crowded trade. Some of those positions have been reduced in recent days, causing long-dated agency paper to sell off somewhat (following treasuries lower).

30y 3% coupon FNMA bonds (price) (source:

As a result, the 30y mortgage rates have bottomed - for now.

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Sunday, December 16, 2012

Grexit expectations hit new lows

Citi's call for Greece exiting the EMU in the next 12 to18 months with a 60% probability (see discussion) looks even more out of sync with current expectations. The latest survey from Barclays shows that 70% of investors do not expect any nation to drop the euro next year. This chart shows how responses changed over time.

Source: Barclays Capital

After all, the Eurozone leadership pulled all the stops out in order to prevent EMU's breakup. That included bringing in the full force of the ECB in the name of fixing the "monetary transmission" (see post) in order to provide central bank funding to periphery governments.

The betting markets seem to agree. In fact Intrade odds are 77% that no nation will exit the union next year. With Greek debt nearly converted to "zero coupon perpetual bond" (see discussion), the probability of near term default and/or exit has collapsed.
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What's spooking AUD shorts?

A number of trades who have shorted the Australian dollar due to weakening fundamentals (see post) are capitulating. The net non-commercial positions on the CME reached a new all-time high.

Source: CFTC

And the CFTC data clearly shows that this increase in the net is mostly due to shorts getting out of their positions (rather than from longs adding to positions). What's spooking the shorts? Here are some thoughts:

1. The recent pickup in China's economic activity (see discussion) could cushion weakening Australian economy.

2. Related to that, China's demand for steel has picked up somewhat, as steel and iron ore inventories decline (see discussion). Steel prices in China have firmed up as a result, which in turn lifted iron ore prices. That may provide some support to Australia's mining industry.

Steel Rebar Futures on SHFE

3. The RBA has taken a surprisingly hawkish approach, which reduces the probability of the central bank pushing the overnight rate below 3% (see discussion). In fact the central bank has been critical of its counterparts in the EU, the US, and Japan for excessive monetary expansion (see discussion).

4.  Being short AUD against USD (using an FX forward for example) costs almost 300bp/y of negative carry due to the rate differential between the two currencies. Plus the Fed's actions to dramatically expand the monetary base makes some traders uneasy with being long the USD.

5. Technically AUD is near a resistance level, which if broken, could send AUD higher.

Ironically, this AUD strength is going to keep the Australian economy from significant improvements (and could in fact weaken it further) - at least in the near term. Strong Australian dollar continues to plague Australia's export sector, which competes with nations who have successfully depreciated their currencies on a relative basis (see discussion).
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Saturday, December 15, 2012

Sharp reversal in the ISI Company Survey of China Sales

On page 4 of this publicly available ISI report (here) from September, there is a chart of the ISI company survey of China sales (US companies exporting to or selling in China). The comment says: "Our China Survey was unchanged this week, but is just 4 pts off the 2009 low" - as the index approached its all-time low. It never quite made it. In a remarkable turnaround, the index (according to ISI) has its biggest 3-week increase in 3 years. There is clear evidence of this improvement from companies like Yum Brands, who saw large declines in China sales that are now expected to stabilize (see Barrons post). This provides further support to the thesis that China's economic output growth has bottomed (see discussion).

Source: The ISI Group
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