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The a.m. Note is a daily 

review of emerging news

and data impacting the 

economy and financial

industry.

Chris Ahrens is the Chief

Market Strategist at First

Empire Securities and is

a member of its Financial

Strategies Group. 

A veteran of the financial
industry, he is an authority
on interest rates and
the economy.

 

cahrens@1empire.com

    Back to a.m. Note

Careful What You Wish For…

 

November 29, 2018 – The markets continue to digest Chairman Powell’s comments while trying to set-up for the aftermath of the Xi-Trump dinner meeting on Saturday at the G-20. Unlike the Powell speech, traders and investors will not be able to respond in real time to the outcome of this get-together. Viewing of Sunday night football might have some competition from the opening of markets in Asia.

 

Yesterday’s rally in stocks was impressive, but from a technical perspective, there are still hurdles to be overcome. The 62 point rally put the S&P at its exact 61.8% retracement level of 2745. Above that level, the next challenge for the market will be the 200 day moving average, currently at 2762. The 55 day moving average (2782) is descending and looks set to intersect the 200 day around the 2762 level. Price action in stocks still looks corrective and likely responsive to algorithmic models.

 

If the Fed does choose to slow its projected pace of hikes (a plausible decision from this vantage point), equity investors will have to acknowledge that the central bank is doing so in response to a change in the data. Such a transition would reflect a deceleration in growth prospects or a lessening in inflation pressures. The level of uncertainty would rise around earnings forecasts and the appetite for committing capital to risk assets might diminish.

 

Today’s economic data is worth focus, as the Core PCE Deflator was revised from 2.0% YoY to 1.9% in September and printed at 1.8% for October. Also, Initial Jobless Claims have crept higher in recent weeks. The 4 week average rose by about 5k to 223.5k, up from a secular low of 206k in mid-September. Continuing Claims have also risen in recent weeks to stand at 1710k, up from 1631k a month ago. The labor market remains very solid, but the shift in these measures is worth keeping an eye on. Personal Spending rose 0.6% (0.4%e) and Personal Income climbed by 0.5% (0.4%e).

 

Treasury yield rallied overnight on solid foreign buying. Chairman Powell’s comments were the primary catalyst, but it’s not unlikely that weakness in oil and other commodities should also be attracting some focus.

 

UST 2 year notes are 2.797%, 10 year yields are 3.022%, and the 2Y10Y curve is flatter at 22.5 bps.

 

 

Brownian Motion

 

November 28, 2018 – There’s been a dearth of news over the past 24 hours, leaving the market to its own devices.

 

Equity markets have firmed a modest amount, soothed by comments out of the White House suggesting that Presidents Trump and Xi will reach some sort of amicable accommodation that will allow for a constructive negotiation on trade.

 

Fixed income prices have been remarkably stable. Today’s speech by Fed Chairman Powell to the Economic Club of New York (12 p.m. ET) may provide a catalyst for price action.

 

Along the yield curve, some interesting movements have been taking place. Since election day, 3-month bills are flatter by 20 basis points versus the 2-year note, 2-year notes to 10-year notes are flatter by 5 basis points, and the 10-year to 30-year spread is steeper by 6 basis points. It’s possible that the front end has focused on the expected movement in monetary policy, while the longer tenors are responding to the recent deterioration in financial conditions. 

 

Treasury will auction $17 billion of 2-year floating rate notes at 11:30 a.m. ET today, followed by $31 billion of 7-year notes at 1 p.m.

 

UST 2-year notes are 2.833%, 10-year yields are 3.061%, and the 2Y10Y curve is flatter at 22.8 bps.

 

 

Managing Expectations

November 27, 2018 – President Trump, doing what he loves to do, elevated the uncertainty surrounding the outcome of his meeting with President Xi, lowered expectations for a positive outcome, and kept the market’s focus on him in a Wall Street Journal interview late yesterday. The President indicated that he expects to raise tariffs on $200 billion of Chinese goods to 25%, saying it was “highly unlikely” that he would accede to China’s request to hold off on these duties. 

Investors hunkered down on this news, while they also await Fed Chairman Jerome Powell’s speech tomorrow to the Economic Club of New York. 

 

While clarity on how the tariff negotiations are going to evolve is critical, market participants must also handicap contemporaneous signs of a potential slowing in different parts of the U.S. economy. The deceleration in autos and housing is almost a well-worn story at this point, with yesterday’s news from GM just another confirmation of the need to embrace structural change in the face of sluggish growth. 

There are other areas that are also raising concerns, such as a story today on Bloomberg flagging a slowing in business investment and more stories out of the middle and upper Midwest regarding problems in the agricultural sector. Highly leveraged corporate balance sheets, also a well-documented condition, may also pose a bigger downside risk than appreciated, if the economy turns in a less than stellar performance. Stronger growth, however, could prompt higher rates, which would then pose a different problem for CFOs.

Equities are trading lower against this backdrop, while fixed income prices are slightly weaker. Price action already displays a lack of urgency, a condition that will only be exacerbated by calendar exigencies in the weeks ahead.
  
UST 2 year notes are 2.835%, 10 year yields are 3.068%, and the 2Y10Y curve is flatter at 23.3 bps.

 

Christmas Arrives Early!

November 26, 2018 – U.S. investors returning from a long holiday weekend, sated from feast and family, are being met with a bevy of bullish headlines. Risk markets, after a rough week, are attempting to make a push to the upside in response to ostensibly positive news.

 

In Europe, word that the U.K. and the E.U. have formally agreed on a Brexit deal was met with some relief. Prime Minister May now has the chore of gaining Parliamentary approval for an agreement that has met with lukewarm sentiment. Having gotten this far, however, she has  proven that underestimating her tenacity has been the wrong choice. The Italian government, having agreed to give consideration to modifying their budget proposal to bring it marginally more in line with E.U. strictures, provided additional reason for optimism. 

 

Analysts want to take a bullish view on a couple of other important events this week. Fed Chairman Jerome Powell is due to speak (11/28) in front of the Economic Club of New York and the hope is that he will present a less hawkish view on the pathway forward for rates. At week’s end, the G-20 will gather in Buenos Aires to discuss the future of work, infrastructure, and sustainable food production. All these topics will be overshadowed by the expected meeting between Presidents Trump and Xi, where some constructive movement on the trade issue is expected be announced.

 

U.S. economic news this week will include house price data from S&P CoreLogic (Tuesday), revisions to U.S. Q3 GDP and New Home Sales (Wednesday), and Personal Income and Consumption figures for October (Thursday). 

Treasury will swamp the market with supply in the next few days, offering about $286 billion of securities, comprised of approximately $161 billion in bills and $125 billion of notes and floating rate notes. 

Primary Dealer positions stand at a record high $183.8 billion as of 11/14/18. This should make for an interesting December, as firms look to manage their balance sheets over the year end marking period. 

UST 2 year notes are 2.834%, 10 year yields are 3.068%, and the 2Y10Y curve is flatter at 23.4 bps.

 

 

Time for a Respite?

 

November 21, 2018 – With the U.S. Thanksgiving holiday almost upon us, selling pressures seem to have abated for the time being. Equity price volatility may abate for a few days, but next week the market will have plenty of news to digest. The E.U. and the U.K. have yet to finalize a deal that Prime Minister May can present to Parliament, Presidents Trump and Xi will meet at the G-20 and discuss trade, and Fed Chairman Powell may provide some insights in a speech to the Economic Club of New York. 

Today, the market is waiting for the E.U. to announce what measures it will take against Italy for violation of the Fiscal Compact. Italian bank stocks and sovereign debt markets are offered lower as investors await the outcome. 

In Bloomberg story this a.m., Apple’s main iPhone assembler announced a plan to make major cost cuts in response to slowing production. The slowing demand for iPhones could be due to a number of factors, including cost, competitive alternatives, and trade frictions. It also highlights the geographic dispersion of the supply chain and China’s reliance on manufacturing and exports to generate growth. 

One of the most interesting features of the recent retreat in equity prices has been the lack of response in the U.S. Treasury market. This may reflect the fact that share valuations had gotten well ahead of what was considered reasonable and that Treasury yields have embraced the reality of rate hikes and the inevitability of increased supply. The breakdown in the inverse correlation has undoubtedly forced risk parity investors to reduce exposures and reevaluate processes. The lack of responsiveness also leaves the thought out there that the equity market hasn’t set a bottom until bond investors acknowledge that real pain has been inflicted. 

UST 2-year notes are 2.808%, 10-year yields are 3.065%, and the 2Y10Y curve is 25.7 bps.

 

Have a Happy Thanksgiving!

 

De-FAANGed

 

November 20, 2018 – Investors and speculators continue to de-risk portfolios. Tech stocks, which had been at the vanguard of the upward movement in share prices, are now the focal point of liquidation. As of yesterday’s close, despite all the negativity and red chyrons on the TV monitors, all three of the main U.S. market indices (Dow Jones, S&P 500, and Nasdaq) were still up – albeit by a thin margin – for the year. That’s not the case with the vast majority of global bourses, many of which are sporting solid double digit declines for 2018.

 

In the U.S. fixed income markets, investment grade and high-yield debt is widening, with the latter leading the way down in price. MBS spreads are also giving ground modestly. Treasury yields are incrementally lower, but for now the flow of capital could best be described as a retreat from risk rather than a flight to quality.

 

This price action should not pose a surprise to seasoned observers, as this is exactly what happens as the Fed removes accommodation. Ultimately, the amount of liquidity in the system contracts to the point where frictions arise, and excesses, which had been lubricated by cheap money, start to face challenges catalyzed by associating a real economic cost to their financing schemes.

 

Financial assets, however, are not the economy at large. It’s now up to the Fed to see if it can operate with the finesse required to keep real activity moving forward, while reigning in the excesses that have proliferated around the edges of the system.

 

As noted, Treasury yields have moved modestly lower. The October 2-year note—the first 2-year issue to trade above its issue price in many months (100-05)—is 2.787%. The 10-year has broken through the bottom of a multi-week range and yields 3.041%. The 2Y10Y spread is 25.4 bps.

 


Meteorological Goulash

 

November 16, 2018 – A weatherman’s description of yesterday’s precipitation event in the Northeast as being “meteorological goulash” could equally be applied to the squalls hitting a variety of financial and real assets over the past few days.

 

Investors and speculators have been buffeted by bad news and uncertainty in a litany of specific names. Some of the issues are idiosyncratic, while some are secular. Without getting specific, the point is that certain companies are victims of their own bad business decisions, while others are getting hit by macro forces beyond their control, such as higher funding costs, supply line disruptions, over-indebtedness, or prospects of slower global growth.

 

Taking a broader view, some of the excesses that are beginning to manifest themselves as fault lines are late cycle phenomena exacerbated by the ongoing removal of policy accommodation. When the tide is coming in, all boats rise, but when the ebb starts to gather force, there’s less depth to navigate around the rocks.

 

Market-based signals such as a flat yield curve, stronger dollar, lower commodity prices, and narrowing inflation break-evens could also be interpreted as signaling that monetary policy action is generating friction.

 

Equity markets are lower as the session gets underway. Administration sources threw cold water on the notion that trade negotiations with China have generated anything of substance. Some weak earnings after the close are also weighing on shares.

 

Treasury yields are lower than the close, but still within the context of yesterday’s range. 2-year notes are 2.829%, 10-year notes are 3.084%, and the 2Y10Y curve is 25.5 bps.

Accumulating Factors

 

“But he’s a human being, and a terrible thing is happening to him. So attention must be paid.”

~ Death of a Salesman, Arthur Miller

 

November 15, 2018 – Are terrible things happening in the markets? No, not terrible. For those of us who have spent time in and around the markets over many years, the current environment is relatively benign. The economy is solid, equities are experiencing a bit of volatility after many years of stellar gains, yields are still very low, and inflation remains well contained.

 

Nevertheless, there are signs of instability percolating and the lid is starting to rattle a bit.

 

The market’s rapid re-appraisal of GE’s status as a bellwether, appropriate given management missteps and miscommunications, smells a lot like the nonsense put forth by several financial institutions (no longer with us) in the days leading up to the financial crisis. 

 

Movements in some of the commodity prices also seem more likely attributable to financial imbalances (bad positions) rather than a sudden realization that a lot of oil is coming out of the Permian Basin. Winter weather usually means colder temperatures, which drives demand for natural gas.

 

Mortgage spreads started widening on October 1st and have continued to do so—more or less in a straight-line—since then. News Flash: The Fed is running off its balance sheet. Is this the sole cause of the widening? Doubtful. And volatility has not moved meaningfully higher either—certainly not to the degree that would explain the widening.

 

On another topic, the yield curve, the response to two questions in the Fed’s October Senior Loan Officer Opinion Survey are well worth noting. “Banks were first asked how their lending policies have changed in response to the flattening of the yield curve since the beginning of this year. Banks generally indicated that the change in the slope of the yield curve so far this year had not affected their standards or price terms across the major loan categories. In contrast, when asked to assess their potential response to a prolonged hypothetical moderate inversion of the yield curve, banks responded that they would tighten standards or price terms across every major loan category if the yield curve were to invert, a scenario that they interpreted as a signal of a deterioration in economic conditions.” (emphasis added, “Senior Loan Officer Opinion Survey”, October 2018, Federal Reserve Board).

 

So, the next time the question comes up as to why recessions follow curve inversions, one plausible answer would be, “Because the banking system slams on the breaks.”

 

Treasury yields are lower in sympathy with other global markets. Disarray surrounding the Brexit proposal is the primary cause.  2-year notes are 2.837%, 10-year notes are 3.094%, and the 2Y10Y curve is 25.7 bps.

Where the Rubber Meets the Road

 

November 14, 2018 – Equity angst, Beltway brawling, global glum, trade tantrums… As the U.S. consumer heads into the holiday season with confidence high, a strong job market, wages on the rise, and gasoline prices dropping towards $2.25/gallon, will any of this matter? Where the rubber meets the road, the economy looks pretty good, and the set-up for a strong holiday selling season is as favorable as it has been in many years.

 

On the geopolitical front, most of the issues confronting investors are fairly stagnant. Global growth appears to be decelerating, with Germany and Japan reporting negative GDP prints for their most recent quarters. Chinese growth is also slowing. Italy has refused to modify its budget proposal and remains a recalcitrant counterparty to the E.U. In a piece of potentially positive news, negotiators for the United Kingdom and the E.U. have reached a draft agreement on what Brexit will look like. For Prime Minister May, it is now her task to convince a wary party and Parliament that she has struck the best deal possible.

 

U.S. equities remain in a corrective mode. Bulls are facing an eroding technical set up, as momentum indicators are rolling over and price action is giving investors pause. The rout in oil prices has damaged the energy sector and technology shares continue to face selling pressure.

 

Treasury yields have risen slightly, perhaps due to the small bounce in stock futures.  2-year notes are 2.904%, 10-year notes are 3.154%, and the 2Y10Y curve is 25.0 bps.

Bonds Aren’t Impressed

 

November 13, 2018 – It seems a bit odd to come in after a three-day weekend with the Dow down by 600 points (-2.3%) and the Treasury market holding a very modest bid. Stocks must feel scorned by the bond market’s casual attitude, and one wonders whether equities will continue to probe for lower prices in a vain attempt to show bonds that what is driving their move lower has implications for fixed income investors also.

 

The question, of course, is what are the predominant drivers of equity prices and whether this is just a volatile correction or the beginning of a bear market. Are lower prices just the result of over-extended valuations, or are they a re-discounting of forward earnings at a lower rate due to changing perceptions of the pathway of global growth?

 

The storylines as this week gets underway remain the same: tariffs, Italian budget negotiations, Brexit negotiations, slowing Chinese growth, and a re-assertion of checks and balances inside the Beltway. The resolution of any one of these matters removes a potential negative, but doesn’t add an accelerant. In general, solutions return conditions to a previous state of existence, rather than creating a positive paradigm shift. The balance of risks, therefore, seems to be tilted to the downside.

 

This week’s economic data is light, with CPI data (0.3/0.2 e) due out tomorrow and Retail Sales (0.5/0.4 e) on Thursday (forecasts are Bloomberg consensus.).

 

Treasury supply is limited to bills, with approximately $150 billion on offer today.

 

Treasury yields are a bit lower as trading gets underway. 2-year notes are 2.899%, 10-year notes are 3.16%, and the 2Y10Y curve is 26.1 bps.

Student Body Left…

 

November 9, 2018 – Markets are returning to a defensive crouch, with concerns rising about the potential for further deceleration in Chinese growth, rising acrimony in the Washington body politic, and a growing sense that the U.S. economic growth could keep the Fed on a more aggressive trajectory than the market is currently discounting.

 

Global equities are on their back foot going into the weekend, and bonds are trading lower in yields. The U.S. markets are set to open in a similar posture.

 

Bloomberg radio had an interesting clip this morning, drawn from a conference given in Boston yesterday. In remarks to the audience, Bank of America Chairman Brian Moynihan observed that the bank processes approximately $3 trillion of customer transactions in a given year. (U.S. GDP is approximately $20 trillion). He therefore believes that their business captures a fairly representative slice of the consumer sector of the economy. In October, consumer transaction volume was up about 9.0% YoY. In October 2017, it was up roughly 6.0% YoY, and in October 2016, the figure was around 3.0% YoY. From his perch atop the Bank of America Center in Charlotte, the U.S. consumer looks pretty healthy.

 

Across the landscape of financial and real assets, the energy sector stands out as the underperformer. The market is in a bit of disarray, as sanctions on Iran are put into place, U.S. production continues to surge (11.6 million bpd), and demand may be softening across emerging markets and China. In 2015, this was a key area of stress for high yield and equities. While companies and markets have restructured and realigned in recent years, attention must be paid because the possibility for dislocations to arise is possible.

 

2-year note yields are 2.957%, 10-year notes are 3.226%, and the 2Y10Y curve is 26.9 bps. The FHLMC Commitment Rate for 30-year fixed rate MBS rose 11 bps in the latest week to 4.94%.

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