Bond Yields And Barbarians

I know Kung Foo, Karate, Bond Yields and forty-seven other dangerous words.

– The Wizard

For forty-four years I have trafficked in the bond markets. I have seen massive inflation, Treasury yields in the stratosphere and risk asset spreads that could barely be included on a chart. At four investment banks I ran Capital Markets, and was on the Board of Directors of those companies, and I have witnessed both extreme anger and one fist fight. It is funny, you know, how people behave when money is sitting there on the table.

One of the things rarely discussed in the Press are the mandates of money managers. Almost no one is unconstrained and virtually everyone is bound by regulations, the tax laws and FINRA and SEC stipulations. Life insurance companies and casualty companies and money managers and Trust Departments and everyone is sidled with something. There are no escapes from the dilemmas.

The markets are a random lottery of meaningless tragedies, a couple of wins and a series of near escapes. So, I sit here and I smoke my cigars, staring raptly at it all. Paying very close attention.

There are two issues, in my mind, to be considered carefully when assessing future interest rates. The first is supply, especially the forward borrowing by the U.S. government. “It’s supply,” Michael Schumacher, head of rate strategy at Wells Fargo (NYSE:WFC), told CNBC’s Futures Now. “When you think about the enormous amount of debt that U.S. Treasury’s got to issue over not just this year, frankly, but next year, it’s staggering,” he said.

Using Michael’s calculations, the Treasury will issue more than $500 billion in notes and bonds in the second to the fourth quarter, pushing the total to around $650 billion for the year. Last year, the total came to just $420 billion. That is approximately a 35% increase in issuance. This raises a fundamental question, who are going to be the buyers and at what levels?

The second issue centers on the Fed and what they might do. They keep calling for rate hikes, like it is a new central bank mantra, and they are increasing the borrowing costs of the nation, corporations and individuals, as a result. I often wonder, in their continual clamor for independence, just who they represent.

You might think that the ongoing demand for higher yields does not exactly help the Treasury’s or the President’s desire to grow the economy as the Fed moves in the opposite direction and tries to slow it down by raising rates. I have often speculated that there might be some private tap on the shoulder, at some point, but no such “tap” seems to have taken place or, if it has occurred, it is certainly being ignored, at least in public.

Here are some interesting questions to ponder:

How much of our U.S. and global growth is real?

How much of it, RIGHT NOW, is still being manufactured by the Fed’s, and the other central banks’, “Pixie Dust” money?

Does the world seem honestly ready to economically walk on its own two feet?

If you answered “No,” to the last question, how do you believe the financial markets will react when they realize that the Central Banks are trying to take away the safety net for the global economies?

Are you really worried about inflation running away from us?

Do you believe that a flat/inverted yield curve has been an accurate predictor of events to come, historically?

Have you run the numbers, can the world’s sovereign nations even afford 4% rates, as predicted by many?

If you answered “No,” do you believe that these nations will suppress yields for as long as they can to push back the “end game?”

Across the pond Reuters states,

Italy’s two anti-establishment parties agreed the basis for a governing accord on Thursday that would slash taxes, ramp up welfare spending and pose the biggest challenge to the European Union since Britain voted to leave the bloc two years ago.

That is quite a strong statement, in my opinion. There are plenty of reasons to be worried about Italy and the European Union now, in my view.

A draft of the accord, reviewed by Reuters, lays out a plan to cut taxes, increase welfare payments and rescind the recent pension reforms. To me, this seems incompatible with the EU’s rules and regulations. These new policies would cost billions of euros and would certainly raise Italy’s debt to GDP ratio, which already stands at approximately 132%.
Reuters also states,

The plan promised to introduce a 15 percent flat tax rate for businesses and two tax rates of 15 and 20 percent for individuals – a reform long promoted by the League. Economists say this would cost well over 50 billion euros in lost revenues.

Ratings agency DBRS has already warned that this new proposal could threaten Italy’s sovereign credit rating. If you have been to Rome, you probably visited the Coliseum. I make an observation today:

The Barbarians are at the Gates!
– Mark J. Grant

Source: by Mark J. Grant | Seeking Alpha

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2017 Was The Biggest “Money For Nothing” IPO Year Since Pets.com

Over 80% Of 2017 IPO’s Had ‘Negative’ Earnings – Most Since Dot-Com Peak

2017 was a banner year for many things – record low volatility, record high complacency, and record amounts of money printed by the world’s biggest central banks, among many others.

All of which heralded the belief in the super-human, ‘can-do-no-wrong’ venture capitalist… and of course the ‘exit’ cash-out moment.

108 operating companies went public in the U.S. in 2017 with the average first day return a healthy 15.0% – well above the average 12.9% bump seen since the start of the 21st century.

But of most note in years to come, we suspect, is the fact that over 80% of IPOs in 2017 had negative earnings… the most since the peak of the dot-com bubble in 1999/2000…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-19_9-52-14.jpg?itok=Ogatu-xI

Put a slightly different way, 2017 was the biggest “money for nothing” year since Pets.com… consider that the next time you’re told to buy the dip. Remember the only reason “the water is warm” is because it has been ‘chummed’ by the the last greater fool ready for the professional sharks to hand their ‘risk’ to…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-19_10-15-43.jpg?itok=r2KyPi-o

Source: ZeroHedge

It’s Not What You Know But Who You’re Related To In The CA Dept of Tax and Fee Administration

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A California tax department where almost a third of managers are related to another employee is unwinding nepotistic chains of supervision six months after a state audit revealed a problematic concentration of personal relationships among staff.

California Department of Tax and Fee Administration Director Nicolas Maduros reported on Thursday that 141 of his department’s 484 managers has a familial or other close personal relationship to another employee.

A handful of those relationships appear to violate the department’s new anti-nepotism policy. Maduros said the department has corrective action plans for 17 of the managers whose relationships present conflicts for the organization.

“We are still working through this,” he told the State Personnel Board.

His department defines nepotism as “any relationship so personal that other CDTFA employees may reasonably perceive that one of the employees may be motivated to treat the other one more favorably than other employees. That includes, but is not limited to, any familial relationship established by blood, adoption, marriage, or registered domestic partnership.” It also includes roommates.

The State Personnel Board released an audit in November that found more than 800 of the 4,200 employees at the tax department has a familial relationship to someone else at the Board of Equalization.

The report drew attention to several instances in which job applicants appeared to receive a hiring advantage because they were related to someone at the department, and it questioned the hiring of a group of employees in December 2012 just before a law took effect that would have limited their potential retirement income.

Maduros’ presentation was intended to follow up on the audit’s findings.

“You all have stepped up. You have done a great job,” State Personnel Board member Richard Costigan told him.

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The nepotism audit was among the last in a series of critical reports on the Board of Equalization that resulted in the Legislature gutting the tax-collecting agency and creating the new California Department of Tax and Fee Administration.

Maduros released an anti-nepotism policy for the new department while the personnel audit was underway. The new policy forbids tax department employees from intervening to help anyone they know get a job there.

His latest report on nepotism disclosed the number of managers and supervisors who have relatives on staff. The department is addressing those conflicts first, and could later move to address close relationships among rank-and-file workers.

The department also is considering whether a job or promotion candidate has a relative on staff when it makes personnel decisions.

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“It’s going to take us time,” he said.

At least one investigation into the former Board of Equalization might still be underway.

Gov. Jerry Brown last year asked Attorney General Xavier Becerra to investigate the tax agency. Staff members from the Board of Equalization told The Bee that they were interviewed by Department of Justice agents.

Neither Brown nor Becerra has released a report. The Attorney General’s Office last month rejected a Public Records Act request from The Sacramento Bee seeking the document. The denial said the review was not complete.

It also said the document would not be releasable through the Public Records Act when it is complete. It said the documents would be exempt because they are “attorney-client privileged records.” The governor is the client.

Source: by Adam Ashton | The Sacramento Bee

A Liquidity Crisis Of Biblical Proportions Is Upon Us


Authored by John Mauldin via MauldinEconomics.com,

Last week, I mentioned an insightful comment my friend Peter Boockvar—CIO of Bleakley Advisory Group—made at dinner in New York: “We now have credit cycles instead of economic cycles.”

That one sentence provoked numerous phone calls and emails, all seeking elaboration. What did Peter mean by that statement?

In an old-style economic cycle, recessions triggered bear markets. Economic contraction slowed consumer spending, corporate earnings fell, and stock prices dropped. That’s not how it works when the credit cycle is in control.

Lower asset prices aren’t the result of a recession. They cause the recession. That’s because access to credit drives consumer spending and business investment.

Take it away and they decline. Recession follows.

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The Debt/GDP ratio could go higher still, but I think not much more. Whenever it falls, lenders (including bond fund and ETF investors) will want to sell. Then comes the hard part: to whom?

You see, it’s not just borrowers who’ve become accustomed to easy credit. Many lenders assume they can exit at a moment’s notice. One reason for the Great Recession was so many borrowers had sold short-term commercial paper to buy long-term assets.

Things got worse when they couldn’t roll over the debt and some are now doing exactly the same thing again, except in much riskier high-yield debt. We have two related problems here.

  • Corporate debt and especially high-yield debt issuance has exploded since 2009.
  • Tighter regulations discouraged banks from making markets in corporate and HY debt.

Both are problems but the second is worse. Experts tell me that Dodd-Frank requirements have reduced major bank market-making abilities by around 90%. For now, bond market liquidity is fine because hedge funds and other non-bank lenders have filled the gap.

The problem is they are not true market makers. Nothing requires them to hold inventory or buy when you want to sell. That means all the bids can “magically” disappear just when you need them most.

These “shadow banks” are not in the business of protecting your assets. They are worried about their own profits and those of their clients.

Gavekal’s Louis Gave wrote a fascinating article on this last week titled, “The Illusion of Liquidity and Its Consequences.” He pulled the numbers on corporate bond ETFs and compared them to the inventory trading desks were holding—a rough measure of liquidity.

Louis found dealer inventory is not remotely enough to accommodate the selling he expects as higher rates bite more.

We now have a corporate bond market that has roughly doubled in size while the willingness and ability of bond dealers to provide liquidity into a stressed market has fallen by more than -80%. At the same time, this market has a brand-new class of investors, who are likely to expect daily liquidity if and when market behavior turns sour. At the very least, it is clear that this is a very different corporate bond market and history-based financial models will most likely be found wanting.

The “new class” of investors he mentions are corporate bond ETF and mutual fund shareholders. These funds have exploded in size (high yield alone is now around $2 trillion) and their design presumes a market with ample liquidity.

We barely have such a market right now, and we certainly won’t have one after rates jump another 50–100 basis points.

Worse, I don’t have enough exclamation points to describe the disaster when high-yield funds, often purchased by mom-and-pop investors in a reach for yield, all try to sell at once, and the funds sell anything they can at fire-sale prices to meet redemptions.

In a bear market you sell what you can, not what you want to. We will look at what happens to high-yield funds in bear markets in a later letter. The picture is not pretty.

Leverage, Leverage, Leverage

To make matters worse, many of these lenders are far more leveraged this time. They bought their corporate bonds with borrowed money, confident that low interest rates and defaults would keep risks manageable.

In fact, according to S&P Global Market Watch, 77% of corporate bonds that are leveraged are what’s known as “covenant-lite.” That means the borrower doesn’t have to repay by conventional means.

Somehow, lenders thought it was a good idea to buy those bonds. Maybe that made sense in good times. In bad times? It can precipitate a crisis. As the economy enters recession, many companies will lose their ability to service debt, especially now that the Fed is making it more expensive to roll over—as multiple trillions of dollars will need to do in the next few years.

Normally this would be the borrowers’ problem, but covenant-lite lenders took it on themselves.

The macroeconomic effects will spread even more widely. Companies that can’t service their debt have little choice but to shrink. They will do it via layoffs, reducing inventory and investment, or selling assets.

All those reduce growth and, if widespread enough, lead to recession.

Let’s look at this data and troubling chart from Bloomberg:

Companies will need to refinance an estimated $4 trillion of bonds over the next five years, about two-thirds of all their outstanding debt, according to Wells Fargo Securities.

https://www.zerohedge.com/sites/default/files/inline-images/debt_1.png?itok=tDF0bTIX

This has investors concerned because rising rates means it will cost more to pay for unprecedented amounts of borrowing, which could push balance sheets toward a tipping point. And on top of that, many see the economy slowing down at the same time the rollovers are peaking.

“If more of your cash flow is spent into servicing your debt and not trying to grow your company, that could, over time—if enough companies are doing that—lead to economic contraction,” said Zachary Chavis, a portfolio manager at Sage Advisory Services Ltd. in Austin, Texas. “A lot of people are worried that could happen in the next two years.”

The problem is that much of the $2 trillion in bond ETF and mutual funds isn’t owned by long-term investors who hold maturity. When the herd of investors calls up to redeem, there will be no bids for their “bad” bonds.

But they’re required to pay redemptions, so they’ll have to sell their “good” bonds. Remaining investors will be stuck with an increasingly poor-quality portfolio, which will drop even faster.

Wash, rinse, repeat. Those of us with a little gray hair have seen this before, but I think the coming one is potentially biblical in proportion.

Source: ZeroHedge

Seattle Crawls Back To Wells Fargo Because No Other Bank Wants Their Business

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Dakota Access Pipeline protesters chant outside of the Wells Fargo Bank at Westlake Center in January 2017. The city of Seattle has renewed its contract with Wells Fargo, after it could get no other takers for its banking business. (Lindsey Wasson / The Seattle Times)

Seattle split with Wells Fargo a year ago in protest over the bank’s investments in the Dakota Access Pipeline and fraud scandals. But the two are together again after the city could find no other bank to take its business.

The city of Seattle will keep banking with Wells Fargo & Co. after it could get no other takers to handle the city’s business.

The City Council in February 2017 voted 9-0 to pull its account from Wells Fargo, saying the city needs a bank that reflects its values.

Council members cited the bank’s investments in the Dakota Access Pipeline, as well as a roiling customer fraud scandal, as their reasons to sever ties with the bank.

Some council members declared their vote as a move to strike a blow against not only Wells Fargo, but “the billionaire class.”

“Take our government back from the billionaires, back from [President] Trump and from the oil companies,” Council member Kshama Sawant said at the time.

The contract was set to expire Dec. 31, but as finance managers for the city searched for arrangements to handle the city’s banking, it got no takers, said Glen Lee, city finance director. That was even after splitting financial services into different contracts to try to attract a variety of bidders, including smaller banks.

In the end, there were none at all.

It became clear this was our best and only course of action,” Lee said of the city’s decision to stick with Wells Fargo after all.

The first sign that it would be hard to make the council’s wish a reality came soon after the vote when Wells Fargo too-hastily informed the city it could sever its ties immediately with no penalty for breaking the contract. The bank even promised to help the city find a new financial partner.

But it quickly became clear how hard that would be as the city reworked its procurement specifications and searched for months.

Source: By Lynda Mapes | Seattle Times

Highest Mortgage Rates In 8 Years Unleash Bidding Wars, Home Buying Frenzy

Yesterday when looking at the latest MBA Mortgage Application data, we found that, as mortgage rates jumped to the highest level since 2011, mortgage refi applications, not unexpectedly tumbled to the lowest level since the financial crisis, choking off a key revenue item for banks, and resulting in even more pain for the likes of Wells Fargo.

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Today, according to the latest Freddie Mac mortgage rates report, after plateauing in recent weeks, mortgage rates reversed course and reached a new high last seen eight years ago as the 30-year fixed mortgage rate edged up to 4.61% matching the highest level since May 19, 2011.

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But while the highest mortgage rates in 8 years are predictably crushing mortgage refinance activity, they appears to be having the opposite effect on home purchases, where there is a sheer scramble to buy, and sell, houses. As Bloomberg notes, citing brokerage Redfin, the average home across the US that sold last month went into contract after a median of 36 only days on the market – a record speed in data going back to 2010.

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To Sam Khater, chief economist of Freddie Mac, this was a sign of an economy firing on all cylinders: “This is what happens when the economy is strong,” Khater told Bloomberg in a phone interview. “All the higher-rate environment does is it either causes them to try and rush or look at different properties that are more affordable.”

Of course, one can simply counter that what rising rates rally do is make housing – for those who need a mortgage – increasingly more unaffordable, as a result of the higher monthly mortgage payments. Case in point: with this week’s jump, the monthly payment on a $300,000, 30-year loan has climbed to $1,540, up over $100 from $1,424 in the beginning of the year, when the average rate was 3.95%.

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As such, surging rates merely pulls home demand from the future, as potential home buyers hope to lock in “lower” rates today instead of risking tomorrow’s rates. It also means that after today’s surge in activity, a vacuum in transactions will follow, especially if rates stabilize or happen to drop. Think “cash for clunkers”, only in this case it’s houses.

Meanwhile, the short supply of home listings for sale and increased competition is only making their purchases harder to afford: according to Redfin, this spike in demand and subdued supply means that home prices soared 7.6% in April from a year earlier to a median of $302,200, and sellers got a record 98.8% of what they asked on average.

Call it the sellers market.

Furthermore, bidding wars are increasingly breaking out: Minneapolis realtor Mary Sommerfeld said a family she works with offered $33,000 more than the $430,000 list price for a home in St. Paul. The listing agent gave her the bad news: There were nine offers and the family’s was second from the bottom.

For Sommerfeld’s clients, the lack of inventory is a bigger problem than rising mortgage rates. If anything, they want to close quickly before they get priced out of the market — and have to pay more interest.

“I don’t think it’s hurting the buyer demand at all,” she said. “My buyers say they better get busy and buy before the interest rates go up any further.”

Then again, in the grand scheme of things, 4.61% is still low. Kristin Wilson, a loan officer with Envoy Mortgage in Edina, Minnesota, tells customers to keep things in perspective. When she bought a house in the early 1980s, the interest on her adjustable-rate mortgage was 12 percent, she said.

“One woman actually used the phrase: ‘Rates shot up,’” Wilson said. “We’ve been spoiled after a number of years with rates hovering around 4 percent or lower.”

Of course, if the average mortgage rate in the America is ever 12% again, look for a real life recreation of Mad Max the movie in a neighborhood near you…

Source: ZeroHedge

 

Mortgage Refi Applications Plunge To 10 Year Lows As Fed Hikes Rates

On the heels of the 10Y treasury yield breaking out of its recent range to its highest since July 2011, this morning’s mortgage applications data shows directly how Bill Gross may be right that the economy may not be able to handle The Fed’s ongoing actions.

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As Wolf Richter notes, the 10-year yield functions as benchmark for the mortgage market, and when it moves, mortgage rates move. And today’s surge of the 10-year yield meaningfully past 3% had consequences in the mortgage markets, as Mortgage News Daily explained:

Mortgage rates spiked in a big way today, bringing some lenders to the highest levels in nearly 7 years (you’d need to go back to July 2011 to see worse). That heavy-hitting headline is largely due to the fact that rates were already fairly close to 7-year highs, although today did cover quite a bit more distance than other recent “bad days.” 

The “most prevalent rates” for 30-year fixed rate mortgages today were between 4.75% and 4.875%, according to Mortgage News Daily.

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And that is crushing demand for refinancing applications…

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Despite easing standards – a net 9.7% of banks reported loosening lending standards for QM-Jumbo mortgages, respectively, compared to a net 1.6% in January, respectively.  

According to Wolf Richter over at Wolf Street, the good times in real estate are ending…

The big difference between 2010 and now, and between 2008 and now, is that home prices have skyrocketed since then in many markets – by over 50% in some markets, such as Denver, Dallas, or the five-county San Francisco Bay Area, for example, according to the Case-Shiller Home Price Index. In other markets, increases have been in the 25% to 40% range. This worked because mortgage rates zigzagged lower over those years, thus keeping mortgage payments on these higher priced homes within reach for enough people. But that ride is ending.

And as Peter Reagan writes at Birch Group, granted, even if rates go up over 6%, it won’t be close to rates in the 1980’s (when some mortgage rates soared over 12%). But this time, rising rates are being coupled with record-high home prices that, according to the Case-Shiller Home Price Index, show no signs of reversing (see chart below).

case-shiller home price index

So you have fast-rising mortgage rates and soaring home prices. What else is there?

It’s not just home refinancing demand that is collapsing… as we noted yesterday, loan demand is tumbling everywhere, despite easing standards…

https://www.zerohedge.com/sites/default/files/inline-images/C%26I%20loan%20demand_0.jpg?itok=jkH8NimE

But seriously, who didn’t see that coming?

Source: ZeroHedge