June 11, 2018
Bond Traders Face $193 Billion Appetizer Before Fed Main Course
Bond traders have their work cut out for them before they get to the pivotal event for U.S. financial markets this week — Wednesday’s announcement from the Federal Reserve. The Treasury is about to pack $193 billion of debt sales into Monday and Tuesday. That potentially puts the onus on Wall Street to absorb the deluge if investors are reluctant to choke it down before the central bank’s decision. There is much at stake this week: In addition to a widely expected hike in borrowing costs, officials will also update their projected rate path for 2018 and beyond. Last week’s emerging-markets turmoil may have made it more likely that bond dealers will be left holding the bag. The 10-year yield flirted with 3 percent at one point before spooked investors piled into the haven of U.S. government debt. It is currently yielding 2.96 percent, making for less appealing auctions at a time when Treasury is ramping up sales to plug growing budget deficits. “I don’t think that it sets up particularly well,” said Thomas Simons, a money-market economist at Jefferies LLC. “There needs to be more concessions in the auctions, or more than the underlying market dynamics are showing.” The Treasury Department will issue a combined $68 billion of 3-, 10- and 30-year securities on Monday and Tuesday, $4 billion more than the equivalent round of sales in April. There’s also an estimated $125 billion pile of Treasury bills that’s about to hit the market. The size of the four-week auction will be announced Monday. Amid all these debt sales, the bond world will get a fresh read on inflation, with a report Tuesday forecast to show consumer prices probably matched the quickest annual pace of increases since 2012.
The Fed’s Fight for Control of Its Key Interest Rate: QuickTake
If a ship crossing a wide and placid harbor yaws so far that it almost hits the channel markers, its captain might want to have its rudder adjusted. That’s what the Federal Reserve is considering as the fed funds rate threatens to slip outside the central bank’s target range. The gap between the rate and the Fed’s upper bound has narrowed to a 7-1/2 year low, setting off alarm bells from Washington to Wall Street. It’s also prompted policy makers to discuss whether shifting tides in short-term markets mean they need to change the way they go about manipulating what is arguably the most important interest rate in the world. In December 2015, the Fed responded to improving economic conditions by raising interest rates that it had cut to near zero during the financial crisis. It set a target range for the fed funds rate of 0.25 percent to 0.5 percent. Since then it’s increased the range five times, to 1.50 percent to 1.75 percent currently, and is on the cusp of doing so again Wednesday. For most of that time, the effective fed funds rate — the average of what borrowers in the market actually paid — rested comfortably near the range’s midpoint, just like it’s supposed to. But since the beginning of the year, fed funds has been creeping higher, now sitting just five basis points below the top of the range at 1.70 percent. It’s the rate at which big banks make overnight loans to each other from the reserves they keep on deposit at the Fed. Because it’s the basis for everything from credit card and auto loan rates to certificate of deposit yields, officials use a range of policy tools to exert control over it and thereby influence the direction of the broader economy.
Investors Prepare for ECB by Underweighting Credit After 6 Years
Money managers have turned underweight on European credit for the first time since September 2011 as they position for the shifting tide of ECB money. A Bank of America Corp. survey this month showed investors had fully unwound long positions, as the so-called Draghi Put eases. On Thursday, European Central Bank policy makers look poised to hold the first formal talks on the end of a bond-buying program that has been mopping up corporate debt for two years. “The relative stimulus for credit drops materially in 2019,” Bank of America strategists including Barnaby Martin wrote in a note. “This year, just under 20 percent of ECB buying firepower is being directed towards credit markets.” Next year, under the reinvestments program, that number drops to just 2.5 percent, Bank of America estimates, a post-crisis watershed for credit markets. The survey of 76 investors, conducted last week in the wake of the Italy crisis, showed exposures to Tier 1 financial bonds have plunged “massively” from net overweight to the biggest underweight in about two years. Market expectations are that bond buying — currently running at 30 billion euros a month — will be phased out by the end of 2018.
These Asian Markets Will Soon Have Lower Rates Than the Fed
With faster growing economies typically generating quicker inflation rates, emerging Asian nations usually have benchmark interest rates above those in the U.S. That’s changing. The Federal Reserve is all but certain to raise its key rate by a quarter point this week, meaning it will then have a benchmark above that of five counterparts in the Asia-Pacific region excluding Japan. The latest to join the group will be New Zealand, whose policy rate will fall below the Fed’s for the first time since 2000. While Indonesia, India and the Philippines — all with key rates much higher than the U.S. — struggle to cope with the Fed’s tightening, investors remain comfortable with a negative differential in some cases. For Thailand and Taiwan, current account surpluses are a key buffer. For New Zealand, South Korea and Australia, real yields remain attractive. Chua Hak Bin, senior economist at Maybank Kim Eng Research Pte in Singapore: “Other countries’ benchmark rates can fall below the Fed funds rate so long as the currency prospects compensate for the interest differential.” He cited the case of Thailand, where investors are willing to accept lower short-term rates relative to the U.S. because of the expected appreciation bias on the back of large current account surpluses.”Countries with large current-account deficits may face currency pressures if their policy rates are perceived to be overly low and accommodative relative to U.S. benchmark rates.” Robert Subbaraman, Singapore-based head of emerging markets economics at Nomura Holdings Inc.: “It is an interesting phenomenon” to be below the Fed’s benchmark, because the natural rate of interest theoretically should be linked to an economy’s growth potential and, for emerging markets, a risk premium for the chance of a boom-bust cycle.