Morning Report: German bonds set a record streak of negative yields

Vital Statistics:

 

Last Change
S&P futures 3023 1.5
Oil (WTI) 56.79 0.84
10 year government bond yield 2.07%
30 year fixed rate mortgage 4.04%

 

Stocks are flat as we await earnings from market heavyweights like Amazon and Alphabet. Facebook’s numbers beat the street, while Tesla disappointed. Bonds and MBS are down small.

 

New home sales came in weaker than expected, but at least exhibited positive growth. In June, we saw new home sales of 646,000, which was up 7% MOM and 5% YOY. New home inventory 338k units, which represents a 6.3 month supply.

 

Durable Goods orders rose 2% in June, according to Census. Ex-transportation, they rose 1.2%, and ex-transportation and defense they rose 3.1%. Non-defense capital goods orders (ex-aircraft) rose 1.9%, which shows that businesses are expanding capacity.

 

In other economic news, initial jobless claims fell 13k to 206,000.

 

The ECB opened the door to future stimulus this morning, saying they saw rates lower over the next 12 months. The German Bund is slightly stronger, however we are still close to record low yields at negative 37 basis points. The Bund set a record for the longest streak of days in negative territory – now 79. This eclipses the record set in 2016. What exactly does “negative yield” mean? It means the German 0s of ’29 is trading at 103.66. It is a zero coupon bond, meaning it pays no periodic interest. You pay 103.66 and on August 15, 2029, you will get back 100.

 

german bund yield

 

To get an idea of how much things have changed in Europe, remember the PIIGS? The PIIGS were an acronym for Portugal, Italy, Ireland, Greece, and Spain – all high-yielding sovereign debt that had fiscal issues. Where are they now? All yielding less than the US 10 year, with Greece at 1.95%, Portugal at 38 basis points, Ireland at 11 basis points, Italy at 1.48% and Spain at 33 basis points. Don’t forget, a huge swath of the European corporate sector trades with negative yields.

 

Most (if not all) of these countries have debt-to-GDP ratios well over 1, so we are seeing a real-time test of the hypothesis that government debt levels don’t matter. The granddaddy of debt to GDP ratios is Japan, sitting at 2.4x and its 10 year bond yields negative 15 basis points. Who knows how all this ends up, but we have a global sovereign debt bubble of epic proportions.

 

Bill Gross used to call the US the “cleanest dirty shirt” in the world. Indeed. For all the handwringing over debt to GDP ratios, the US debt to GDP ratio sits at just over 1, and a good chunk of that is owned by the Fed. Essentially, the low yields overseas cannot help but act as an anchor for US yields, which means unless the bubble overseas pops, I can’t see an impetus to push rates dramatically higher. And the first rule of bubbles is that they go on longer and go further than anyone expects.

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Morning Report: Negative yielding corporate debt.

Vital Statistics:

 

Last Change
S&P futures 3020 5.35
Oil (WTI) 60.39 0.19
10 year government bond yield 2.11%
30 year fixed rate mortgage 4.13%

 

Stocks are higher as we kick off earnings season. Bonds and MBS are up.

 

The upcoming week will be dominated by bank earnings. The economic data is unlikely to be market-moving, however we will get some real-estate related data with housing starts and homebuilder sentiment. We will also get retail sales, industrial production and capacity utilization.

 

Citigroup reported earnings this morning that beat Street estimates. Mortgage banking revenues were down 2% QOQ and down 9% YOY.

 

Manufacturing activity in New York State rebounded last month, climbing out of negative territory. New Orders were flat, shipments improved, while employment hit the lowest level in 3 years.

 

Europe is used to negative yields on sovereign debt, with the German Bund yielding -29 basis points. In other words, you are paying 105.25 to get back 100 in 10 years, along with some interest. That is strange enough, in of itself, but how about this? Corporate bonds trading with negative yields. Don’t believe it? US jar maker Ball Corp, maker of the mason jar, trades at a yield of -20 basis points and matures in 18 months. Why would any investor buy that? Because the principal hit will be less than deposit rates of -40 basis points or 18 month German paper yielding -70 basis points. It is a fascinating study of the law of unintended consequences. The whole point of negative interest rates is to push investors to get out of safe haven sovereign debt and take some risk – specifically lending money to businesses that need it. The whole point of this exercise is to increase the amount of credit in the system in order to fuel economic growth. However, instead of providing financing to nascent businesses who could be the growth drivers of tomorrow, they are lending money to a company that makes jars (hardly emerging technology) instead.

 

A portfolio manager at Janus Capital explained it as follows: “A bond like Ball Corp’s is “a safe place to hang out,” [Janus Capital Portfolio Manager Tim] Winstone said. “And just because something is negative yielding, that doesn’t mean it can’t get more negative yielding.” In other words, we are in greater fool territory. Fun fact: around 2% of the European junk bond market trades at negative yields. In fact, Winstone says that about 24% of the European investment grade market trades at negative yields. It isn’t entirely irrational – money managers are making a bet on further central bank stimulus and are positioning themselves to reap capital gains on negative yielding paper, which means they could end up making a positive return despite a negative yield headwind.

 

euro corporates

 

John Maynard Keynes once advocated inflation as the “euthanasia of the rentier class.” In reality it may turn out that negative interest rates will do the job. Fascinating times we live in.

Morning Report: Powell discusses homebuilding

Vital Statistics:

 

Last Change
S&P futures 3009 6.5
Oil (WTI) 60.31 0.26
10 year government bond yield 2.14%
30 year fixed rate mortgage 4.11%

 

Stocks are higher this morning on no real news. Bonds and MBS are down.

 

Two Fed governors (Bostic and Barkin) pushed back on the need to cut rates to maintain the expansion yesterday. That might have explained the increase in the 10 year yesterday afternoon.

 

Inflation at the wholesale level rose 0.1% month over month and 2.3% YOY, according to the Producer Price Index. Ex-food and energy, it was flat MOM and up 2.1% YOY. Inflation remains comfortably stuck in a range around 2%.

 

Jerome Powell mentioned homebuilding in his Humphrey-Hawkins testimony yesterday. He blamed tariffs and labor shortages for the lack of building. That said, the underbuilding phenomenon didn’t just start in the last couple of years – housing starts have been at recessionary levels since 2008, and we have had an acute shortage of housing for at least 7 years. Something else is going on, although immigration restrictions and tariffs certainly don’t help matters. But that isn’t the explanation. When you look at new home sales divided by population, you can see just how much we have underbuilt:

 

new home sales divided by population

 

The CFPB has been upping its spending on consumer financial education. Democrats are complaining that it shifts the burden of consumer protection from the financial industry to consumers. That said, the enforcement budget has increased.

 

Jim Grant argues in the WSJ for a return to the gold standard.

Morning Report: Powell soothes US stock indices

Vital Statistics:

 

Last Change
S&P futures 3002 6.5
Oil (WTI) 60.62 0.26
10 year government bond yield 2.08%
30 year fixed rate mortgage 4.08%

 

Stocks are higher this morning after Jerome Powell hinted strongly that the Fed would cut rates at the July meeting. The S&P 500 is at record levels and is flirting with the 3000 level. Bonds and MBS are down small.

 

Oil prices are rallying as tensions rise in the Strait of Hormuz. Iranian considers the Strait to be its territorial waters, and has been hassling warships going through the area for decades. The latest incident involves a British oil tanker. Persian Gulf tensions largely impact North Sea Brent prices more than West Texas Prices (which most of the US uses).

 

If the Fed is cutting rates, why aren’t yields going lower? Bond yields are higher across the board globally, with the German Bund yielding -26 basis points on hints that the ECB could launch further stimulus plans. The Bund yielded -38 bp last week, so perhaps US bond yields are simply following what international bonds are doing. Don’t forget, the last time the Fed Funds rate was in the 150 – 175 basis point range (May of 2018) the 10 year was about 2.9%. So, the Fed could cut rates 75 bp by the end of the year and we could see yields go nowhere. Look at the chart below, which plots the 10 year bond yield versus the Fed Funds rate:

 

10 year vs Fed Funds rate

 

Initial Jobless Claims came in at 209k last week, which was a touch below expectations. Regardless, the last time we were at similar levels was during the Vietnam War when we had a military draft.

 

Consumer prices rose 0.1% in June, according to the Consumer Price Index. The core CPI, which excludes food and energy rose 0.3%. On a YOY basis, the headline number rose 1.6% and the core index rose 2.1%. That said, the Fed prefers to use the PCE index, which shows inflation to be lower. The CPI overweights housing compared to the PCE, which is why it shows higher levels.

 

Jerome Powell’s Humphrey-Hawkins testimony dominated the headlines, but the FOMC minutes also confirmed his outlook.

Participants judged that uncertainties and downside risks surrounding the economic outlook had increased significantly over recent weeks. While they continued to view
a sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes, many participants attached significant odds to scenarios with less favorable outcomes. Moreover, nearly all participants in their submissions to the Summary of Economic Projections (SEP), had revised down their assessment of the appropriate path of the federal funds rate over the projection period that would be consistent with their modal economic outlook.

 

Separately, Larry Kudlow emphasized that Trump has no plans to fire Powell. The Fed’s independence from politics makes it highly unlikely he could do so in the first place, however Jimmy Carter did do it to G William Miller, kicking him upstairs to Treasury and hiring Paul Volcker to run the Fed.

 

The first hurricane of the 2019 Atlantic season looks like it will hit Louisiana.

Morning Report: Small business optimism slips

Vital Statistics:

 

Last Change
S&P futures 2968 -10
Oil (WTI) 57.95 0.25
10 year government bond yield 2.06%
30 year fixed rate mortgage 4.03%

 

Stocks are lower this morning as we await a speech from Jerome Powell. Bonds and MBS are down.

 

Jerome Powell speaks at 8:45 this morning at the Boston Fed regarding stress-testing for the banks. Here are his prepared remarks. He doesn’t address monetary policy.

 

There were 7.3 million job openings in May, down slightly from April. The quits rate, which tends to lead increases in wages, was steady at 2.3%, where it has been all year. Private sector openings were flat, while government fell by about 40,000.

 

Small Business Optimism slipped in June, according to the NFIB. This reversed May’s jump, however sentiment is still at historically high levels. Expectations eased for sales and profitability, and the outlook for capital expenditures weakened. The capital expenditure level was the lowest since May 2015. Employment also decreased, however most firms are still in hiring mode, with the availability of qualified labor the biggest issue.

 

NFIB

 

The Congressional Budget Office analyzed the probable effects of raising the Federal Minimum Wage to $15 an hour. Unsurprisingly, they concluded that it would cost jobs, with the median estimate coming in at 1.3 million. The graph below looks at how the constant dollar minimum wage has behaved relative to the bottom 10th and 25th percentile of workers over time.

 

minimum wage

 

Mortgage delinquencies are the lowest in 20 years, according to CoreLogic. 30 day DQs fell 0.7% to 3.6%, while the foreclosure rate slipped 0.1% to 0.4%. Delinquencies fell pretty much across the board, with the exception of areas that were affected by natural disasters.

Morning Report: Strong jobs report knocks stocks

Vital Statistics:

 

Last Change
S&P futures 2982.25 -8.4
Oil (WTI) 57.45 0.2
10 year government bond yield 2.02%
30 year fixed rate mortgage 4.00%

 

Stocks are lower this morning after Friday’s strong jobs report stoked fears the Fed might not cut rates as much as the market expects. Bonds and MBS are up.

 

Jobs report data dump:

 

  • Payrolls up 224,000
  • Unemployment rate 3.7%
  • Labor force participation rate 62.9%
  • Employment-population rate 60.6%
  • Average hourly earnings up 3.1%

 

Overall, a strong report which should in theory argue against easing rates at the upcoming July meeting. That said, the deceleration in the labor market is being taken as a sign that the Fed needs to act, especially since inflation remains stubbornly below the Fed’s 2% target. The July Fed funds futures are pricing in a 100% chance for a cut, with a 92% chance for 25 basis points, and an 8% chance of 50 basis points.

 

We don’t have much in the way of economic data this week, however we do have Jerome Powell’s Humphrey-Hawkins testimony on Wednesday and Thursday. Humphrey-Hawkins testimony is usually more about posturing politicians than it is about useful insights, but with the markets on edge about a potential rate cut, we could see some volatility. Expect a lot of questions about Fed independence.

 

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Deutsche Bank is retreating back to Europe, as it cuts 18,000 jobs and exits a lot of overseas businesses. DB has been underperforming for years, and it looks like its decades-old attempt to become a player on Wall Street and in London are over. It would be cool to see them spin off Bankers Trust, Alex Brown and Sons and Morgan Grenfell, but it doesn’t look like that will happen.

Morning Report: Two new Fed nominees, weak payroll growth

Vital Statistics:

 

Last Change
S&P futures 2986.25 6.4
Oil (WTI) 56.75 0.9
10 year government bond yield 1.96%
30 year fixed rate mortgage 4.06%

 

Stocks are higher this morning as we are approaching detente in the US-China trade spat. Bonds and MBS are higher.

 

Bonds are rallying globally, with the German Bund yield hitting a record low of -39 basis points. Ex-IMF Chair Christine Lagarde is in the running to replace Mario Draghi as the head of the ECB. She is considered to be more of a politician, so the markets are interpreting her nomination to be bond-bullish. US rates will be influenced by overseas bond markets, so that means lower rates here at least at the margin.

 

Christopher Waller and Judy Shelton are the latest Trump picks to join the Federal Reserve Board. Judy Shelton has been vocal in criticizing the Fed’s practice of paying interest on excess reserves, and has questioned the effectiveness of the current regime of floating exchange rates versus the gold standard and the gold exchange standards of yesteryear. While there is a 0% chance we go back to some sort of hard-asset backed currency, between the serial bubbles of the past 40 years and the hyper-inflation of the 1970s, the economic record of post-Bretton Woods era (basically from when Nixon closed the gold window) has been mixed.

 

Construction spending fell 0.8% MOM and 2.3% YOY in May. Residential construction continues to be an issue, falling 0.6% MOM and 11.2% YOY.

 

Manufacturing expanded in June, according to the ISM Manufacturing report. That said, it decelerated compared to May. Tariffs remain the largest concern. New Orders were flat, while employment and production increased.

 

Mortgage Applications were more or less flat last week, as purchases increased 1% and refis fell 1%. Mortgage rates were unchanged-to-slightly lower, depending on the product. We have left the tightening-driven doldrums of 2016-2018 and approaching more normal levels. Here is the MBA Mortgage Index going back 20 years to give some perspective:

 

MBA application index

 

Private payrolls increased by 102,000, according to the ADP Employment Report. This is the second weak-ish reading in a row. Jobs were created in education and health as well as professional and business, while the construction sector lost jobs. Note the Street is looking for 160,000 new payrolls in Friday’s jobs report. Separately, initial jobless claims fell to 221k last week. You can see the drop-off in hiring in the ADP chart below:

 

ADP report