Month: March 2018

Authored by Kevin Muir via The Macro Tourist blog,

They’re back. I thought they had all given up, but like an old college buddy who’s going through a bad divorce and just needs a place to crash for a ‘few days,’ the corporate credit skeptics are a tough lot to shake.

This crew is a left-over remnant of the 2008 Great Financial Crisis. After watching the global financial system implode in a crisis that threatened to topple the entire world economy, there is a group of market participants who believe the next dislocation is right around the corner – only this time will be even worse given the increased debt levels. Although their views can be nuanced, usually they believe the market stresses from the last crisis will simply replay in a more dramatic fashion. In 2008 stocks fell, credit spreads exploded higher, VIX shot to the moon and sovereign long-dated bonds were the best asset to own by a long shot. Therefore at the hint of any trouble, they skedaddle to put on whichever part of this trade is most in fashion.

Over the past few weeks, with concerns about higher rates rattling the markets, speculators have flocked to shorting corporate fixed-income. I have created a custom index that is comprised of the total short interest of the most popular corporate credit ETFs.

Last week the short position ticked at a record high.

The most interesting part of this development? Although speculators are leaning heavily against credit, the spread versus governments is barely moving.

The fact that spreads are relatively stable means that most all of the recent decline in corporate bonds can be attributed to a rise in the “risk-free” rate and does not represent an increased worry about company specific credit.

Usually, I would write about positioning in the futures market, but since there is a not an easy way to trade corporate credit through futures, I will stay consistent and show the short position of government based fixed-income ETFs. This makes a much better comparison.

Ironic isn’t it? The decline in corporate bonds was almost solely the result of US treasuries selling off, yet speculators are leaning heavily on corporate bonds and have not increased the treasury index ETF short at all.

There is a bizarre phenomenon when people who lose a limb report sensations in their missing appendage. The experiences can even be painful. Well, markets sometimes suffer from their own version of phantom limb syndrome. Too many market participants remember the pain from the 2008 GFC and reflexively assume it will repeat. They rush to put on the same positions that benefited the most during that market crisis.

Well, I may not know much, but I know that markets seldom repeat, especially so quickly after the last crisis. Everyone hedges for the previous crash, and by definition, it means that the next dislocation will be different. After all, you don’t have surprises that everyone is expecting.

Could corporate spreads trade lower and even go negative?

This next part of my post might be difficult to accept. Many will simply write off the theory as the ravings of a lunatic.

But let me remind you of something. It used to be that everyone assumed swap rates could never go negative. Why would anyone ever accept a lower rate on a bank contract versus risk-free government sovereigns? Yet in the aftermath of the GFC, swap rates did the impossible and not only dipped below zero, but stayed there for years.

Perhaps even more astonishing than swap rates turning negative, who would have predicted a decade ago that sovereign rates themselves would trade with a minus sign in front of their yield? We have now accepted this abomination, but negative bond yields still boggle my mind.

Last night, as I thought about this post, I remembered an interview with a macro trader that I had read ages ago. This trader had a short position in Eurodollar futures, or some other short-term fixed-income instrument. He wanted to limit his risk, so he tried to buy call options (put option on yields) at a 0% rate. His counterparty thought he was nuts and was happy to sell him “worthless” options for something everyone “knew” couldn’t happen.

Well, I thought I read this interview in one of the Market Wizards books, yet I couldn’t find it. This morning, after an exhaustive search, I gave up, and threw it out to twitter for some help. The answer came back almost immediately. The reason I couldn’t find it in the Market Wizards books is that I had confused them with Steve Drobny’s “Inside the House of Money.” My copy of the Drobny book is at home, so I can’t grab the quote, but the trader in question is Jim Leitner, described as the greatest macro trader you have never heard of.

That book was written in 2006, before the GFC and well before negative rates. Traders laughed at Leitner, but he knew that anything can happen. His insight was sheer brilliance.

I don’t pretend to be even a quarter of the trader as Jim, but in my own Leitner-esque manner, I would like to remind everyone that credit spreads don’t have to be the source of the next crisis.

In fact, here is something to think about. Over the centuries, there have been plenty of sovereigns that have defaulted on their bonds. Risk-free sovereigns are not nearly as devoid of risk as many market participants believe.

Don’t forget, governments are the borrowers, but they are also the ones that set the rules. Although it’s easy to argue it’s not in their best interest to default on their bonds and increase their cost of funding, there reaches a level of indebtedness where the short-run consequences of a default are outweighed by the long-term gains from canceling debt.

Although recent history has seen relatively few sovereign defaults, history teaches us otherwise. From the Bank of Canada:

From RealClear Markets:

And finally, from the WSJ:

So if you are an endowment that is considering the credit worthiness of a sovereign issuer versus an AAA corporate borrower over the coming decades, is it really such an easy call that the corporate bond should yield more than the sovereign? The corporate creditor is backed by real assets whose security is enforceable by a third party. You might argue that the sovereign is also subject to rule of law that is held in check by the world’s court, but if you consider global government debt burdens, blindly assuming it will all be paid back without politicians testing the boundaries is naive.

So would you rather own Toyota or JGB paper? How about Eni or BTPs? I am not so sure that sovereigns should always yield less than corporates. Government finances are in a terrible bind. In a lot of cases, private corporations that have real assets, which will be able to maintain their value in an inflationary environment, might be a better bet than hoping governments live up to their promises.

In the coming years, I could easily envision a situation where stronger rated corporate credit curves trade through sovereign curves. I know that seems crazy, but don’t forget negative swap rates and absolute yields below zero were also theoretically impossible. Leitner would probably counsel us to expect the unexpected.

Putting it all together

With market participants leaning heavily short corporate credit, the chances of a big accident diminish. Crises always occur in something that just ‘cannot happen’. Whether it is home prices can’t fall at a national level or the internet has changed the nature of investing, as Mark Twain reminds us, there is always something that everyone knows for sure that just ain’t so.

I find it funny that the most vocal critics about the spiralling upward out-of-control government debt are often those investors most likely advocating positions in long-dated sovereign bonds as a place to hide. The surprise of this cycle will be that risk-free sovereign bonds provide no safety against the next crisis, but will instead themselves be the source of the instability. Think about hedging against the unthinkable happening. That’s what Jim would do.

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The UK was braced for a showdown with Russia on Wednesday after a midnight deadline set by Prime Minister Theresa May expired without an explanation from Moscow about how a Soviet-era nerve toxin was used to strike down a former Russian double agent.

Russia, which denied any involvement in the poisoning of Sergei Skripal and his daughter with Novichok, a nerve agent developed by the Soviet military, said it was not responding to May’s ultimatum until it received samples of the nerve agent, in effect challenging Britain to show what sanctions it would impose against Russian interests.

“Moscow had nothing to do with what happened in Britain. It will not accept any totally unfounded accusations directed against it and will also not accept the language of ultimatums,” Kremlin spokesman Dmitry Peskov told reporters on Wednesday according to Reuters. He added, however, that Russia remained open to cooperating with Britain in investigating the poisoning, blaming the British authorities for refusing to share information.

Russia’s Interfax news agency reported the Russian embassy in London planned to ask for consular access to Yulia Skripal, Sergei’s daughter.

Britain’s response to the expiry of the deadline and lack of explanation from Moscow was expected to be announced by May in parliament later, after May convened a meeting of the National Security Council at her Downing Street office in the morning. Furthermore, Bloomberg reported that the U.K. has called for an urgent meeting of the UN Security Council to update Council members on the investigation into the nerve agent attack in Salisbury, the U.K. Foreign Office said in a tweet.

The UK has called for an urgent meeting of the UN Security Council to update Council members on the investigation into the nerve agent attack in Salisbury. pic.twitter.com/jFQ2HA4JV0

— Foreign Office 🇬🇧 (@foreignoffice) March 14, 2018

In retaliation, it is possible that London could call on Western allies for a coordinated response, freeze the assets of Russian business leaders and officials, limit their access to London’s financial center, expel diplomats and even launch targeted cyber attacks. Furthermore, as Boris Johnson threatened, the UK may also cut back participation in the soccer World Cup, which Russia is hosting in June and July.

Meanwhile, as Reuters notes, the UK has already started its retaliation:

• BRITAIN TO EXPEL SIGNIFICANT NUMBER OF RUSSIAN DIPLOMATS THOUGH NOT AS MANY AS IN 1971 – SKY NEWS REPORTER SAYS

This is likely just the start.

On Tuesday, President Trump told May by telephone Russia “must provide unambiguous answers regarding how this chemical weapon, developed in Russia, came to be used in the United Kingdom,” the White House said. The White House said Trump and May “agreed on the need for consequences for those who use these heinous weapons in flagrant violation of international norms.”

A British readout of the conversation said, “President Trump said the US was with the UK all the way.”

As a reminder, Skripal, 66, and his daughter Yulia, 33, were found slumped unconscious on a bench outside a shopping center in the genteel southern English city of Salisbury on March 4. They have been in a critical condition in hospital ever since. British scientists identified the poison as a military-grade nerve agent from a group of chemicals known as Novichok, first developed in the Soviet Union in the 1970s and 1980s.

On Monday, Theresa May said either the Russian state had poisoned Skripal, a former Russian military intelligence officer, or Russia had somehow lost control of its chemical weapons. Putin said last year that it had destroyed its last stockpiles of such weapons.

May said Russia had shown a pattern of aggression including the annexation of Crimea and the murder of former KGB agent Alexander Litvinenko, who died in 2006 after drinking green tea laced with radioactive polonium-210.

A public inquiry found the killing of Litvinenko had probably been approved by Putin and carried out by two Russians, one of them a former KGB bodyguard who became a member of the Russian parliament. Both denied responsibility, as did Moscow.

Counter-terrorism officers began investigating the death of another Russian in Britain on Tuesday, although police said it was not thought to be linked to the attack on the Skripals. Nikolai Glushkov, 68, who was an associate of late tycoon Boris Berezovsky, was found dead on Monday. Berezovsky was found dead in March 2013 with a scarf tied around his neck in the bathroom of his luxury mansion west of London.

And now that the UK has formally commenced retaliation, all eyes are on the Kremlin and how Putin will respond.

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It will probably be a few more days before Pennsylvania’s eighteenth district can definitively declare either Republican Rick Saccone or Democrat Conor Lamb to be the newest representative of a district that will cease to exist by next year.

Several media outlets, including NBC News, declared Lamb – who is ahead of his rival by several hundred votes – the winner. But more than 1,000 absentee ballots have yet to be counted, as CNN points out. Though Saccone is definitely at a disadvantage, and a come-from-behind victory is looking increasingly unlikely. Saccone and Lamb were running to replace former GOP Rep. Tim Murphy, who resigned after allegedly urging a woman he was having an affair with to have an abortion.

Lamb declared victory early this morning, telling a crowd of his supporters: “It took a little longer than we thought, but we did it!”

Lamb, a Marine veteran and former prosecutor, told the crowd at his victory speech that the voters had directed him to “do your job” in Washington. “Mission accepted,” he declared. Meanwhile, Saccone told his own supporters, “It’s not over yet, we’re going to fight all the way, all the way to the end, we’ll never give up.”

As several reporters pointed out last night, Pennsylvania doesn’t require recounts for non-state-wide elections. However, either candidate’s supporters can ask for one – though at least three supporters must attest that there was an error or fraud when counting the ballots.

The margin between the two candidates was less than 700 votes:

Though some Republican strategists pointed out that Saccone had outperformed polls of likely voters, which had assigned Lamb between a two and a six point lead, others claimed the performance was still problematic for Republicans, and did not bode well for their chances of retaining the House later this year. If Lamb is victorious, he will need to run again – but for a seat in a different district – later this year.

As CNN reported, before it became clear the results would be so close, several Republican officials said they were expecting Saccone to lose.

Before the votes had even been counted, party leaders were already distancing themselves from Saccone and placing the blame squarely on Saccone’s campaign but also on Trump’s Saturday rally for the candidate, which some Republicans believe helped drive up Democratic turnout.

NBC is reporting that Saccone, who has not yet conceded, is working with lawyers to discuss next steps.

When the race tightened, one GOP source told Jim Acosta: “This isn’t a blowout – for now, we’ll happily take it.”

Republicans also said President Trump, who was soliciting campaign contributions in Beverly Hills Tuesday night, was pleasantly surprised by the narrow margin.

Lamb, who benefited from his background  disowned Minority Leader Nancy Pelosi, D-Calif., and staked out positions on abortion, guns and fracking that hewed closer to the GOP.

Still, as we pointed out yesterday, a Lamb victory wouldn’t mean all that much for other Democrats running in deep-red districts. As one RNC spokeswoman pointed out, the only reason Lamb won over so many conservative voters is because he “essentially ran as a Republican.”

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Two days after Trump put his foot down, blocking the Singapore-based Broadcom’s $117 billion takeover attempt of the biggest US-based chipmaker Qualcomm on national security grounds, Broadcom officially abandoned its pursuit to buy the chipmaker.

Moments ago, Broadcom announced that it has withdrawn and terminated its offer to acquire Qualcomm Incorporated and has withdrawn its slate of independent director nominees for Qualcomm’s 2018 Annual Meeting of Stockholders.

Broadcom today issued the following statement:

Although we are disappointed with this outcome, Broadcom will comply with the Order. Broadcom will continue to move forward with its redomiciliation process and will hold its Special Meeting of Stockholders as planned on March 23, 2018.

Broadcom’s Board of Directors and management team sincerely appreciate the significant support we received from the Qualcomm and Broadcom stockholders throughout this process.

Broadcom thanks the independent nominees who stood for election to the Qualcomm board, not only for their time and effort but also for their unwavering commitment to act in the best interests of Qualcomm stockholders.

And in a snarky aside, Broadcom also said that it appreciates the following statement from U.S. Treasury Secretary and CFIUS chair Steven Mnuchin on March 12:

“This decision is based on the facts and national security sensitivities related to this particular transaction only and is not intended to make any other statement about Broadcom or its employees, including its thousands of hard working and highly skilled U.S. employees.”¹

And then added the following snippy footnote: “¹ Permission to use quotations was neither sought nor obtained.”

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After two consecutive days of failed S&P ignition attempts, in which US stocks opened sharply higher only to close near the lows, on Wednesday the algos will try for the third consecutive time to escape the recent late-day selloff funk. S&P futures are higher after declining on Tuesday following a fresh personnel shakeup in the Trump administration and renewed US trade war speculation with China dampened investor sentiment.

European stocks rose modestly led by mining shares even as Asian shares fell despite stronger than expected Chinese economic  data. 

Equity markets were attempting to recover after Tuesday’s hefty losses, heartened by robust Chinese factory data, but struggled to overcome fears of a global trade war as well as the prospect of political uncertainty in the United States. “As long as the threat of protectionism and a trade war remains, markets will remain vigilant,” Rabobank analysts told clients according to Reuters.

The latest set of tariffs, reportedly targeting Chinese tech, electronics and telecoms, were revealed by sources hours after Trump abruptly fired Secretary of State Rex Tillerson. Tillerson’s exit follows that of economic advisor Gary Cohn, a strong free trade proponent. Since Trump took office in 2017 as many as 35 senior officials from his administration have walked out, including Tillerson, according to Citi.

“The market probably correctly viewed this move as weakening internal White House opposition to some of Trump’s less market-friendly policies, in particular the President’s trade policy,” Daiwa strategist Mantas Vanagas said, quoted by Reuters.

The negative momentum faded somewhat in Europe, with a pan-European equity index up 0.24% after falling 1% on Tuesday. That left MSCI’s all-country equity index down 0.12% its second day in the red, although a rebound in the US will likely push it back in the green.

European stocks rose modestly after opening in the red after Tuesday’s plunge as traders assess the implications of a shakeup in the Trump administration amid corporate updates from companies including Inditex SA and Prudential Plc. The Stoxx Europe 600 Index rises 0.3%, with all major sectors with the exception of utilities are trading higher in the Euro Stoxx, while much of the morning stock movers have been dictated by company earnings, with Adidas (+9%) shares sitting at the top of DAX. Elsewhere, the IBEX underperforms its counterparts as index heavyweight Inditex (-3%) slipped after highlighting concerns over FX headwinds. Zara owner Inditex drops after reporting a slowdown in sales and its weakest profitability in a decade, while U.K. insurer Prudential rises after saying it divested 12 billion pounds ($16.7 billion) of annuities from its U.K. portfolio and plans to spin off its M&G Prudential unit. Miners were the best-performing industry group after Goldman Sachs analysts said the sector is enjoying robust global demand and after China reported strong economic data overnight.

There was no bounce earlier in Asia, where markets followed the negative US lead with the Nikkei (-0.9%), Kospi (-0.3%), Hang Seng (-0.5%) and Shanghai Comp (-0.6%) all down. The latest batch of mixed activity indicators were  released in China early this morning. Industrial production in February rose unexpectedly to +7.2% ytd yoy (vs. +6.2% expected; +6.6% previously), as did fixed asset investment (+7.9% yoy vs. +7.0% expected; +7.2% previously) while retail sales were slightly below expectations at +9.7% yoy (vs. +9.8%) from +10.2% in the month prior. As shown in the chart below, Chinese macro data has been disappointing in recent months so the modest upside surprise in factory orders was a welcome change.

In global FX, the dollar pared an early decline as the euro felt some heat from another Draghi reference to the exchange rate, while the Yen rose following continued focus on the Moritomo scandal that has again rocked the Abe administration. A lackluster London session saw the pound shedding gains ahead of a May speech over the U.K.’s relationship with Russia. Bloomberg breaks down the latest overnight FX action:

• The euro set a day low of $1.2364 in early London trading after ECB President Draghi said in a speech that adjustments to monetary policy will remain predictable as policy makers look for further evidence that inflation dynamics are moving in the right direction
• He also said the central bank needs to monitor developments in the common currency closely as its appreciation since the beginning of the year cannot be explained solely by economic expansion
• AUD/USD saw leveraged demand on stronger-than- expected gains in China’s factory output and investment growth
• Kiwi shook off weaker-than-estimated 4Q current-account balance to climb on global fund demand to buy New Zealand’s bonds after Tuesday’s issuance

Treasuries and euro-area bonds were little changed.  German 10-year government bond yields approached one-month lows and currently stand 20 basis points below this year’s peak at 0.60 percent, following a soft 30Year debt auction.

Economic data include retail sales and PPI. Williams-Sonoma and Signet Jewelers are among companies due to release results

Market Snapshot

• S&P 500 futures up 0.3% to 2,776.00
• STOXX Europe 600 up 0.3% to 376.55
• MXAP down 0.5% to 178.18
• MXAPJ down 0.4% to 587.85
• Nikkei down 0.9% to 21,777.29
• Topix down 0.5% to 1,743.21
• Hang Seng Index down 0.5% to 31,435.01
• Shanghai Composite down 0.6% to 3,291.38
• Sensex down 0.4% to 33,720.90
• Australia S&P/ASX 200 down 0.7% to 5,935.31
• Kospi down 0.3% to 2,486.08
• German 10Y yield fell 1.0 bps to 0.609%
• Euro down 0.2% to $1.2370
• Brent Futures down 0.2% to $64.51/bbl
• Italian 10Y yield fell 0.9 bps to 1.737%
• Spanish 10Y yield rose 0.8 bps to 1.405%
• Brent Futures down 0.2% to $64.51/bbl
• Gold spot down 0.2% to $1,324.41
• U.S. Dollar Index up 0.2% to 89.83

Top Overnight News

• ECB’s Praet says the central bank’s forward guidance on the path of policy rates will have to be further specified and calibrated as appropriate for inflation to remain on the sustained adjustment path toward levels below, but close to, 2% over the medium term
• The special election in southwestern Pennsylvania remained too close to call with all precincts reporting results. House seat in Pennsylvania may be a bellwether for the fall elections that will decide control of Congress
• Theresa May will meet with her national security and intelligence chiefs Wednesday to assess whether Russia has given a credible answer to her charge that it was behind the poisoning of Sergei and Yulia Skripal in Salisbury. She will then update Parliament on her response.
• China’s factory output and investment growth unexpectedly accelerated in the first two months of the year amid robust global demand
• U.S. Trade Representative Robert Lighthizer presented President Donald Trump with package of tariffs targeting equivalent of $30b a year in Chinese imports, but Trump urged him to aim for higher number, Politico reports, citing three unidentified people familiar with discussions
• Japanese Prime Minister Shinzo Abe and his finance minister denied ordering officials to tamper with documents at the center of a scandal rocking his administration.
• German Chancellor Angela Merkel was formally elected to a fourth term in a parliamentary vote, extending her 12 years in office at the helm of Europe’s biggest economy
• Germany may be ready to sacrifice Jens Weidmann in the contest of becoming the next head of the ECB in a trade for more influence on French President Emmanuel Macron’s push to create closer ties among euro countries

European equities are trading in the green this morning, subsequently pairing the initial losses that stemmed from Asian and US bourses, which saw risk-sentiment soured by reports of Secretary of State Tillerson being fired and increased caution over trade wars. All major sectors with the exception of utilities are trading higher in the Euro Stoxx, while much of the morning stock movers have been dictated by company earnings, with Adidas (+9%) shares sitting at the top of DAX. Elsewhere, the IBEX underperforms its counterparts as index heavyweight Inditex (-3%) slipped after highlighting concerns over FX headwinds.

Top Asian News

• China’s Factory Output, Investment Rise on Robust Global Demand
• China Imposes Record $870 Million Fine for Stock Manipulation
• Noble Group Seeks to Sweeten Disputed Debt Deal After Backlash
• Toyota Offers Bigger Raises as Japan Pushes for Inflation
• Not Even Trump Can Slow Vietnam’s Economy, Official Says

In Asia, markets followed the negative US lead with the Nikkei (-0.9%), Kospi (-0.3%), Hang Seng (-0.5%) and Shanghai Comp (-0.6%) all down. The latest batch of activity indicators were  released in China early this morning. Industrial production in February rose unexpectedly to +7.2% ytd yoy (vs. +6.2% expected; +6.6% previously), as did fixed asset investment (+7.9% yoy vs. +7.0% expected; +7.2% previously) while retail sales were slightly below expectations at +9.7% yoy (vs. +9.8%) from +10.2% in the month prior. The combined Jan and Feb data is meant to smooth out the effects of the Lunar New Year. Meanwhile, the Pennsylvania Congressional District special election in the US is appearing to head for a neck and neck finish.

Top European News

• Germany Ready to Sacrifice Weidmann as a Pawn in EU Chess Match
• Draghi Says Policy Adjustments to Proceed at Measured Pace
• Corin’s Billionaire Owners Said to Mull Sale of Orthopedic Firm
• Volvo Venture Seeks Top Self-Driving Role Angling for More Deals
• May Plots to Punish Russia as Crisis Over Poisoned Spy Deepens

In FX, USD weakness amidst ongoing global trade war and White House personnel concerns remains the principle theme, as the DXY continues to reject advances towards the 90.000 level and beyond, which in turn is shifting the technical outlook more bearish. However, EURUSD and single currency crosses have been knocked back to an extent by comments from ECB President Draghi and Chief Economist Praet, reiterating that inflation is still below target and therefore policy needs to stay ‘patient, persistent and prudent’. Key downside risks were highlighted – FX and the aforementioned potentially adverse trade developments due to US President Trump’s import tariff proposals. Eur/Usd is back below 1.2400, but holding above the 30 DMA at 1.2345, and also eyeing decent expiry interest from 1.2390-1.2405 (around 1 bn). Conversely, Aud/Usd is testing resistance either side of the 0.7900 handle again and recent peaks just below the big figure, aided by some Chinese data beats overnight and more balanced rather than dovish/cautious RBA rhetoric via Assistant Governor Kent. Chart-wise, yesterday’s 0.7898 high forms the first/nearest bullish target and offers are touted around 0.7925, if 0.7900 is breached. Cable looks capped by the 1.4000 level, and Usd/Cad by 1.3000, while Usd/Jpy is back in the 106.50 area after a further retreat from 107.00+ peaks late last week and earlier this week with the 10 DMA at 106.31 holding in for now. Elsewhere, Eur/Sek just a fraction softer after broadly as forecast Swedish CPI data that will underscore growing calls for the Riksbank to refrain from tightening for longer.   

In commodities, oil prices are trading slightly higher with prices finding some slight reprieve from yesterday’s smaller than expected build in the latest API report, alongside the improvement in risk sentiment, which has seen WTI retest USD 61/bbl

Looking at the day ahead, it looks set to be another important day of data with February retail sales and PPI, followed by January business inventories. It’s worth also highlighting that the European Commission is expected to make comments on US steel and aluminium tariffs to the European Parliament.

US Event Calendar

• 7am: MBA Mortgage Applications, prior 0.3%
• 8:30am: Retail Sales Advance MoM, est. 0.3%, prior -0.3%
  • Retail Sales Ex Auto MoM, est. 0.4%, prior 0.0%
  • Retail Sales Ex Auto and Gas, est. 0.32%, prior -0.2%
  • Retail Sales Control Group, est. 0.4%, prior 0.0%
• 8:30am: PPI Final Demand MoM, est. 0.1%, prior 0.4%
• PPI Ex Food and Energy MoM, est. 0.2%, prior 0.4%
• PPI Ex Food, Energy, Trade MoM, est. 0.2%, prior 0.4%
  • 8:30am: PPI Final Demand YoY, est. 2.8%, prior 2.7%
  • 8:30am: PPI Ex Food and Energy YoY, est. 2.6%, prior 2.2%
  • 8:30am: PPI Ex Food, Energy, Trade YoY, prior 2.5%
• 10am: Business Inventories, est. 0.6%, prior 0.4%

DB’s Craig Nicol concludes the overnight wrap

Picking the right moment to run out and grab lunch is something of a fine art working in markets. Indeed, anyone who was out for the 12 minutes between 12.30pm GMT and 12.42pm GMT yesterday probably felt like they’d been gone a lot longer when they returned to their screens. It takes something fairly significant to overshadow US inflation data at the moment however the shock news that President Trump had ousted now former US Secretary of State Rex Tillerson was certainly enough to do just that.

The announcement came via a tweet from the President and it also included confirmation that CIA Director Mike Pompeo would take over the role. Trump confirmed with reporters that Tillerson “had a different mindset” relative to the President with the Iran nuclear deal named as an example. It was no secret that Tillerson’s tenure had been somewhat rocky however it’s fair to say that markets were still caught off guard, despite his clock probably ticking. Indeed Politico also reported that Tillerson had no plans to leave and was also unsure why he had been let go. There were suggestions that Tillerson’s vocal statements on Monday about condemning the Russian government about its alleged role in the Russian spy incident in the UK could have played a part however that remains to be seen. Various news outlets also confirmed that Trump wanted a new team in place ahead of talks with North Korea and also ongoing trade talks.

It’s not the first time that Trump has moved quickly in his administration without warning, with Reince Priebus and James Comey two other such examples. In fact, the NY Times also reported that Trump’s personal assistant, John McEntee, was let go on Monday and escorted from the White House, while another headline from the Times suggested that there would be more staff shifts this week. The bottom line for us is that all these moves show that the President is certainly moving a lot closer to his anti-globalist policy agenda. On that point, the view on Pompeo is that he and Trump are a lot closer aligned and that Pompeo is more likely to have the President’s ear. On a related note, it also appears that Larry Kudlow is now the favourite to replace Gary Cohn based on comments from the President yesterday. That’s perhaps more interesting given that Kudlow and Trump have clashed in the past over tax reform and also the recent tariff announcements.

Aside from the 12 minutes of a slightly more positive risk environment following the US CPI report (more on that below), the Tillerson news certainly more than played its part in equity markets dropping from early highs. The S&P 500 finished -0.64% last night after being up as much as +0.67% at one stage. A Reuters story suggesting that Trump was seeking for tariffs of up to $60bn a year on China imports seemed to just extend selling pressure into the evening. Meanwhile the previously untouchable Nasdaq (-1.02%) snapped its 7-day winning run while in Europe the big mover was the export-heavy DAX which tumbled to a -1.59% loss. Moves for bonds were actually a bit more contained. The high-to-low range on 10y Treasuries was 6bps and the yield did fall to the lowest in over a week (2.828%) at one point, however by the end of play they were just 2.6bps lower at 2.843%. The 30y auction was also relatively solid  with the highest award to direct bidders since October 2015. In Europe bond markets were broadly 1-2bps lower while the Greenback was well offered with the Dollar index falling -0.26%. Gold (+0.26%) also seemed to benefit from a flight to quality bid.

With regards to the CPI data, that in-line +0.2% mom core print meant that the annual rate also held at +1.8% yoy for the third consecutive month. The unrounded reading was +0.182%, so the overall feeling was that it largely mirrored the marginally softer earnings number on Friday. However, momentum is still favouring the hawks with the three-month annualized rate now up to +3.1% and the highest since 2007. The six-month annualized rate is also at a
robust +2.5%. That should be comforting to a Fed which is targeting the gradual approach for now though. As a reminder that is the last CPI report that the Fed will see prior to the FOMC meeting next week however they will benefit from the release of the February PPI data today. Expectations for that is also for a +0.2% mom core reading while the headline is expected to show a +0.1% mom rise in producer prices.

Here in the UK there were no huge surprises to come from Chancellor Hammond’s Spring Statement. As widely expected the borrowing numbers for the current fiscal year and also the next were revised down. This year was  revised down from £50bn to £45bn while next year was revised down from £40bn to £37bn. Headroom relative to the 2% cyclically adjusted borrowing to GDP target by 2020-21 is more or less unchanged versus the November estimate at around £15bn, so not a huge amount more fiscal room. Finally GDP forecasts remain fairly lacklustre and included a cut to the 2021-22 forecast. The 2018 forecast was however revised up one-tenth to 1.5%. Sterling closed up  +0.40% last night versus the USD but that appeared to be more USD weakness related to the Tillerson news than anything else. Indeed versus the Euro, Sterling was closer to unchanged. Gilt yields also finished more or less unchanged by the end of play.

This morning in Asia, markets have largely followed the negative US lead with the Nikkei (-0.83%), Kospi (-0.51%), Hang Seng (-1.30%) and Shanghai Comp (-0.60%) all down as we type. The latest batch of activity indicators were  released in China early this morning. Industrial production in February rose unexpectedly to +7.2% ytd yoy (vs. +6.2% expected; +6.6% previously), as did fixed asset investment (+7.9% yoy vs. +7.0% expected; +7.2% previously) while retail sales were slightly below expectations at +9.7% yoy (vs. +9.8%) from +10.2% in the month prior. The combined Jan and Feb data is meant to smooth out the effects of the Lunar New Year. Meanwhile, the Pennsylvania Congressional District special election in the US is appearing to head for a neck and neck finish.

Bloomberg is reporting that Democrat Conor Lamb holds a tiny lead of 579 votes over Republican Rich Sacconne, out of about 227,000 votes cast. Finally in Japan, the BOJ minutes showed most board members believe the bank must “persistently” pursue powerful easing. Notably, during Q&A BOJ Governor Kuroda noted “by combining various tools, it’s possible to shrink the BOJ’s balance sheet at an appropriate pace while keeping markets stable”.

Turning back to Europe, another Politico article yesterday suggested that the Bundesbank’s Weidmann is the favourite  to replace Mario Draghi as ECB President from October 2019. However the story also suggested that his support was receiving pushback, in part given Weidmann’s vocal opposition to Draghi’s QE policy and his strict enforcement of the EU’s fiscal policies. Other potential German candidates touted include Klaus Regling (current head of the ESM) and Marcel Fratscher (Head of the research institute DIW Berlin). Notably, the swing factor for the candidacy likely depends on the relative support of French President Macron, who has been relatively quiet on this topic.

In other news, the OECD has upgraded its forecasts on global economic growth by 0.2-0.3ppt to 3.9% for both 2018 and 2019, with “private investment and trade picking up on the back of strong business and household confidence”. Across countries, growth in the US has been lifted to 2.9% for 2018 (+0.4ppt) and 2.8% for 2019 (+0.7ppt) in part  due to the tax cuts and new fiscal spending increases, while the UK’s growth was revised slightly higher to 1.3% in 2018 and 1.1% in 2019. Notably, the agency also warned on protectionism and noted that “an escalation of trade tensions would be damaging for growth and jobs” and that countries should “avoid escalation and rely on global solutions to solve steel excess capacity”.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the February NFIB small business optimism index was above market at 107.6 (vs. 107.1 expected) and marked a fresh high since 1983. The survey also showed that c.1/3 of owners reported raising compensation to retain or attract workers in the month, the largest share in 17 years. In Europe, Italy’s Q4 unemployment rate was in line at 11% and the final reading of Spain’s February CPI was confirmed at 1.2% yoy. Elsewhere, France’s Q4 total payrolls was up +0.3% qoq (vs. +0.2% expected).

Looking at the day ahead, we’ll get final revisions to February CPI in Germany along with January industrial production and Q4 employment data for the Euro area. ECB President Draghi is scheduled to speak in the morning (8am London  time), as well as the ECB’s Coeure, Praet Constancio and then Bank of France’s Governor Villeroy. In the US, it looks set to be another important day of data with February retail sales and PPI, followed by January business inventories. It’s worth also highlighting that the European Commission is expected to make comments on US steel and aluminium tariffs to the European Parliament.

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In the past year, there has been a lot of debate whether Trump’s tax plan will make the poor poorer and the rich richer. Well, we now have one glaring example of the latter, and to a degree never seen before, if in a different format than most envisioned: according to Bloomberg, Jeffrey Talpins’s Element Capital Management made more than $3 billion in the last five months, mostly as a result of a trade that President Donald Trump’s tax bill would pass successfully, driving stocks and yields on U.S. Treasuries higher.

Talpins – whom we first profiled back in 2015 when he quietly emerged as a massive buyer of Treasurys – put on the “Trump trade” one year ago when investors still had doubts that a tax bill, or frankly anything proposed  by Trump, would succeed. The manager’s vision – which was 100% correct – was that Trump and fellow Republicans, having failed to pass major legislation, including an overhaul of Obamacare, would unite to push through a large tax cut for individuals and corporations.

That’s exactly what happened, and it’s not over yet: the hedge fund macro manager still thinks the trade has some room to run.

“We expect the U.S. equity market to fully recover the peak to trough decline and hit new highs over the next few months,” he said in a mid-February letter to investors seen by Bloomberg. “As the market gradually recovers its February losses, we also expect that volatility will subside commensurately.’’

Talpins first made his tax call in an April 2017 letter to investors, saying a lack of cohesiveness within the Republican Party and the dim prospect of legislative support from Democrats would drive Republicans to “take the path of least resistance” in the form of a large tax cut for companies and lower marginal rates for individuals.

A month later, he told them he had increased his exposure to stocks on the view that a tax package, deregulation, an accommodative Federal Reserve and healthy earnings “all support equity prices moving higher.”  In the May letter, he also said that he expects the Fed will raise rates by 25 basis points a quarter this year, and continue to remove accommodation, which has so far been accurate.

Oh, and he was also spot on in predicting that back then that there was a high chance for a 10% correction in the next 12 months that would hit commodity trading advisers and volatility targeting funds hardest, though the market would then recover within a few months.

As stocks climbed for 2017, and yields on Treasuries jumped at the very end of 2017, Talpins’s correct view was rewarded. So was his bank account.

As a result, while most of his peers have languished and scratched their heads how to generate alpha, Elements figured it out: have trust in Trump… and be rewarded. This year its fund has already climbed 11.5%, following a 9% return in the last quarter of 2017 fueling the multibillion-dollar gain. The tax call was the latest correct call for the $13.5 billion Element, which was launched in 2005 after Talpins’ stints at Goldman and Citigroup. Incidentally, less than 3 years ago, Elements had less than half in AUM, or roughly $6 billion.

Unfamiliar with Talpins? Here is some detail from our 2015 profile of Element, and the formerly unknown hedge fund manager:

“Mr. Talpins is an intense and reserved trader formerly at Citigroup Inc. and Goldman Sachs Group Inc. He is known for a tenacious style that can grate on rivals and once tested the patience of former Federal Reserve Chairman Ben Bernanke.”

According to the NYT, in 2005, Trader Monthly named Mr. Talpins one of the top 30 traders under 30, when he was still an employee of Vega Asset management. “Youth is not wasted on this crop, any of whom could be a billionaire by 40,” the magazine said. “Or, then again, they could be belly up and bust.”

Back in 2010 the FT profiled Element Capital, then at just $1.5 billion, saying that fixed-income relative value trading, “the hedge fund strategy pioneered – and made notorious – by Long Term Capital Management is returning to prominence amid one of its most successful years yet.” It added that “fixed-income relative value trading – shunned by investors after the collapse of LTCM in 1998 – has been one of the industry’s few outperformers this year, thanks to massive pricing anomalies caused by fiscal stimulus packages and unconventional central bank monetary policies around the world.”

In any case, Talpins also posted double-digit returns in 2015 and 2016, while other macro traders including Ray Dalio, Paul Tudor Jones and Louis Bacon lost money or made only a few percent. His fund has posted annualized returns of 21% since inception.

* * *

Now for the not so good news: Talpins warns that he isn’t a long-term bull.

In his latest letter, Talpins said that the increased volatility in February was initially caused by pension funds rebalancing their portfolios at the end of January by selling about $50 billion worth of stocks. That pushed stocks lower and caused CTAs, volatility targeting funds and short volatility products to dump an additional $200 billion in stocks. The firm, known for its heavy use of options in its wagers, used baskets of single-name equities as well as call options on the S&P 500 to make the bets. As a hedge, it shorted stock indexes outside the U.S.

He also warned that the S&P 500 is about 3% below its January peak, and once stocks surpass that point, rising interest rates, stretched valuations and a maturing economic cycle will start weighing on the market later in the year.

In other words, enjoy the next 3-4 months: that’s about as good as it will get.

Oh, and for those who can’t wait to have Talpins manage their money, get in line: the fund has been closed to new investments since last year, when it pulled in $2 billion of fresh capital in two weeks.

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Authored by Kent Moors via OilPrice.com,

For the ministers and officials assembled, it was an embarrassment all around.

Late last week, as we were at the annual Windsor Energy Consultation (WEC) just outside London, British Gas Plc confirmed that the nation was facing a natural gas shortage as freezing temperatures grip the country.

You see, blizzards, strong winds, drifting snow, and bitter cold recently brought Britain to a standstill as the weather system nicknamed the “Beast from the East” combined with winter storm “Emma” to create some of the most testing weather the U.K. has had to face in years.

Now, I can attest first hand that this cold snap was not something to take lightly.

As a regular attendee of the Windsor Energy Consultation over the past decade, a visit that includes spending three days each year at the royal residence, I know that Windsor Castle can be drafty in any weather.

But this time around, it was positively frigid.

“Frosty” Windsor Castle grounds (St. George’s Chapel on the left), March 2, 2018; photo: Bill Arnold

And nationwide, this “big freeze” has brought to light a very serious problem.

And it’s one that is only getting worse…

Bitter Cold Adds (Further) Fuel to the Flames

The unfolding gas crisis has brought about a renewed immediacy to a major political issue that has been percolating in the U.K. for some time now.

You see, for the third year in a row, a portion of my two briefings (one to the plenary meeting; one to the ambassadors), was devoted to the growing global need for a new “energy balance.”

Simply put, that balance involves two related advances.

The first is an expansion in the number of reliable (and distinct) energy sources. The second addresses the extent to which these sources provide a genuine interchangeable network of availability from such sources.

The rise of renewable sources (solar, wind, biofuel, even geothermal) has been the most visible manifestation of the developing balance. But the crucial element to remember is the balance nature of it all.

As we have noted in the past, this is not an exercise in finding a “silver bullet” to wean the market from a dependence on any particular energy source.

All energy sources are required. It’s the integration of these sources that translates into the most efficient, cost-effective, and best solution for both producers and consumers.

Now, among the assembled officials and sector dignitaries at this year’s Windsor meeting, there was a widespread agreement that a global “energy balance” is necessary.

But you wouldn’t know it looking at the situation developing currently.

In fact, despite that agreement, the current gas crisis emerging in the U.K. actually results from a shocking referendum decision back in 2016…

Planning Limbo

Delays in moving on still contentious (and well over budget) nuclear power plants combined with ongoing pipeline problems from the North Sea offshore fields has left any “energy balance” forward planning very much in limbo.

Yes, the increase in wind power in the U.K. has occurred more rapidly than expected, but it still lags behind the rise in demand.

The majority of demand in the U.K. is still covered by natural gas – both from the North Sea, which is becoming increasingly questionable when it comes to extractable volume, and expanded liquefied natural gas (LNG) imports.

Unfortunately, the nation’s supply issues have been complicated by one event that has overshadowed everything else for more than a year and a half.

I’m talking about “Brexit,” the British decision to leave the European Union.

And the supply issue that followed this landmark decision is creating a major problem for British energy consumers.

But after a sidebar conversation with a British Gas executive at Windsor, the reasoning behind my original argument has become even more compelling…

Why Brexit is Hiking U.K. Power Prices – and the Worst is Yet to Come

As I explained back in July 2016, history tells us that the winter of 1946-1947 was one of the worst experienced by the U.K. in a century – and the coldest in three.

Coming so soon after the end of World War II, an already crippled economy felt the full impact of freezing weather that killed both livestock and crops, while jamming roads and railways with snow.

It got so bad that at one point, Winston Churchill observed that he couldn’t even get his favorite cigars.

But the main concern was the provision of electricity. Not a single power-generating station in all of England had escaped wartime destruction, and a return to “normalcy” in the power sector was still years away.

So during the cold winter of 1946-1947, the entire British population had to hunker down.

Now, the current situation is hardly as dire.

But ever since the U.K. voted to separate from the EU on June 23, I’ve been waiting for the initial signals that this divorce will have consequences in the energy sector.

Now we have one, with dire consequences for British consumers…

Brits Should Expect (Much) Higher Power Prices

The signal shows a coming double whammy for British natural gas users, as a result of the post-Brexit decline of the British pound sterling to more than thirty-year lows against the dollar.

This decline has prompted two energy moves in very different directions. Unfortunately, neither is good for anyone living in the U.K. as temperatures decline…

First, the descent of the pound sterling has prompted U.K. retail natural gas distributors to forego discounts moving forward. This is, of course, based on the same reasoning that will certainly result in another round of appreciable electricity price hikes by the major national utilities.

Maintaining profit margins will be impossible at current levels, given the forex pressure on the bottom line. Most observers also believe that increased taxes are now inevitable, as the unexpected currency (effective) devaluation has made revenue an important factor.

Fact is, even before Brexit, this was placing additional pressure on an already strained power sector.

But in a post-Brexit world, this is leading to some serious difficulties, both for end users and domestic power distributors, with problems – some Brexit-related, some not – hitting all British energy sources…

The U.K. Cut its Winter Gas Reserves – Just in Time for the “Big Freeze”

Chief among those concerns are the profitability of North Sea production, and a decimation of renewable alternatives (for example, over a third of all jobs in U.K. solar have vanished).

The British end user, however, is going to feel the pinch in an additional way…

You see, in June 2017, utility giant Centrica plc announced plans to close the offshore Rough storage facility, which currently accounts for about 70% of all British natural gas storage capacity.

Immediately, the news caused a spike in winter-month natural gas futures prices, as fears of a natural gas shortage come winter began to swarm.

Fears that seem to have come full circle…

An Ill-Timed Outage

In the midst of the “big freeze,” Centrica announced a 12-hour outage at the Rough facility.

As a result, gas prices for immediate delivery more than doubled to their highest level in almost a decade as the arctic chill, and high snowfall levels drove up the demand for heat and electricity. In fact, demand for gas was so high last week that the National Grid Plc asked large industrial customers to scale back consumption.

“The closure of Rough has changed the landscape for U.K. gas storage. and today that landscape looks very bleak for major energy users such as U.K. manufacturing industry,” Mike Foster, chief executive officer of the Energy and Utilities Alliance told reporters. “Prices have rocketed, hitting British industry particularly hard. If supply is interrupted, it will be the industry that has to stop production to protect consumers and their heating needs.”

In previous years, Rough acted as a buffer for supply shocks like the U.K. is currently dealing with. In fact, the Rough facility was previously able to meet as nearly 10% of the nation’s daily peak winter demand.

But with its impending closure, Centrica now is only withdrawing gas that remains at the site, and even that process is subject to hiccups like they saw last week.

And that’s creating a knock-on effect.

You see, in the summer, U.K. demand for natural gas comes primarily from gas being pumped into storage for winter heating.

And that has introduced the second major post-Brexit energy move…

British Gas is Being Exported – Only to Be Reimported Again at a Premium

The dramatic change in cross-currency valuations following the Brexit decision has resulted in the U.K. exporting more natural gas to Belgium.

The “spare fuel” being exported is actually coming primarily from volume that would have gone to Rough for storage…

Except that the weaker pound means that it’s now more profitable to send the gas along the east-west North Sea pipeline to the terminal center at Zeebrugge on the Belgian coast instead.

However, just about all analysts agree that the rising exports from Britain to Europe are more a result of the collapse in currency value than the impending Rough closure. A Brexit-induced “pounding of the pound” has provided some nice profits for European importers… and Centrica has obliged.

But for the average Brit back home, hoping to heat their house during this year’s “big freeze,” the short-term future may require a traditional British stiff upper lip.

Now, due to its limited natural gas storage capacity, the U.K. has tried to counteract its supply woes with increased LNG imports from Norway, Qatar, and the U.S. In fact, the National Grid welcomed its first LNG import from the U.S. last summer, as this super-cooled fuel continues to find new buyers abroad.

But even that has come with its own set of challenges this winter.

Truth is, even with the influx of supply from the U.S., LNG imports have been scarce across Europe this season, as a surge in demand from China and other Asian counties have driven up the cost of this super-chilled fuel.

Which left the U.K. with little maneuvering room when the cold arrived last week.

In other words, we’re looking at a nasty cycle: today’s rising exports of British gas will go to European storage, with some of that returning as higher-priced imports when the weather gets colder.

Now, Britain isn’t suffering alone.

Gas prices in the Netherlands have surged to more than four times the levels it saw this time last year, according to data from the Pegas exchange, after demand rose there with the cold.

But this isn’t the first time that natural gas price shocks have left U.K. consumers out in the cold this winter. In fact, the market was roiled by an explosion at one of Europe’s major gas trading hubs combined with a major outage at the North Sea Pipeline just before the Christmas holiday.

The bottom line here is, as I mentioned back in 2016, the energy situation in the U.K. is quickly heading from bad to worse.

A predicament that has only intensified over the past 20 months since I first wrote about it.

Which only goes to show that a global “energy balance” is more imperative than ever.

And as the rest of the world slowly starts to catch up to what we’ve been saying, this means one thing.

The next few years will be brimming with “energy balance” plays.

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