Month: August 2021

Submitted by Bill Blain via Blain’s Morning Porridge

“Anyone who claims to know the future of interest rates is certifiable.”  

The great Autumnal Bond Funding Season is upon us, but the looming taper of Central Bank Asset Purchase Schemes could well expose just how broken and dysfunctional bond markets have become. Markets always over-react to stress and panics, but when markets struggle with price discovery and liquidity, the coming sell off could be magnified, which means a great buying opportunity in bonds may be coming!

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There is lots to worry about this morning – the consequences of the Afghan Skedaddle on perceptions of the US, the inflation threats central banks wish us to believe are “transitory”, Hurricane Ida’s trail of insurance claims, the rising backlash against ESG, and the apparent emergence of a new SuperCovid variant that’s more infectious…

Instead.. this morning let’s think about the bond market, because in the bond market there is always truth… It’s still August (for a few more hours at least) but today marks the start of the 2021 Bond Market Autumn Steeplechase. With bond yields still falling despite taper talk and record stock market levels – it promises to be a fascinating season.

The September funding Boom is a traditional feature of the Eurobond market year. It’s when all the banks and bankers realise year-end is approaching and get desperate for fees from business closed, pushing their capabilities by being seen to do deals and rise up the league tables. Smart corporate treasurers will be dangling mandates for deals in front of their bankers – knowing this is the best time to get the finest and tightest terms because this when their bankers are most desperate. The result is we’ll see a deluge of new bond supply.

Normally, the funding orgy lasts a couple of weeks before investors start to gag on a succession of too tightly priced deals that widen soon after launch. But, hey-ho, pricing doesn’t matter because Central Banks are all out there buying corporate bonds as part of their QE Asset-Buying Programmes. So… it’s possible to sell just about anything…

This year corporate treasurers know the Taper is coming – that’s what Jerome Powell confirmed last week at Jackson Hole – so they will be even more enthusiastic to get their deals done ahead of the stable-door to cheap financing slamming shut.

And bankers? Well they remember what happened last time the Fed tried to taper its monetary experimentation – a panic and closed market, therefore its even more important to get deals done now.. done ahead of any market unpleasantness..

The Corporate Bond markets are anything but perfect. There are massive underlying problems as banks don’t support deals, the secondary market is “by appointment only” via brokers, small investors (ie anyone with less than a couple of hundred billion Assets Under Management) can’t get allocations of new deals, much of the market is now in ETFs, yet things could get even less functional.

I suspect this year’s funding steeplechase and the coming Central Bank Taper is going to expose a fundamentally broken market. Liquidity is dry and the price discovery mechanism is busted. I was recently fortunate to be shown some confidential numbers on European Government Bond market liquidity. Strip out the asset-purchase activities of the ECB buying bonds, and the numbers show the Bund, OAT and other European markets have seem volumes plummet in recent years.

The flows in fixed income markets were once circular – investors could buy and sell via market making banks who would set the price based on demand and supply, the orders they were seeing from their universe of clients. It worked. Now it doesn’t. Now, rather than bond holders calling a couple of banks to get the best price, there is no market making anymore. Central banks set the price of bonds. When they aren’t their buying – who will?

As banks don’t trade as market makers, there is no longer a price-setting mechanism – when the central banks stop posting bids, there is no-one to replace them. The result is likely to be a massive liquidity block on even the hint of Central Banks tapering their asset purchases… and that spells…  Opportunity.

When markets panic they over-react every time. When markets seize up – as I expect they will when the Taper becomes real – we’re likely to see massive over-compensation in bond markets, and by extension, in equity markets also. I suspect the coming bond market wobbles could prove to be something of a buying window.

Why? A small hint of taper will expose the broken mechanisms of the bond market in terms of price discovery and market making, but we also know Central Banks are unlikely to allow wild rises in interest rates. Since a bond price is a reflection of the likelihood the bond issuer is going to repay, and interest rates will be unlikely to change much… then a sell off becomes an opportunity to invest at a much more attractive yield when the interest-rate environment has barely changed.

But risk will have changed – a bond market sell off will trigger a crisis of confidence across markets changing perceptions and appetite for risk, which again is an opportunity for the wise to generate cheap cost opportunities.

The problem is… much of the bond market is under 35 and has never seen the conditions that caused the crisis back in 2008. On the other hand, and talking my own book….. some of us have weathered several bond market crashes… we’ve done it before, and know nothing really changes about the ways in which markets panic!

When the crisis comes… well you know my email and phone number!

Just when you thought Wells Fargo was finally putting its unpleasant regulatory transgressions behind it once and for all, today Bloomberg reported today that regulators aren’t happy with how quickly the bank is paying restitution and cleaning up its act. This, in turn, could lead to even more regulatory action heading the bank’s way. The news sent Wells stock tumbling more than 5% on the day.

The bank has already paid more than $5 billion due to its various fraudulent cross-selling scandals which cost the former CEO his job, but the Office of the Comptroller of the Currency and the Consumer Financial Protection Bureau are warning the company that new sanctions could be on their way due to how slowly the bank is fulfilling consent orders it signed about three years ago, according to a new article by Bloomberg.

If new sanctions point out wrongdoing by the company’s new management team, which took over in 2019, it could restart the clock on a Fed cap on the bank’s growth.

The bank has already paid out restitution to millions of consumers, but it is having trouble identifying which customers were affected and how much they are owed, the report says.  Now, regulators are mulling new fines and/or sanctions, or potentially even additional consent orders. 

Clues have started to emerge over the past few months that all wasn’t well with regulators, the report says. The bank disclosed in regulatory filings that it could face new consent orders and Scharf has said there could be “setbacks” in attempting to fulfill the needs of regulators. 

New Chief Executive Officer Charlie Scharf has said that his sole goal has been satisfying regulators, recently adding that “while what’s required for each is clear, there are numerous complexities with managing this amount of work concurrently. It will take time to consistently accomplish all at the level we and our regulators expect.”

The implications for the bank could be far reaching, should regulators decide to sanction it again. Not only would the optics be ugly, as the bank has spent the last 3 years on a PR campaign to make it look like it is cleaning up its act, but additional sanctions could also throw a wrench in the gears at the other inner-workings of the bank, as we noted on Twitter today.

If Wells is hit with another regulatory action which limits its balance sheet, that would be especially problematic for tapering as it is one of the few banks with capacity to buy TSYs

— zerohedge (@zerohedge) August 31, 2021

Now that the last American soldier (though not the last American citizen) has left Kabul, President Biden has apparently gotten permission from his handlers to address the American people and remind us all that the disastrous final moments of the nearly 20-year-long war weren’t his fault.

With 90 retired generals signing a letter calling on Biden’s defense secretary and leader of the Joint Chiefs of Staff to quit and take responsibility for the disastrous pullout, the messiest pullout in US history, according to President Trump, it’s hardly a surprise that President Biden feels another face-to-face with the American people is necessary.

He is slated to begin speaking at 1445 (though he has been notably late recently):

As we noted earlier, now that the Taliban have taken control over every province in Afghanistan except for 1 (the rebel bastion of Panjshir), it’s up to them to govern effectively. To try and accomplish that, they’re seeking help from one of the most unlikely places: the US (along with Russia and China).

There are still at least 100 to 200 American citizens trapped in Afghanistan after being unable to reach the airport. Right now, it’s unclear when commercial flight will restart; Turkey has reportedly offered to assist the Taliban in getting the airport up and running against.

Ahead of Biden’s speech, Republican lawmakers held a press conference criticizing Biden’s “bungled” removal of troops from the country. Meanwhile, the MSM has taken every opportunity to point out that the timeline for the withdrawal was set by President Trump in negotiations with the Taliban.

But whatever happens next in Afghanistan – it’s not America’s problem. Or at least, not yet. 

Aluminum prices on the London Metal Exchange hit a 10-year high Tuesday, extending a year-long vertical surge as demand rebounds and supply shrinks, as smelters in top producer China faced tougher power controls, stoking supply worries for the energy-intensive metal. Benchmark three-month aluminum climbed 1.8% to $2,696 a tonne in official trading after touching its highest since May 2011 at $2,726.50, and rapidly approaching all time highs around $3,000.

In China, the most-traded October aluminum contract on the Shanghai Futures Exchange closed up 1.2% at 21,390 yuan ($3,311.09) a tonne, hovering near its highest since August 2008 of 21,550 yuan a tonne hit in the previous session.

Aluminum prices have been supported by production curbs in Chinese smelting regions often aimed at easing the strain on the power grid. The latest price surge comes as the government in China’s Guangxi region, an aluminum and alumina production hub, on Monday called for tougher controls on energy consumption in a statement issued after a teleconference. The region is China’s third-biggest producer of alumina, a primary product of aluminum, with output of 925,500 tonnes in July, according to the National Bureau of Statistics.

A stream of announcements from China about the challenges faced by smelters, combined with soaring global demand, have buttressed prices, said Wood Mackenzie analyst Uday Patel. China’s production would still rise this year compared with last year, albeit at a slower pace, he said, adding that its output is about 500,000-600,000 tonnes lower than was expected at the start of 2021.

Meanwhile, Consultancy Mysteel said that eight aluminium smelting companies in Guangxi will have to keep their September production at a maximum of 80% of average monthly output in the first half of the year. That could equate to a reduction in annual operating capacity of 475,000 tonnes, it said.

“The impact of power and production restrictions in Yunnan is still expanding,” Huatai Futures said in a report, adding the addition of other production areas to the list was not ruled out. Yunnan, as Reuters reminds us, is an aluminum hub and has seen some smelters forced to cut production due to power curbs this year.

The China Nonferrous Metals Industry Association held a meeting of top aluminum smelters on Monday to address what it described as an “irrational surge” in aluminum prices. Paradoxically, also on Monday, local government officials gathered to discuss cutting output of energy-intensive materials in response to Beijing’s campaign to save power and restrain emissions, according to people familiar with the situation. The meeting followed comments last week from Vice Premier Han Zheng, who called for nationwide curbs on industrial activities that produce too much pollution or fail energy-intensity standards.

The problem is that by further shrinking supply, prices will explode even higher. Amid the confusion, analysts are trying to forecast where the demand and supply curves – both of which are in constant flux – will settle:

“A slew of Chinese policies has recently come to affect aluminum output, pushing prices higher,” Wei Lai, an analyst with TF Futures Co., told Bloomberg via phone. “Policies including the power consumption cap are expected to stay through the rest of the year. So the upside momentum remains for aluminum. Prices can hardly retreat as long as demand remains intact.”

The metal, which has wide applications in everything from car pates, appliances, defense weapons, airplanes, and even down to the typical soda can, has faced strong demand since the pandemic after global central banks and governments unleashed trillions of dollars in stimulus. Goldman Sachs’ Jeffery Currie told clients last week: 

As demand improves seasonally from September, aided by reduced lockdown effects and some probable supportive policy adjustments, we expect continued tightness onshore into Q4 and support for higher import volumes of refined metal. This fundamental setup will offer support for a trend higher in both copper and aluminum prices in particular.

Deutsche Bank’s Liam Fitzpatrick expanded more on China’s curtailment of power in industrial hubs that will impact metal outputs: 

Aluminum prices in China have reached the highest levels since 2007, reflecting a range of production disruptions, including emissions-related curtailments and power rationing. The tight power market and recent announcement from the NDRC that a number of provinces missed their power consumption targets in H1’21 increases the risk of further smelter curtailments/ramp-up delays later this year and in 2022. Earlier this month, the Chinese government issued the “Barometer of Completion of the Dual Control Targets” for energy consumption in H1’21. Five provinces with substantial aluminum capacity (~16 mt productions in 2021) received first-level warnings and will face pressure to reduce energy consumption for the rest of the year. 

China produces about 60% of the world’s aluminum and output reductions suggest prices will remain elevated for the foreseeable future, further denting any hopes that the current price surge will be “transitory.”

Op-Ed Authored by Merryn Somerset Webb via the Financial Times (emphasis ours),

What’s the point of a central bank? The old fashioned among you will think the answer to that is obvious: to manage interest rates and the supply of money such that inflation remains firmly under control. Central bankers have different ideas. Where they once liked to consider themselves technocratic, they now think of themselves as rather more nuanced — able to “look through” inflation rather than being wedded to metric-driven interest rate rises.

And where they once figured that they had just the one job, they now seem to feel the world needs their input on pretty much everything. Former Bank of England Governor Mervyn King recently complained about central banks “moving into the political arena”, and with good reason. Data from the Bank for International Settlements show that references to “inequality” have risen sharply in central banker speeches, while the chief executive of the Reserve Bank of Atlanta (among others) called for central banks to “play an important role in helping to reduce racial inequities and bring about a more inclusive economy”.

You can also be sure that climate change will get a mention within the first few minutes of every speech at the central bankers’ (now virtual) meeting at Jackson Hole. At first glance this might seem to make perfect sense. The European Central Bank’s Christine Lagarde explains it in terms of the fable of the mice, the cat and the bell: all the mice agree that life would be better for all if the cat wore a bell — but no one wants to be the one who actually creeps up and attaches the bell.

To want to help with the bell placing is not mission creep, she says, but “acknowledging reality”. You can also argue that it fits perfectly within the traditional brief of most central banks: if, say, climate change could in the medium term be both a nasty driver of inflation and a challenge to long-term financial stability, why shouldn’t central banks have a go at helping out? Most other central banks agree: the Bank of England has climate change down as a “strategic priority”.

There are a good few reasons why this is a mistake. The first is that most of these things are none of their business. Central banks have huge power — but as their leaders are unelected it is vital that that power remains as contained as possible. Look at what has already happened over the past decade as central banks have blended monetary and fiscal policy, first by using quantitative easing to finance anything governments fancy, and second by turning a blind eye to the asset market bubbles and fast-rising wealth inequality that their insanely loose monetary policy has created.

There’s a reason the wealth of the world’s billionaires has soared during the pandemic — and it is more likely to be the $120bn of bonds the Federal Reserve has bought every month than fast global GDP growth (the S&P 500 is up 21 per cent so far this year alone). The inequality that the world’s central banks are so worried about? They might have caused much of it. In that sense they have been dabbling in politics for a long time already. Just not in a good way.

The second is that once you start mission creep (for that is what it is) where does it end? It is possible that climate change might cause inflation. But so can a shortage of HGV drivers (currently causing supply havoc in the UK) — and thus far no one has suggested the Bank of England have policies to speed up the training of lorry drivers. These are jobs for other organisations.

However the most obvious reason is that central banks have more than enough to do just covering their basic brief. The developed world is in as hideous a monetary policy trap as it is possible to imagine. Low rates are causing asset price bubbles all over the place (from housing to NFTs); ordinary people have no hope of getting a real return on their cash; inflation is confusing and potentially frightening; and the rise of cryptocurrencies is threatening central bank control over transactions and deposits.

Just trying to figure out if inflation is transitory — or not — would be enough work for most institutions. And that’s before you see the way clear to back out of the monetary policy of the last decade. Once you’ve let markets bubble, how on earth do you unbubble them?

Now try doing that, all the other things mentioned above, and worrying about politics. You might soon find you can’t see the macro for the micro. How for example would you square raising interest rates sharply into fast rising inflation, with protecting minority groups who have high levels of debt or low levels of employment? And how do you keep inflation expectations anchored if everyone knows you have that conflict? That’s not a job description most people would write themselves — particularly given that the last bout of nasty inflation happened in the 1970s (when central banks were explicitly not independent of politics).

Mission creep is a common problem. It might be time for national politicians to start insisting that political issues are left to them and that everyone else just gets on with their own jobs. Local councils could fix the roads really quickly. Companies could make, sell and deliver stuff. And central banks could use monetary tools to have a go at controlling inflation. Much easier all round.

Merryn Somerset Webb is editor-in-chief of MoneyWeek. Views are personal. merryn@ft.com. Twitter: @MerrynSW