Hot Fun in the Summertime
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DOW – 85 = 18,105
SPX – 10 = 2105
NAS – 9 = 4993
10 YR YLD + .12 = 2.27
OIL – .10 = 59.29
GOLD – 4.00 = 1184.50
SILV – .13 = 16.38
The S&P 500 Index went up to 2117.69, it sat there for a couple of seconds then fell; the reason this is important, or not, is because 2117.69 is the record high from April 24; also, last Friday, the S&P hit 2117.66 for an intraday high. It has been at or near this level several times in the past 3 months, but it can’t break through. Meanwhile, about $100 million in options on the VIX changed hands at 12:16:04 this afternoon; that’s a little more than a half day’s normal volume in a split second. The VIX is the Volatility Index. Just over 1 million contracts were traded. The trades were spread among four contracts that pay off at different dates and prices, say if the VIX rises to 17 by June or 23 by July. We don’t know who made the trade, but somebody is betting things will get hot this summer.
On Friday, the Jobs Report showed the economy added 223,000 jobs and the unemployment rate dropped to 5.4%. We’ll get more information on the labor market tomorrow with the JOLT survey, which takes a look at job openings and labor turnover; that should tell us whether workers are confident enough about their job prospects to quit their current job. On Wednesday, we’ll get reports on retail sales and inflation at the wholesale level.
The bond market tantrum that lasted for most of the past three weeks seems to be cooling off as signs of mixed global economic growth revive demand for the fixed-income assets. In that time frame, the amount of bonds trading with negative yields has dropped from $3 trillion to $1.7 trillion in a sign that borrowing costs may have hit their floor. Benchmark 10-year Treasury yields at today’s level of 2.27% have risen beyond the level many economists projected for mid-year, while German bunds remain little changed at 0.61%. And it may surprise you that short-term US bonds have been slipping in and out of negative territory.
The problem is there aren’t enough to go around. With supply at multi-decade lows, investors are signaling alarm as regulations intended to shore up banks and prevent a run on money-market funds exacerbate the bill shortfall. Financial institutions expect an extra $900 billion of demand for government securities during the next 18 months, putting pressure on a sizable chunk of the $1.4 trillion bill market. It might even put pressure on the Fed. What if the Fed raised its Fed Funds target rate, and short-term rates went down? The mismatch between supply and demand has been so acute that four-week bill rates fell to minus 0.0304 percent on April 29, the lowest on a closing basis since December 2008. Yields on three-month bills also turned negative. The consequences extend well beyond the fixed-income market as depressed rates in the $2.5 trillion money-market fund industry stand to deprive savers of income long after the Federal Reserve starts raising interest rates.
The Treasury says it will sell more short-term bills, but they haven’t offered details. Meanwhile, the government seems focused on longer-term debt. The average maturity of US debt outstanding has stretched to 69 months. One reason for the increased demand is that banks and other financial institutions have higher capital requirement; that makes deposits more costly for banks to hold, so they are discouraging some depositors from depositing cash; the logical place for cash not deposited is in short-term bills.
Now for the good news/bad news. The good news for the bond market is there isn’t much cash sitting on the sidelines. The bad news for the stock market is there isn’t much cash on the sidelines. Mutual fund managers have the lowest cash levels in history and money market fund levels are lower now than in 2007 and near a record low from 2000 relative to the capitalization of the stock market. This suggests that investors are heavily allocated in stocks. So what is propping up the stock market? Buybacks, mergers and acquisitions, and demand from foreign central banks; all of which falls under the category of financial engineering.
At least 30 countries have loosened monetary policy this year. On Sunday, China’s central bank cut its benchmark one-year lending rates by 25 basis points to 5.1%, its third reduction since November, as economic growth cools to levels not seen since the global financial crisis. The People’s Bank of China also reduced one-year benchmark deposit rates by 25 bps to 2.25%; it also gave banks leeway to offer up to 1.5 times the benchmark deposit rate, up from 1.3 times previously. Now you might be wondering why the PBOC would cut rates, which would encourage more lending activity, while at the same time increasing rates for people to park money in deposits, which takes money out of circulations.
Part of the problem for China is that they still peg the yuan to the dollar, and the dollar has been strong; if the yuan follows the dollar, it leads to effective monetary tightening despite two rate cuts so far. Since mid-2014, China’s real effective exchange rate has appreciated by more than 15% against its peers. Also, as the PBOC is buying back its own money to protect the level of the yuan, this is again another form of tightening. And in a further counterproductive move, the more China cuts interest rates, the more it encourages capital to exit due to declining yields. If that new money created is not leaking abroad, it is either going into servicing China’s large existing debt or else is flowing into the stock market rather than going to supporting real economic activity.
And while China has strong capital controls in place, smart investors follow the money. The problem for mainland Chinese authorities is they are not in control of how private holders of wealth move their money. For example, only last week it was revealed Chinese investors and immigrants together purchased more than $6.3 billion in Australian residential property over the space of 12 months. And if the People’s Bank of China loosens monetary policy at the same time that the Federal Reserve tries to hike rates, this might trigger further capital outflows into the dollar.
China overtook the U.S. as the world’s biggest importer of crude oil in April, with purchases from overseas hitting a new high of 7.4 million barrels a day (equivalent to roughly one in every 13 barrels consumed globally) and topping U.S. imports of 7.2 million barrels per day. While China’s imports are not expected to consistently surpass those of the U.S. until the second half of this year, the move highlights how the U.S. shale revolution has cut the country’s reliance on oil from overseas – and how China’s demand has grown even as its economy slows.
Eurozone finance ministers met today in Brussels to discuss Greek debt. Athens has reportedly scraped together 750 million euro to pay the International Monetary Fund. However, the coffers in Athens are thought to be completely dry and it’s uncertain how Greece will make welfare payments in the coming days. The IMF is now working with national authorities in southeastern Europe on contingency plans for a Greek default.
Citigroup says the Justice Department declined to prosecute the bank after a probe into rigging of the London Interbank Offered Rate, or Libor. In 2013, Citigroup agreed to pay $78 million as one of six banks to settle with the European Union over allegations they rigged interest rates tied to Libor. Citigroup still has legal problems. In a regulatory filing, Citi said it could plead guilty to an antitrust charge to resolve a Justice Department investigation of its dealings in foreign exchange markets. And Citi might not be alone. The parent companies or main banking units of as many as five major banks, rather than their smaller subsidiaries, are expected to plead guilty to US criminal charges over manipulation of foreign exchange rates; deals could be announced this week. It would be unprecedented for parent companies or main banking units, rather than smaller subsidiaries, of so many major banks, to plead guilty to criminal charges in a coordinated action. The banks looking at a forex deal include JPMorgan, Citigroup, Royal Bank of Scotland, Barclays, and UBS. If parent companies of JPMorgan and Citigroup plead guilty, it would be the first time in decades that a major American financial institution has done so.
The Justice Department has been negotiating with the banks for months over how to resolve allegations that traders colluded to rig rates in the largely unregulated $5.3 trillion-a-day currency market. Authorities now may seek to limit the fallout from guilty pleas with assurances from various regulators that banking licenses will not be automatically revoked. Institutions may obtain waivers if the pleas would otherwise prohibit them from business activities such as participating in certain private offerings, or trading in government securities.
Noble Energy agreed to acquire Rosetta Resources for $2.1 billion in stock, giving the natural gas and oil producer a position in two of the largest areas of shale production in Texas. It’s the largest takeover of a U.S. oil and gas producer announced this year. Noble will also assume Rosetta’s net debt of $1.8 billion. The per-share offer is valued at $26.62, a 38 percent premium to the target’s closing price on Friday. The premium for Rosetta is below average for the sector over the past five years, suggesting there are more mergers to come.
DTZ, a commercial real-estate-services firm backed by TPG Capital, has agreed to buy Cushman & Wakefield, the largest closely held commercial-property brokerage, in a deal that values the company at about $2 billion.
The World Health Organization has declared Liberia free of Ebola, marking the end of a national outbreak that infected as many as 400 new victims a week at its peak. Liberia has now gone 42 days – twice Ebola’s maximum incubation period – since the burial of its last confirmed patient without discovering a new case. The disease is still spreading in Sierra Leone and Guinea, though at a slower pace. According to WHO statistics, more than 11,000 people have died from the virus, with about half of them in Liberia.
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