MORNING BID – Dot Matrix

Apr 10, 2014 12:52 UTC

The Federal Reserve did it again, giving back to the markets at a time when it wasn’t expected, and showing once again that the early months of a new Fed chair’s tenure are fraught ones, in terms of interpreting monetary policy.

Janet Yellen probably didn’t mean to suggest rate hikes could come as soon as six months after the bond-buying program ends for good. And the release of the Fed minutes also demonstrated that the Fed – even in discussing projections – worried about how it would all look, specifically the “dot matrix” that showed several Fed members saw higher rates before long, and really, that it was all just kind of overstated. (Yellen even said this at her press conference – that the dots did not mean what you thought they meant).

Either way, that’s wreaked some havoc on expectations for policy, with the market shifting back towards thinking this is all going to come down a bit later than expected. This comes just after the most recent Reuters primary dealers’ poll that suggested major strategists were finally getting comfortable with the idea of possible rate hikes in the first half of 2015 rather than later – there were 8 who saw that happening out of 18, compared with just 4 in the previous poll. CME Fedwatch data shows now the chances of a rate increase before July at 42 percent, down from 52 percent on Tuesday.

“The latest round of minutes highlighted a Fed that in the interest of being ever-more transparent really continues to muddy the waters even more,” wrote Tom Porcelli, fixed income strategist at RBC. But honestly? Early in a Fed chair’s run, that’s just not unusual, and difficult for the market to take after spending several years getting used to someone’s tendencies.

So that happened. Really, on some level we’re still talking about developments scheduled to take place more than a year from now, and markets can only discount so much.
Either way, it helped unwind some of the selling that the market had seen in the short end of the curve, steepening the curve once again and reducing some concern about the front end and the effects of the higher short-term rates and the flattening of the yield curve. It also sparked some life in the biotech and other momentum names as well, though for how long is another question.

Markets will keep an eye on the 30-year bond sale later today, the last of three auctions in the quarterly refunding. Lately, Treasury auctions have been a complete wild card, with bidding by direct bidders – those who aren’t going through the 22 primary dealers in Treasury securities who directly deal with the Treasury and New York Federal Reserve – all over the map.
Direct bidding was high in some recent auctions, especially in the three-year auction on Tuesday, and then fell off again on Wednesday. Coupled with the recent spike in bank buys of five- and seven-year paper, there are a lot of questions around the dynamics in the Treasury market right now.

We’ll be looking at this phenomena later in the day and the market gets the third of its three auctions this week, the 30-year bond sale that shapes up to be relatively attractive given the release of Fed minutes that showed the Fed’s whole deal about being more aggressive in rate cuts? Never mind all that stuff or what not, we’re going at the same pace that we’d been going.
Concern over what was to happen with the Fed minutes (just one hour after the auction) may have kept buyers cooling their heels with the 10-year note sale on Wednesday. Still, much remains unclear about activity in the Treasury market where long-dated yields remain at relatively attractive levels and the short end saw yields drop to their lowest in weeks as prices rallied after the Fed minutes.

MORNING BID – The same-store situation

Apr 9, 2014 13:36 UTC

Same-store sales figures may be enough to inspire some investors to resume paring portfolios of some consumer discretionary stocks that have underperformed in the last five or six weeks.

Equities rebounded on Tuesday, but the overall feeling is that the market hasn’t yet finished with the bout of selling infecting the high-volatility, high-beta names that dominate conversations.
Most consumer names aren’t in this rarefied air (they don’t trade at price-to-sales ratios of a gajillion) but they’ve still been a target for some time on bad news.

The ones to watch are the likes of Costco, expected to come in strongly, while teen apparel retailers face some pressure, even with easy comparisons to a year ago. Gap, Zumiez and Buckle all look to post worse year-over-year results for March, and Shoppertrak data has shown how mall visits have changed over time. People no longer wander the mall for hours, but find deals online, shop at a few stores, and get outta there. That’s not a weather thing, that’s a “how I run my life” thing.

This data is likely to be bad news. Excluding the drug store sector, same-store sales are expected to have grown at a 1.5 percent rate for March, down from the 2.7 percent growth rate for the ex-drug sector last year, according to the Thomson Reuters outlook.

Investors hope retailers see a pickup in the next few weeks and that the group’s earnings reports point to underlying demand that was at least seen in the car-sales figures and some signs of home-buying activity. That might revive some demand for that sector, which is down 5.4 percent since March 7.

Hedge funds seem to be still reducing positions in this area even as they don’t drop out of the market entirely; ETF flows this past week show more reduction in buying in consumer cyclical shares, according to Credit Suisse, though it hasn’t been terribly pronounced.

There’s been a bit of strange activity here and there in some of the official Fed and Treasury data.
First, a number of weeks ago, someone either sells or moves about $100 billion in holdings that had been custodied with the Federal Reserve – the biggest ever such move.

It has since been restored, and yet it remains a mystery; speculation had focused on Russia as the culprit, but no proof is there. Monday, new data showing who the buyers were of the most recent Treasury auctions (two weeks ago) showed a big buy by banks and other similar institutions of five- and seven-year notes. They accounted for about 15 percent of the auction, compared with about 0.11 percent of the February auctions of five- and seven-year paper.

Again, there’s not much in the real facts here and a lot of speculation – quarter-end positioning wouldn’t seem to make sense, as banks looking to shore up their balance sheets could just buy lots and lots of bills. Is it mortgages? Unclear.

MORNING BID – Pitfalls and switchbacks

Mar 31, 2014 13:36 UTC

This week profiles as one that contains a bunch of potential minefields that could challenge the market’s prevailing view on what’s to happen with major market-moving events.

The ECB meeting is one of the more obvious ones, what with investors expecting for some time that the euro would push higher and higher on the expectation of an improved outlook in the economic situation there.

That changed somewhat abruptly last week when Bundesbank President Jens Weidmann came out with some rather dovish comments that threw people for a loop. This looks like there could be some kind of situation where people are positioned against a rebound in the euro, only to be disappointed by the lack of action from the ECB should it go down that way.

The same can be said when it comes to events like Friday’s jobs report. The market still has to try to suss out the likely reaction to this and weekly positioning figures that show the market’s short position in five-year Treasury notes getting bigger than a week ago, as for other parts of the yield curve. A modest long position in two-year futures turned into a short position last week; long positions in the 30-year contract were trimmed, and investors extended short positions in the five- and 10-year area as well.

That seems to set up nicely for a jobs-report-weather-payback kind of deal this Friday, but it’s entirely possible that this won’t happen, and we’ll have another weak result on the jobs front. The latter would certainly reverse a lot of these bets and make for some volatile action as investors try to figure out what’s going on.

Either way, Jason Goepfert of Sundial Research points out that the positioning in the five-year hasn’t been this short since 2005, and even then, that short position was eventually overrun by unexpected consequences that resulted in a multi-month rally – so let’s be extra careful out there.

Ukraine’s situation remains fraught with concerns about Russian designs on part of the Ukrainian mainland following the annexation of Crimea.
And herein we have a third possibility of surprise, where tensions worsen, the price of oil spikes, and the European economy, much more dependent on Russian engineering than the US or the Far East, feels the pain, again, hitting the euro.

And then there’s China. The Financial Times reported bad loans written off by China’s biggest five banks increased by 127 percent in 2013. This is an ugly situation that will stoke concerns about a potential debt crisis, one made worse by the strange nature of many Chinese loans, whereupon deals made to borrow in dollars were backed by copper – which has been sinking as investors sell the metal for collateral.

MORNING BID – $4 trillion, through the eye of a needle

Mar 28, 2014 13:19 UTC

The shift in the stock market away from momentum names and toward value is encouraging at least in some sense because it points to an ongoing appetite for equities rather than a reduction in interest there. However, one has to add the caveat that the Federal Reserve is still very much a part of this market, even as it diminishes its footprint.

The $55 billion in bond buying per month definitely continues to underpin rates and keep funding costs low for companies. Still, the market has reduced its reliance on the central bank and yet bond yields continue to sink, at least in the long-dated part of the curve, where the 30-year note neared 3.50 percent and the 10-year came close to 2.60 percent yet again.

The immediate expectation would seem to be for still-higher rates, particularly in the short end of the yield curve, where investors would be thought to trim positioning as the yield curve flattens. The market-implied rates suggest bonds are still a ways behind where the survey expectations are for the Federal Reserve – a two-year rate of just 0.45 percent will do that.

On the other hand, Citigroup analysts point out that the Fed has been consistently overestimating inflation and growth, and the Fed continues to want to adjust its target for when it will start raising rates, moving most recently from “definitely when unemployment hits 6.5 percent!” to “definitely when we say so, based on lots of indicators or something!” So maybe it’s not an underestimation so much has it is prudence. And those expecting more curve flattening, that is, buying in the short end and selling in the long end, would be ignoring that forward rates – the market’s expectations for rates going out into the future – already imply substantial flattening out (47 basis points between the 10 and 30, compared with 56 basis points in June 2004 when the Fed last began rate increases).

What’s that make out as? Essentially, Citigroup things it’s not a given that the short end will continue to sell off in a rapid fashion, but that things might take time, and the market is already on some levels pricing in a rate increase. So the slow unwind of the most accomodative monetary policy ever has begun, and it’s starting to show in rates markets, if not equities. Reducing or rolling off this $4 trillion balance sheet is threading the smallest needle in history will be quite the feat, if it can be done without more major shocks.

MORNING BID – Hi Janet, Here’s a Selloff.

Mar 20, 2014 14:06 UTC

Welcome Madame Chair, here’s a market selloff for you.

Fed Chair Janet Yellen made some news that she didn’t expect yesterday. She perhaps thought she was offering some clarity when she answered the question from Reuters’ Ann Saphir as to when the Fed might start raising interest rates. That’s not how it worked, although at least in this case she didn’t mouth off to Maria Bartiromo the way Ben Bernanke did eight years ago.

What we didn’t see in her answer on the distance between the end of QE3 and the first rate hikes of “six months” (or something like that), is whether we will start to see any kind of reaction from the primary dealers surveyed by Reuters yesterday.

Most still see the Fed not raising rates until late in 2015 although there were a couple of notable changes. Barclays moved up its expectations for the rate increases to the second quarter of 2015. There were still, however, four dealers that do not see rate hikes coming until 2016. This may, on some level, put the Fed behind the curve as interest-rates adjust, though it was notable to see several Fed members in the Fed’s projections believe rates should be at 1 percent by the end of 2015. (It wasn’t much of an adjustment, but somehow, the way it looked on the dot matrix chart the cool kids were talking about was enough to get the bond market in a lather. The stock market, of course, didn’t react until someone (Yellen) told it what to do.)

What is undetermined now, however, is what the Federal Reserve will be looking at when it decides whether to raise rates or not. The market has gotten awfully used to the idea of a threshold on the unemployment rate that made things easy. Without that, it reverts to looking at a number of indicators, although the Fed chair yesterday did say that she thought the unemployment rate was one of the best indicators.

It is perhaps to the markets’ credit that many commentators remarked on the Fed’s use of several indicators as worrisome. In years past, there was great praise for Alan Greenspan just because he used to discuss looking at various pieces of data in his bathtub or whatnot. Now the market finds such alchemy to be less comforting. That may at least be a sign of maturity. Or, perhaps, the Fed has through years of communication efforts changed the markets’ belief that the Fed chair should be this omniscient presence in the market. If so, that bodes well for what is usually an awkward transition between Fed chairs. This may make that much easier, regardless of what Yellen said.

MORNING BID – Puerto Rico in the spotlight

Mar 11, 2014 13:45 UTC

The market remains in a bit of a vacuum, with interesting activity focused on a few speculative investments that don’t necessarily suggest anything about the larger environment – though one could extrapolate from the interest in these myriad issues that the market is getting frothy, one way or another.

The island of Puerto Rico will sell about $3 billion in bonds to a varying group of investors on Tuesday, many of whom are likely not to be traditional municipal bond buyers. What’s interesting to see, as our muni team pointed out late Monday, is that the bonds appear set to sell at an 8-percent coupon, with yields somewhere in the mid-8s or high-8s. That’s nowhere near the 10-percent yield that some had expected. (Full Story)

What may be happening is a bit of fortuitous timing as the market had been in the midst of a half-way decent rally for a bit here and as investors clear the decks of some emerging-markets assets that have underperformed. The rest of the world has caught a bit of a cold here, it seems, so safer assets – and Puerto Rico qualifies on some bizarre level – will reap the rewards.

Some of it is also the buyers: Distressed debt funds and high-yield funds, along with hedge funds looking for fat yields and a bit less concerned about the implied risk that the junk-level sale suggests. The constant refrain one hears is that people would invest in somewhere other than the stock market but have nowhere to go. Well, there’s some nice beachfront property here.

Tuesday also promises the latest chapter in the saga of Bill Ackman vs. Herbalife HLF.N. This has so far not worked out all that well for Ackman, given the share increase in the last 12 months (admittedly, the stock has been weaker so far this year, losing about 18 percent). The hedge fund manager is expected to make a presentation that will include new allegations relating specifically to its operations in China, suggesting the company is violating laws in that country.

The Ackman thesis, essentially, is that Herbalife is a pyramid scheme, where only the first few investors are guaranteed to make money, though he has motivated opponents on the other side, including Carl Icahn, and of course, the company itself. As of Friday, about 18 percent of the company’s shares were being borrowed for short bets – a high figure – though it had been more than 20 percent a few months ago, according to Markit data.

Options action doesn’t really suggest much of a move for the rest of the week (at the money straddles put it at about 5 percent), suggesting people have, in part, grown weary of this battle, even as Ackman is reluctant to give it up.

MORNING BID – But I never could find…(sha na na na, sha na na na na)

Feb 7, 2014 14:05 UTC

An odd jobs report sets the tone for what’s likely to be another choppy day in the markets – stock futures plunged, briefly, after the Labor Department said nonfarm payrolls grew by just 113,000, but the household survey saw a drop (again) in the unemployment rate to 6.6 percent on a big gain in jobs in that survey. An odd decline of 29,000 in government payrolls offset the overall about-at-trend-but-let’s-not-kid-ourselves-about-this-being-awesome 140,000 or so gains in the private jobs market, so there’s a little bit to like, some to shake one’s head at, and still more to wonder about how many people didn’t get to work because their feet froze to the ground when they tried to get into their cars.

(More seriously on that point – the establishment survey doesn’t get some kind of massive job loss just because of a storm on a particular day of surveying, so it’s not as if a snowstorm destroys job growth, so let’s not overstate the weather issue here. It’s a factor, but don’t look for a revision to +300,000 or something.)

The activity in equity futures, however, seems to point to where we’ve been all along: jobs growth, factory activity and overall economic figures are just enough to put a brake on getting any kind of incipient rally and keeping the buyers less motivated right now, though the shallow correction we’ve seen so far appears to have hit a stopping point for the time being. Futures bottomed out around 1758 on the S&P E-Minis, a few points below the level the market had been sitting at before the downdraft that took futures to about 1730 for a few days. Stocks recovered from that level and now appear content to hang out around 1760 or so or even a bit higher, while the bond market is doing something similar – a quick post-jobs rally that took yields down to about 2.64 percent on the 10-year before the buyers eased off the throttle, lifting yields again to around 2.67 to 2.70 percent. Absent more emerging markets turmoil – and this appears to have been somewhat stemmed in the last few days, though maybe that’s just because we haven’t had bad news from China in the last day or two – these levels might end up prevailing for some time.

The jobs number of course raises the usual back-and-forth about whether the Fed might decide to accelerate or decelerate its schedule for winding down stimulus, but with the Federal Reserve – and especially with a new chair coming in – predictability when it comes to this policy is probably the preferred course of action. There’s enough weather-related shenanigans and uncertainty about global growth offsetting the relatively solid economic figures for the Fed to not want to jolt markets, and the Fedsters have been talking pretty tough on this one, essentially making it clear that this wind-down will become the equivalent of stock buyback programs: They continue, no matter what, unless something drastic happens to alter that expectation.

While we’re on the subject of buybacks, Apple is upping the ante on its own share repurchase schedule, succumbing to some of the pressure from the likes of Carl Icahn and others who have demanded the company boost shareholder returns in the absence of real spending plans. And of course, Apple has a ton of cash on hand, and they’re generating enormous profits even if they’re not the growth engine they had been in the past. It’s a bit early to say that the company should be lumped in with the likes of Exxon or IBM – gigantic businesses mostly notable now for moving money around, using up their free cash flow (and then some, thanks to low borrowing costs) for buying back their own shares.

Some analysts, notably Tobias Levkovich of Citigroup, have done studies that show that serial repurchasers – those who are steadily reducing their outstanding share count (share shrinkers, to come uncomfortably close to a Costanza-ism here) – have been better performers in the stock market over the last decade, with a total return of about 550 percent coming into the year compared with the S&P, which is up about 200 percent since the beginning of 2003. From a shareholder perspective, that works as long as these companies are so entrenched that their products deliver big sales at steady margins; once they fall behind, though, look out.

MORNING BID – Contagion abounds, and the Super Bowl

Jan 31, 2014 13:57 UTC

On Thursday, this column suggested that a bunch of stock markets selling off in tandem did not satisfy the definition of contagion. Central banks dumping U.S. assets, weak auctions of government debt in seemingly less related countries, and big sell offs in less affected currencies? That’s getting closer to the mark.

Foreign central banks cut their holdings of U.S. debt stored at the Federal Reserve by the most in seven months in the past week, in a bid to defend weak currencies. “It makes sense,” said Scott Carmack, fixed income portfolio manager at Leader Capital, which has $1 billion under management. “It will probably continue as emerging markets try to prop up their currencies.”

So, overall foreign holdings of securities like Treasuries, mortgage-backed securities and agency debt at the Fed fell by $20.77 billion to $3.325 trillion in the week ended Wednesday, the biggest drop since June. The overall draw-down has come to about $55 billion since the Fed first said it would cut back its monthly bond buying. Debt and equity funds, meantime, continue to shift away from the emerging markets, with EPFR reporting a pullback of about $10 billion from such funds; debt funds have shed $4.6 billion so far in 2014, about one-third of 2013′s total drawdown of $14.3 billion (and that’s for a full year).

While in some ways, the most attractive solution for some of these countries to try to stem capital flight is through higher interest rates (making their debt more attractive to investors who need a bigger return over inflation, which is too hot in places like Brazil and Turkey), higher rates aren’t going to entirely solve the problem. And so you get the spectacle of Hungary cutting its 1-year Treasury bill auction and yields rising by about two-thirds of a percentage point just to garner enough interest for what they did manage to sell.

Hungary’s less in danger than some other countries. It’s got a big current account surplus rather than a deficit, but that hasn’t stopped investors from pulling back there either, driving the forint to a two-year low against the dollar.

The ongoing weakness in currencies – which many analysts say has not yet run its course – is going to pinch economic growth in tandem with higher rates. This can sometimes launch a vicious cycle that has consumers in those countries saving money rather than spending it – again, because of inflation. Combine that with a slowing in capital flows, and a weak export environment thanks to the China slowdown, and it gets a lot uglier, as Reuters’ Sujata Rao pointed out in an overnight story.

She quotes Steve O’Hanlon, a fund manager at ACPI Investments, who summarizes it well by saying: “Markets are pricing a pretty dire situation in emerging markets (but) is EM cheaper given potential future output? I wouldn’t say so but it’s getting there. When currencies stop selling off, if (governments) produce real reforms, I will be investing in those markets. If you don’t see any reforms, the rate hikes will just destroy growth, discourage investors and make the situation far worse.”

On the U.S. side of things, the stock market might see a bit of relief, however briefly. The outperformance by bonds against stocks this month might spur some reallocation trades, helping the market on its last day of the month. So it’s got that going for it, which is nice. Of course, futures are getting hit hard this morning, so maybe this is false hope.

From a more grounded (well, ridiculous) perspective, it’s the Super Bowl this weekend in the U.S.

Strategists have long made sport of the vaunted “Super Bowl Indicator,” which, for a long time, stipulated that when teams in the National Football Conference (the 49ers, Giants, Cowboys, to name a few) were victorious, the stock market was in line for a good year, but when teams in the American Football Conference (Dolphins, Raiders) won the big game, the equity market was set for a bad year.

That was modified a few years ago to include old NFL teams that had migrated to the AFC – the Steelers and the Baltimore Colts (this column does not recognize teams that move in the middle of the night.) So that puts us in a unique position this year.

First off, the AFC team is the Broncos, so a win by them should put the market on track for weakness for the rest of 2014. This is, of course, undermined by the fact that when the Broncos do win (and they won in early 1998 and early 1999), the market does pretty darned well. Furthermore, their opponent, the Seattle Seahawks, spent most of their existence in the NFC before moving to the AFC a few years back. If the Steelers and Colts can be grandfathered into the good side of the ledger, it stands to reason that the Seahawks ought to be included on the bad side of the ledger, no?

MORNING BID – The prime directive

Jan 30, 2014 14:08 UTC

So, it’s been a few days. Which means the markets have hit that point in the Star Trek episodes when the Klingons were temporarily short of torpedoes, which gave the Enterprise crew time to suss out what was going on.

Some of the missiles were fired. Big rate hikes from Turkey and South Africa, that followed a rate hike from India, and a few conclusions are inescapable:

  1. The selling hasn’t run its course yet
  2. Rate hikes aren’t enough to turn the tide in favor of a struggling currency because people extrapolate that higher rates are going to pinch growth
  3. People may have been holding out hope that the Federal Reserve would have nodded in some way to the emerging markets and got no quarter from Ben Bernanke as he dropped the mic and disappeared in a puff of smoke at his last-ever Fed meeting.

Add in the latest – a decline in China’s manufacturing – and the pullback certainly has not run its course. Overnight volumes and trading during the NY cash session showed once again that the better volumes have been on the selling, rather than the buying.

The question now is how far this can go? And that depends on what kind of developments we’re looking at. If there’s a massive flight of capital, the selling will remain indiscriminate, and long-running. It’s not too encouraging that the Turkish lira’s rally was good for a few hours and not much more, and nobody even tried to take the South African rand that much higher at all.

But let’s hold fast on the ‘contagion’ notion for a bit here, because ‘contagion’ does not simply mean ‘a whole load of people selling stocks.’ So we’ve seen actions from central banks in India, Turkey, South Africa and earlier Indonesia, and Citigroup suggests Russia could take surprise action in a couple of weeks as well. Having central banks take the initiative to force adjustments in policy is preferred on some levels to the damage markets can dish out (though markets can keep dishing it out also).

But the true measure of contagion relates to how quickly short-term funds leave a country, how much of a country is dependent on foreign funding of longer-term obligations (do foreigners own all the short term debt? If so, not good – Turkey’s short-term external debt is equal to 116 percent of its FX reserves, leaving it unable to defend against capital flight, according to Morgan Stanley,) current account balances, and a few other factors. In a note late Wednesday, Morgan Stanley threw in China exposure to the mix as well, noting that those exporting lots of commodities – be it fuel, metal or ore – are in a more precarious position.

The more troubled nations when it comes to debt issues – like Brazil, Turkey or South Africa – are a bit less exposed to China than Malaysia or South Korea, but they’re plenty exposed, and the latter two don’t have problems with current account deficits and as much in the way of short-term funding. Closer to home, Goldman Sachs notes that just 5 percent of S&P 500 sales derive from emerging markets, and that during EM selloffs, the S&P tends to fall about half as much – with the most exposed naturally being materials and energy sectors.

So there’s some comfort on the U.S. side of things. Still, with US growth not helping emerging markets and China’s slowing and adjustment to the debt it has in its economy weighing heavily, the contagion problem is a very real one that may rear its head in a bigger way. If a slew of rate hikes can head off massive capital flight, the slow growth that comes from higher rates may be something individual economies can deal with. However, that’s only if this is enough of a confidence-inducing measure to keep investors somewhat invested. That’s a big ‘IF.’

MORNING BID – Turkey, the Fed, and we all float down here

Jan 29, 2014 14:46 UTC

The messy sell-off in emerging markets was stemmed overnight after Turkey surprised everyone by raising rates to 12 percent – but it didn’t last. Major averages in Britain and Germany opened at their highs of the day but have since faded, and even though the big rate increases in Turkey, South Africa and India are meant to stem capital flight, so far the market’s shooting first and asking questions later. S&P futures were up about 20 points after the Turkey rate hike – an odd move for such a localized event – and we’re seeing the reaction now, which, to quote Tom the cat about the ‘white mouse no longer being dangerous,’ “DON’T…YOU…BELIEVE…IT.” So we’re lower, and continue to head lower, and for those of you new to the markets, this is what’s called a selloff.

The big question: Will the Federal Reserve defer its tapering campaign in recognition of emerging-markets difficulty? One could say the Fed cannot be expected to act as the underwriter for global risk-taking, but you’d be laughed out of the room, given the performance of assets around the world in the last several years as the Fed went into full-QE mode.

On the other hand, there’s a difference between providing broad support to the markets (via helicopter or not) and an actual admission that you’re changing policy to respond to specific issues worldwide, and such a move strikes us as the latter, not the former. With that in mind, it would be remiss to think the Fed does not continue at its measured pace, dipping down to $65 billion in bond purchases per month this time, as Janet Yellen takes the reins and we find out what kind of situation the new Fed head has gotten herself into while Ben Bernanke eases into what one hopes is a steady and muted retirement (think Johnny Carson, not Alan Greenspan).

For one, eventually reducing the monthly stimulus to zero at least gives the Fed room to ratchet up that stimulus again if they really need to.
Furthermore, the emerging markets, in a sense, are already gone. No, it’s not a disaster yet – but the implosion of China’s shadow banking system, the resignation of every Turkish official in Ankara, and the, well, uh, never mind, Argentina is Argentina, and isn’t going to be solved by the Fed put. The Fed might give it lip service in its statement but any more than that really ratchets up the moral hazard.

Furthermore, when one takes a look at the relative strength of emerging markets stocks with the U.S. market, it’s clear EM has been struggling for a while anyway. A comparison of relative performance between the MSCI EM index (.MSCIEF, or EEM.P if you’re into the ETF thing) is at 0.7 or so, and U.S. markets have been the steady outperformer since the beginning of 2013, and that outperformance accelerated throughout the year but particularly in the second quarter when the Fed started talking about reducing stimulus in the first place.

That doesn’t mean they can or will reverse course – it makes no sense. But less liquidity washing ashore means a bad investment can no longer be covered by smoke and mirrors. The MSCIEF’s relative performance index is still looking terrible, having fallen below the 30 level that indicates an oversold condition. It’s not quite at the nadir of the June 2013 or May 2012 selloffs, but it’s close, so if there’s a place one might expect some buying, it’s now. But it’s not happening yet – and that does raise questions about whether we’ll see more soothing words from central banks.

Back in the USA, the Treasury is readying its first-ever auction of two-year floating-rate securities, likely to see demand from various types of investors.
There are currently more than $200 billion in agency and “supra-sovereign” floating rate notes outstanding, mostly from Federal Farm Credit and Federal Home Loan Bank, per Morgan Stanley data. So, Treasuries should add nicely to the mix here, and it’ll quickly become a very big dog in a very small pond (dogs can jump in ponds, go with the analogy). So the $15 billion will add to the week’s mix of other supply.

For one thing, this gives the Treasury the chance to manage its issuance a bit more by reducing the number of short-dated auctions of bills, instead issuing this note that resets based on market rates for floating-rate notes. It will helpfully cut back on the weird dislocations that the market has seen of late in bills that are maturing just as the United States is set to run afoul of the debt limit (again) or face some kind of annoying only-in-Washington-type spectacle.

(Of course, if it was all two-year floaters, then in the month it had more floaters coming just as a budget crisis hit, those yields would go through the roof. So you can’t entirely solve the Washington problem this way, and floating-rate notes as far as we know cannot hold Congressional office).

The other advantage for the Treasury is the lack of what’s called “term premium,” which Morgan Stanley says will lead to interest-rate payment savings.
Term premium refers to how much additional interest you have to offer someone who is taking the risk of buying longer-dated securities (and therefore risking wide swings in interest rates or other unforeseen events over a five-year period vs. say, six months). But floating rate notes have no such provision (they float, after all), so that *should* save Treasury some money.

Reuters’ bond correspondent Richard Leong points out they’re expected to sell with a yield of 0.10 percentage point, almost a quarter less in the two-year fixed-rate note supply sold on Tuesday. So, that’s savings for Uncle Sam until the FRN yield rises above the fixed-rate two-year notes. Overall, the interest rate should be greater than what’s embedded in notes, though, which is good for money market funds (they hold about $276 billion of floating rate notes already).

FRNs are great in an environment where interest rates are on the rise, which has been the case for several months now (until this month that is), and therein, of course, lies the danger. If rates fall, well, not so great, as the interest rate on the notes would be chipped away.

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