Bond Love Affair Rolls On

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After 10,000 news stories lecturing us about the death of the bond market, global investors cannot get enough investment grade paper.

U.S. companies are issuing bonds at the fastest pace ever. And investors say the Federal Reserve’s next rate hike may do little to change that.

Bond Sales Nearly 20% Ahead of 2016’s Record Pace

Investment-grade firms are on track to complete the busiest first quarter for debt sales since at least 1999. Firms from Apple Inc. to Morgan Stanley have pushed new issues to more than $360 billion so far in 2017, closing in on the previous record of $381 billion from 2009, according to data compiled by Bloomberg.

Three Weeks Left

IG Sales Surge

Pending tax reform legislation in Washington is incentivizing corporate bond issuers to pile into the primary (new issue) market like never before.  CFOs are afraid politicians will take away interest deductibility going forward, so they’re selling next year’s paper today.  The market is dramatically over supplied.

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Health Care Reform: Back to the Drawing Board

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Updated March 18, 2017 at 10:30ET

Nearly 24 million more people would be uninsured under the Republican plan to replace Obamacare, according to the nonpartisan Congressional Budget Office, creating an up hill political battle for a proposal that would reduce the deficit by more than $300 billion.

How’s the CBO’s Record on Scoring Health Care Plans?

Back in 2010, the CBO’s forecast was for nearly 24 million to be on Obamacare health plans by 2017. Only about 9 million people came on board.  The CBO missed by a country mile, listen to their predictions with caution.

The 24 million (lost insured) over 10 years hurts the GOP sales case, especially heading into the midterm elections, it’s tough vote for Republicans to wear heading into 2018.  Sure the States can pick up some of lost insured but the media will hammer 24m across social media and cable television. It’s back to the drawing board, the ugly CBO headline speaks to more work to be done by the GOP.

“Ryan has also, according to Trump ally Sen. Rand Paul (R-KY), misled President Trump into believing that Ryan’s bill can pass Congress. Paul and others believe the bill is dead on arrival in the U.S. Senate since a number of GOP senators have come out against it, and there are serious questions about whether it can pass the House. This is the first major initiative that Trump has worked on with Ryan—and the fact it is going so poorly calls into question whether Speaker Ryan can lead” (Trump’s growth agenda in 2017).

Breitbart, March 14, 2017

With nearly 300 S&P handles riding on Trump and Ryan’s ability to navigate an aggressive growth agenda through Congress, institutional investors we spoke with feel Ryan is in some trouble with the White House.

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Cost of Default Protection on Hospital Companies has been Heading Lower

Hospital CDS

What’s going on here?  As you can see, heading into the election credit risk on hospitals was moving substantially wider, the cost of default protection was surging.  After the election of President Trump CDS on Tenet Health rose to 860bps, today she’s less than 500bps.  The cost of default insurance is the cheapest in well over a year.

Default protection on hospitals is the ultimate expression of the GOP’s Freedom Caucus’ strength (or lack there of) in Washington.  Credit default swaps (CDS) are telling us Rand Paul is correct, the proposed Republican led healthcare legislation looks more like Obamacare-lite than a radical transformation.  Hospital credit default protection is extremely tight (cheap) relative to possible (short term) headline risk curve balls.  Bottom Line: Hospital credits have figured out there’s no way on God’s green earth the second and third stages of Obamacare replacement get on the President’s desk without 60 votes and Democrats.  In other words, after a shift right to land the Freedom caucus on board, the final stages of Obamacare replacement will come barreling back to the center.  Click on the link below to receive our full report and trading ideas:

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Jobs’ Surprise

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Jobs Recap

Employers added an above-forecast 235,000 positions in February, while measures of joblessness and underemployment improved, the Labor Department’s monthly report showed on Friday.

U.S. Jobs

NFP new

Headline job growth was right in the ball park our 228k estimate at 235k for the month of Feb. Despite the month over month miss in the AHE (average hourly earnings) number, the post Jan revisions shows year over year wage growth at 2.8%, above estimates of 2.7%. This is a strong number. Another piece of strength that seems to show this report in a positive light was that the unemployment rate fell even though there was another raise in the labor force participation rate, which ticked up to 63%. We also saw a Janet Yellen favorite, U6, a measure of employment slack, tick back down to 9.2% from 9.4%. After two positive revisions we are now averaging 209k job on three month average. A decently strong report in our view.

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Q1 GDP Outlook

NY Fed: 3.2%*
Atlanta Fed: 1.2%
Bear Traps: 1.7%
Street: 2.2%

Bloomberg

*FRBNY Staff Nowcast stands at 3.2% for 2017:Q1 and 3.0% for 2017:Q2.  This week’s news nudged up the nowcast for both Q1 and Q2 by about 0.1 percentage point each.  The small increase was driven by inventories, international trade, and labor market data.

Goldman Sachs analysts: now sees Fed raising in March, June, September (prior March, Sept, Dec).

– Rates seem to be dealing with the month over month miss in AHE and the strength in the headline figures such as participation rates. While we still think bonds are due to rally, given their oversold nature, especially in the longer end, this report did not give us the catalyst to do so.

U. S. 10 Year Bond Future

10s new chartsA Perfect Storm for Treasuries:  Bonds have been hit by perfect storm since the 10 year hit 2.32% two weeks ago. Hawkish Fed speak that was culminated by Yellen last week, has repriced March as meeting they will hike in. Asian data points, including China’s unexpected trade deficit number this week, also put pressure on bonds, as China’s imports are a large driver of global growth. Draghi and the ECB did not help proceedings with a more hawkish than usual Q&A session in his press conference. These data points have pressurized bonds in the near term.

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– Part time work for economic reasons fell in Feb as did the not in the labor force number. Yellen will be comforted by the fact that many of her slack indicators were better than expected in February.

– Private sectors such as manufacturing and construction were standouts in the report. Unseasonably warm weather probably helped construction jobs while the improved manufacturing sector has been seen in the recent ISM survey data points. Over the past three months manufacturing has now added 57k jobs. Nondurable goods firms added 18k jobs in February, more than in the prior nine months combined and the most for a single month since Aug ’91.  the only sector that was a drag was retail goods which makes sense given the current retail climate and post holiday moves.

– Aggregate payrolls growth was back up to 4.3% y/y in Feb, but on very soft comp.

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Levered shale, Funded by Wide Open Capital Markets Breaking the Saudi’s?

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Blog Updated 3/14/17 at 7:50am

Breaking: OPEC UPS NON-OPEC SUPPLY FORECAST BY 160,000 B/D THIS YEAR AS US SHALE RETURNS

Breaking: *SAUDIS TELL OPEC THEY PUMPED 10 MILLION BARRELS A DAY IN FEBRUARY

The Saudi’s told OPEC they “increased” output in February?  Yes, back above 10 million barrels a day.  This took away about a third of the cuts it made the previous month.

The Kingdom had promised to curb supplies and did so more than it needed in January.   In a reversal, the Saudi’s have shown leadership to re-balance world markets, BUT NOW THEY INCREASED production by 264k barrels a day to 10.011 million a day, according to a monthly report from OPEC on Tuesday.

OPEC Monthly Report: raises 2017 global oil demand growth from 1.19M bpd to 1.26M bpd.

Boosts non-OPEC supply growth (shale) forecast from 240K bpd to 400K bpd.

They Did it Again

Excerpt from Our Bear Traps Report from March 7, 2017

We think oil is capped and the balance of risk to price is to the downside.  While OPEC is cutting production, shale is back and stronger than ever. Oil per rigs are up and employment necessary for rig operation is down, this all fosters a positive output environment. What has driven this rapid supply response is the insane debt levels these frackers have. To pay the coupons they have to hit the supply hard, and they have in recent months.  Now, with oil stuck in this range, we feel the next break is lower. This will be very consequential for markets, Fed policy and the global economy.

Oil Positioning is at Record Longs, Too Many Bulls

oil longs (1)Despite U.S. production roaring back, the market is still record long oil contracts. With positioning so one sided in crude oil, it seems that the relative upside is capped. The market has a few catalysts which could drive prices higher as global demand is improving at a time when OPEC is actually cutting their output levels. This does present a positive backdrop for prices but the question is how sustainable is it. Can the Saudi’s continue to shoulder the majority of OPEC cuts with global demand picking up, watching Iraq’s production shift in the coming months will be telling. Iraq is one of the largest OPEC producers and also has constantly been hesitant about production cuts; if they give way, it would be a trickle down to Libya, Kuwait and other GCC (Gulf Coast Countries) members. This is part of the Saudi peg, but if there is a catalyst for this positioning to give way and push the curve out, oil could slide hard. 

High Debt Load = Lower Oil Prices

The price of eight years of central bank zero interest rate policy is found in oil’s flat line since June. The bottom line net result of an easy money gravy train is playing out in commodity market supply distortions. Without colossal leverage and unprecedented (2010-15) capex ($500B per Wood Mackenzie) in the oil patch, supply would NEVER in a million years come back this violently in U.S. shale. Now, the Trump administration is talking up $50T of untapped U.S. reserves to help fund the infrastructure rival. We
expect deregulation and a contained EPA to only had more juice into U.S. oil production, the supply – demand imbalance.

Shale Pain for Crude

cost of production shale

Another key element for the shale players is that oil production costs have come way down in recent years. Breakevens for all of the big shale locations are well below current prices. As we have seen in recent earnings reports, margins for production have actually increased dramatically in recent months as breakevens are now near $35-40 a barrel on average.  With lower breakevens and heavy debts to pay, shale production is not going anywhere if oil prices remain in range. That is problem for prices in the medium term.

While Speculators are Long, Producers are Short

While speculators are jumping over each other trying to get long oil contracts, the guys who actually produce the commodity are heavily short it. Well it is obvious that shale producers have used this OPEC led rally to lock in prices, it does say that they are not very confident prices can rise meaningfully from current levels. This has contributed to the backwardation beyond the 3-month contract in the curve. There are some cases of levered players that need to hedge prices to lock in financing, but to see so many producers short makes us think they are skeptical of how much higher prices can go.

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A Warning from High Yield

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Updated March 14, 2017

Positioning in High Yield, Net % Overweight Longs

2017: -12%
2016: +17%
2015: +28%
2014: +41%
2013: +36%
2012: +43%
2011: +9%
2010: +22%
2009:  -17%
2008: -28%
2007: -10%

Merrill Survey data, March 2017

Our institutional clients are growing far more concerned with the insanity in the junk bond market.  There’s a lot of crummy coupons on crummier credits.  As credit quality moves down yields should move higher, this has not been the case over the last year.   High yield is starting to show real signs of a crack in the foundation, for the first time since 2009 long – overweight positioning is negative.  This is one of our 21 Lehman Systemic Risk Indicators, click here for more:

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Oil’s Pain is High Yield’s

Over the last week, junk bond funds posted their biggest outflow this year as investors yanked more than $2 billion from BlackRock Inc.’s iShares iBoxx High Yield Corporate Bond ETF.

Companies issuing high yield debt now see their borrowing costs close to the obscene cheap levels observed just before the 2008 crisis.  We’re seeing asset managers are buying protection against losses, while junk-bond funds posted the biggest redemptions since November.

Junk is Rolling Over While Equities are Smiling

Cash high yield bonds traded very weak today as hedgers sprayed the street over the last hour of trading.  Both investment grade and high-yield debt moved wider (higher yield – lower bond prices) without much support.  Oil’s plunge kept many buyers on strike.  Likewise, there’s $19B of new high yield supply, banks are hedging their books in size.

In March, we’ve seen a divergence between high-yield bonds and equities, this speaks to trouble ahead.   As we witnessed in 2015 and 2016, credit (junk bonds) led stocks lower (weeks in advance).

Junk Omen

HY CDX new

Markit CDX North America High Yield Index is composed of 100 non-investment grade entities.  The index is nearly 30bps wider this month, a move from 300bps to 330bps.  Average borrowing costs on the debt rose by the most in four months, according to Bloomberg index data.

Oil and Junk: Connect the Dots

Large shale companies announce substantial increases in  (capex) spending for this year, and the U.S. government says domestic oil output next year will surpass the record high set in 1970. OPEC ministers have said they are keeping a close watch on shale production to decide in late May whether to extend their oil-supply cuts into the second half of the year.  U.S. shale is MASSIVELY levered to oil.  Their colossal debt load keeps them pumping out supply, placing a ceiling on prices.

U.S. Oil Production*

2017: 9.1m
2016: 8.2m
2015: 9.6m
2014: 8.5m
2013: 7.1m
2012: 5.5m

*High yield bonds, syndicated loans sold to fund this binge? $3T!!

BIS Data

Oil prices plunged 5 percent on Wednesday to their lowest level this year, falling just above $50 a barrel, on investor concerns about unbridled growth in America’s shale basins swelling U.S. inventories.

With the S&P 500 relatively steady in the last week, the HYG high-yield bond ETF (below) has taken a leg lower, this is a ominous sign for market pros.

HYG SPY

In 2017, the S&P 500 is up 6% while the HYG iShares iBoxx $ High Yield Corporate Bond ETF has wiped out nearly all its gains, a strong divergence indeed. 

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Moody’s: North American High-Yield Bond Covenant Quality, on the Lows

One of our 21 Lehman Systemic Risk Indicators is found in junk bond covenant quality.   As we wrote in our New York Times bestseller, froth in the credit markets is the ultimate signal of a coming risk off.  We measure froth by covenant quality analysis.   Let us explain.

When the Fed keeps interest rates too low for to long, investors begin to cheat and reach for yield.  The distant pain of the credit crisis is almost forgotten.  Like a bad relationship in years past, after the healing it’s time to love again 🙂

The same is true bond covenants,  the weaker the terms the more power CFOs (issuers / companies) have over investors.  By our measure, they’ve NEVER had more power than today.

A true moral hazard, as credit quality has deteriorated in swift fashion, buyers keep up demand for crummy coupons on crummy credits.  Moody’s new report indicates the average covenant quality is down at 4.28 in the last six months of 2016.  Moody’s measures bond covenant quality on a five-point scale, with 1.0 denoting the strongest investor protections and 5.0, the weakest.

Investor protections remained at their weakest level, with the cumulative average covenant quality score hitting 4.00 for the first time in December.  One word, UGLY.

In a desperate reach for yield, investors were more willing to purchase bonds rated B1 and below.  As a result, bonds rated single B and Caa/Ca made up a larger percentage of total issuance.

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New Issues Strong

Five more issuers for $2.8b were placed on the calendar today.  Eight deals for $4.7b to price later today, making it the second busiest day for issuance since June.

A sudden and sharp shift by the Fed from no likely hike in rates until May of this year to a near-certain hike this month, gave a big and expected push to new issuance.

Market expectation of a likely rate hike moved from 32% on Feb 1 to 94% end of last week, causing issuers to expedite their refinancing plans.

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Political Risk Takes Down the Bull in Early Trade

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A weekend filled with HIGH drama in Asia and Washington has S&P 500 futures off 10 handles in the first few hours of this week’s trading session.   We essentially have civil war breaking out inside the Executive Branch of the United States government.

“A phrase I keep hearing from Trump ally after Trump ally: “deep state.” Growing belief inside White House that elements of their own Intelligence Community are aligned against them.”

Robert Costa, Washington Post

Headlines Over the Weekend

FBI asked Justice Department to refute Trump’s wiretapping claim – CNN / NYT

Mark Levin on Trump Wiretapping Claims on Obama: ‘The Evidence Is Overwhelming’ – Brietbart

Trump angry and frustrated at staff over DOJ Head Sessions fallout – CNN

Obama faces Congressional Inquiry. Congress to probe Donald Trump’s explosive claims Barack Obama wiretapped him – Drudge

Geraldo: Obama operatives planted landmines for Trump – FOX

S&P 500 Futures – ES1

SPX 30 Min

After the weekend punches thrown in Washington, the S&P has violated its one month trend line.  Today, our friend Niall Ferguson noted in The Sunday Times:

“The House Republicans have a 200-day plan as follows.  First, regulatory reform, including repeal of the Dodd-Frank banking act and deregulation of the energy sector. Second, the repeal of Obamacare and its replacement with a more competitive market-based system. Third, comprehensive tax reform, including lower rates on personal and corporate income tax, a new border adjustment tax (BAT) and abolition of the inheritance tax.”

U.S. equities are up on a ledge on hopes of an aggressive 200 day agenda, this weekend’s ugliness in Washington throws a money wrench into those plans.  Distractions are high, toxic relations between Dems and Rs higher.

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Asia Risk Off

Stocks in Tokyo and Seoul fell and the yen strengthened after a North Korea missile launch, while investors also weighed messages from China’s National People’s Congress and Federal Reserve Chair Janet Yellen.

Dollar Yen, Risk On Takes a Break

Dollar Yen 3Many market participants look at dollar yen as the ultimate expression of a “risk on” or “off” mood.  A stronger yen has a lot to do with the current flight to quality and political risks on the rise.

U.S. stock futures were also lower on geopolitical risk surging in Asia.  Prime Minister Shinzo Abe said the government will hold a National Security Council meeting today after North Korea fired four ballistic missiles. The move comes as South Korea and the U.S. undertake annual military drills that Pyongyang has called a prelude to an invasion. Tensions have been rising over North Korea, which also conducted a missile test during Abe’s state visit to the U.S. last month and is suspected of being behind the assassination of its leader’s half brother in Malaysia. – Bloomberg

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What are the Fed and Gold Telling us about Inflation?

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“There’s nothing in this world, which will so violently distort a man’s judgement more than a sight of his neighbor getting rich. ”

J.P. Morgan, 1907

Important Headlines Last Week
*YELLEN: MARCH HIKE APPROPRIATE IF ECONOMY EVOLVES AS EXPECTED

*DUDLEY: CASE FOR TIGHTENING HAS BECOME A LOT MORE
COMPELLING

Gold Miners, a Rates Trade

In recent years, many gold bugs still haven’t figured out trading gold and the miners has become far more of an (interest) rates rather than a inflation trade.

Let Us Explain

Heading into the last two Federal Reserve rate hikes (December 2015 and 2016), each time the gold miners $GDX lost 43% in the six months preceding the rare FOMC action.  Many of gold’s loyalists have been sucked into losing investments by focusing on deficits and money printing as gold’s chief price influencer.   They didn’t get the joke.  It’s been all about interest rates and negative yielding bonds, but is this all about to change?

Global Government Bonds with Negative Yields vs. Gold

2017 March:  $9.3T vs. $1234
2016 December: $7.8T vs. $1125
2016 October: $9.6T vs. $1265
2016 September: $12.4T vs. $1350
2016 July: $13.8T vs. $1375
2015: $1.4T
2014: $175B
2013: $0
2012: $0
2011: $0
2010: $0

Bear Traps Report and Bloomberg data

If we gave you one billion dollars would you put it in a negative yielding German government bond or 0% gold, both offer similar liquidly.   Bottom Line: as you can see above, the amount of negative yielding bonds on earth has been the KEY driver of gold prices in recent years.  So much of gold’s price action has been tied to interest rates and anticipating Fed policy from Janet Yellen and Company.

Our Sell Call to Clients from Early February:

“Last week, the Fed statement was very dovish relative to expectations, now it’s likely the governors on the Fedspeaking (coming speeches from Fed) tour will come out on the hawkish (point to a March rate hike) side in the near term.  Positioning the gold miners is a rates trade, very similar to Eurodollars.  As we’ve stressed in recent years, the Fed “shows it to you and then they take it away.”  This is classic Lucy and the football behavior from the FOMC, we’ve seen this show so many times. Likewise, as we move through the middle innings of the Trump reflation trade unwind, the risk – reward in owning the gold miners has become less attractive, it’s time to SELL our Gold Miners $GDX.”

The Bear Traps Report, February 7, 2017

Where’s the Trade?  Join us here:

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The Federal Reserve has been Gold’s Biggest Driver, NOT Deficits

GDX vs Fed FundsGold is off 2.4% its recent highs, while the miners ($GDX) are 15% lower since their February 8th high, that’s a profound underperformance.  As you can see above, in the months and weeks before that only two rate hikes in the last 11 years, the gold miners $GDX plunged an average of 43% each time.  Now, what about the next rate hike from the FOMC?

Fed Fund Furfures for a March 2017 Rate Hike vs. the Gold Miners $GDX

Today: 94% vs. $22.20
One Week Ago: 40% vs. $23.17
Three Weeks Ago: 26% vs. $25.71

Bloomberg data

Recent speeches from Fed governors have driven rate hike expectations MUCH higher for a hike this month, but this time the gold miners are only off 15%, not 40% +?

What’s Going on Here?

There’s no question in mind, gold’s price driver eventually will shift from FOMC interest rates policy and negative yielding bonds globally back over to inflation expectations.  Getting the timing right on this future development will present us with a colossal trading opportunity.  Click on the link below and join us. 

Where’s the Trade?  Join us here:

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The Fed Funds Rate and Financial Crisis’ Evolution

FOMC Policy 1970-2017

Fed Funds Long TermAs you can see above, since 1970 Federal Reserve accommodation has grown both in scale and duration ahead of each financial crisis.  More disturbing facts lie in the explosion of destructive power found in the last three global wrecking balls, as the financial panics have become far more deadly.  As the next Lehman moment comes at us, the opportunity will be found in gold and the miners.

Where’s the Trade?  Join us here:

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