Natural Born (Volatility) Killers! ECB’s Draghi’s Low Volatility Legacy (Fed Also Kills Bond Volatility AND Term Premium)

The ECB under Draghi has been effective a depressing bond volatility and yields as he passes the torch to Christine Lagarde.

(Bloomberg) — Looking through the lens of rates market volatility, Mario Draghi has performed a masterclass in the art of keeping it very low. Incoming European Central Bank President Christine Lagarde will have a challenge to achieve the same effect as monetary policy nears its limits.

A successful central bank will aim to keep market volatility controlled by the predictability of its policy. Draghi has been in the business of keeping euro rates volatility suppressed, by communicating policy shifts effectively and deploying large-scale monetary easing.

Lagarde may find it harder to achieve a consensus on easing, inheriting a divided Governing Council. Policy makers disagree on whether more monetary stimulus is needed, and have voiced louder calls for fiscal policy to do more.

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Of course, The Federal Reserve is not too shabby about killing bond volatility.


Treasury note term premium (the amount by which the yield-to-maturity of a long-term bond exceeds that of a short-term bond) has been reduced to negative territory.


Yes, the ECB and Fed are natural born volatility killers.


Giddy Up! Mortgage Refis Decline Most In Three Years (Fed To The Rescue?)

According to the Mortgage Bankers Association (MBA), mortgage refinancing applications declined the most in three years on a slight rise in mortgage rates.


Of course, some of the decline is due to smaller pool of eligible borrowers following a “refi wave.” But still, The Federal Reserve may be prodded into action like in the song “Elvira.” Giddy up!

The MBA purchase applications index fell by 3.5% from the previous week, which is understandable since it is October and the October Country from home sales and purchase applications.


Actually, it is somewhat surprising that purchase applications are rising despite the decline in “subprime” (FICO < 620) borrowers.


Yes, it is The October Country for mortgage purchase applications which normally peak in May then decline.


Bond Quants Are Growing in Negative-Rate World (Bridgewater’s Pure Alpha Fund Loses 2.3% In Nine Months)

Slicing and dicing risk is the name of the game in equities, but not so much in fixed-income … until now.

The surge in negative-yielding debt is making the bond market the next frontier for factor investing, according to a study by Invesco Ltd.

About 70% of institutional and 78% of wholesale investors see the concept of slicing and dicing securities by their characteristics as applicable to fixed income, the survey showed. That’s up from 62% and 57% respectively in 2018. The study polled 241 factor investors responsible for managing more than $25 trillion across the world.

Quant houses have been trying to convert investors to fixed-income factors with the pitch that just as in equities, there are proven systematic sources of long-term returns in bonds. The result of Invesco’s survey is another sign that their push is gathering steam amid concern that the bull market in credit is in jeopardy. More than $13 trillion of debt worldwide has a negative yield, according to data compiled by Bloomberg.

“We are in an environment where yields continue to be very low and the yield curve is very flat and investors are increasingly looking at ways to add value to the portfolio,” Mo Haghbin, chief operating officer at Invesco Investment Solutions, said by phone. “The results show a very high conviction that this is possible, and the allocations are starting to come through as well.”

The survey showed yield (or carry), liquidity and value were the fixed-income factors most commonly cited by investors.

Here are other findings from the survey:

  • Around a third of the respondents have boosted their allocations to factor strategies in fixed income. Still, nearly nine in 10 said the asset class is currently poorly covered by factor offerings.
  • Some 59% of respondents plan to boost their allocations to factor strategies over the next three years.
  • 66%-70% reported factor investing met or exceeded the performance of their traditional active or market-weighted allocations in the year through March 2019.
  • Value was included in 69% of respondents’ portfolios, a drop from 78% in 2018. It was the most common factor, along with momentum. Low volatility followed at 68%.
  • Liquidity and transparency are the main reasons for using exchange-traded products for exposure to factors, according to institutional investors. Meantime, price is a key driver for wholesale investors.

While a large majority of investors now incorporate environmental, social and governance (ESG) goals, they are divided over how these interact with factors. The most common view is that it’s a combination of styles, while about a quarter sees it as an independent factor and another quarter considers it a variation of quality.

Deutsche Bank, as an example of FI factor momentum investment.

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And here is an example of a Nomura FI momentum index.


Negative interest rates are causing havoc for some hedge funds, like Bridgewater.

Bridgewater’s flagship fund has failed to recover the losses it suffered in August when government bond yields globally plummeted to multiyear lows.

The Pure Alpha fund at Ray Dalio’s $160bn hedge fund group lost 2.3 per cent in the nine months to September, after a particularly difficult August when the firm was wrongfooted by the decline in global interest rates.

Dialo wrong footed? Apparently his “Economic Machine” model failed to predict the onslaught of Central Banks and negative interest rates.



Act (Un)Naturally! ECB’s Draghi Warns of Bubble Risk (Including Real Estate) in the Euro Zone (17 European Nations Have Negative 2-year Sovereign Yields)

Slowing European economic growth coupled with massive, unnatural Central Bank policies has led to a massive bubble in stocks and real estate. All the ECB did was “act (un)naturally.”

WASHINGTON (Reuters) – There are “mild signs” of overvaluation in the euro zone financial and property markets, creating a risk for stability at a time when the economy is slowing, the European Central Bank’s President Mario Draghi said on Friday.

“The financial stability environment remains challenging, as the global economic outlook has deteriorated,” Draghi told fellow policymakers on the International Monetary and Financial Committee in Washington.

“There are mild signs of overstretched valuations in the euro area in some riskier segments of the financial markets, as well as in real estate markets, with marked differences across regions.”

The ECB has acted unnaturally since the financial crisis of 2007-2009 by dropping their main refinancing rate to 0% and rapidly expanding their balance sheet.


In addition, the ECB’s M3 money growth continues to grow.


And 17 European nations now have negative 2-year sovereign yields.


The heartland of Euro (meaning Germany, France and Austria) oppose more QE (asset purchases by the ECB) while peripheral counties (Spain, Italy and Greece) want to keep on expanding the ECB’s balance sheet.


Of course, none of this Central Bank interference is natural and sets the stage for a bubble burst.

ECB’s Draghi is a regular “buckaroo.”




U.K. Bank Credit Rallies as Johnson Strikes Brexit Deal With EU (UK CoCo Prices Jump, But Not Deutsche Bank’s 6% CoCo)

While the UK Parliament has to sign off on the Brexit agreement, bank credit rallies after Boris Johnson reached an agreement with the EU.

U.K. lenders’ riskiest notes jumped, leading a credit rally, after Prime Minister Boris Johnson reached a Brexit agreement with the European Union.

Barclays Plc’s 1.25 billion pound ($1.6 billion) 5.875% CoCo reversed earlier losses and hit 99.5 pence on the pound, the highest since May 2018, according to data compiled by Bloomberg.


Nationwide Building Society’s 600 million-pound perpetual bond, sold last month, hit a record. Oddly, NBS’s perpetual bond started rising on October 10th, well before PM Boris Johnson announced his Brexit agreement.


A contingent convertible bond (CoCo), also known as an enhanced capital note (ECN) is a fixed-income instrument that is convertible into equity if a pre-specified trigger event occurs.

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A famous CoCo bond is the Deutsche Bank 6% Perpetual.


While issued at par (100), the G-spread on the Deutsche’s 6% CoCo bond is … 11%.


Odd, that DB’s CoCo bond remained relatively calm after the Brexit deal was announced.


Is that UK PM Boris Johnson or Martin Kernsten, the Nipple King from Parks and Recreation?


Its always sunny in the UK!

JPMorgan Chase’s BIG Earnings Surprise As Net Interest Margins Skyrocket! (Thanks Fed!)

In a day of wonderful earnings reports, one notable leader is JP Morgan Chase with a 9% surprise in Earnings Per Share (EPS).


Like other banks, JP Morgan Chase’s net interest margin and interest income are soaring!


Of course, recent Fed activities have lowered the short rate (deposit rates) relative to longer-term asset yields.


Life is so good in America, particularly for banks!


Minneapolis Fed’s Kashkari Says Banks Didn’t Plan Well for Liquidity Needs (Did The Fed??) Bank Excess Reserves Positively Correlated With Home Price Growth

Neel Kashkari was one of the Godfathers of TARP when he was at Treasury under Henry Paulson,  Here is the longer version of the hearing in which I testified (you can see the back of my head at the beginning of the video).

(Bloomberg) — Minneapolis Fed President Neel Kashkari says banks don’t like to use a so-called discount window for emergency funding because “they think it makes them look weak,” according to an interview with Axios.

Says banks are supposed to plan for their own liquidity needs

Says banks did not do that adequately, “And now they’re complaining because they failed to plan”

Neel, one reason that banks may not want to use the discount window is that is 50 basis points higher than the upper bound of The Fed Funds Target Rate.


What Mr. Kashkari may be saying is bank excess reserves are positively with home price growth. As US home price growth is shrinking, so are bank excess reserves.


The good news for banks is that mortgage originations are a smaller part of their business models. Take JP Morgan Chase, for example. They went from over $60 billion in mortgage originations at the peak of the housing bubble in 2005 to $24.5 billion in Q1 2019.


JP Morgan Chase shifted away from residential mortgages to business loans, credit cards, etc. That is, shorter maturity loans.


Commercial bank credit continues to grow, but no where near the levels of the 2005-2007  credit boom years.

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So, Kashkari bashes banks, but The Fed certainly has their own history of policy errors.


Trade Fog! UK Industrial Production Falls 1.8% YoY In August, China’s Offshore Currency Goes Bananas And Gold Price/ Volatility Rises, V2X Volatility Goes Haywire

This is an update on key economic news relating to US/China trade and UK/EU Brexit talks. Better known as Trade Fog … or simply “The Fog.” 

On the Brexit side, the UK avoided recession by posting of 0.3% in August. Unfortunately, UK industrial production tanked to -1.8% YoY signaling a slowdown for the UK economy.


On the China/US trade arm wrestling match, China’s offshore currency is showing volatility as even the NBA is getting caught up in the trade scuffle.


The volatility surface for the CNH is quite steep.


Of course, trade fog helps assets such as gold to rise.


The volatility surface for gold is similar to that of the Chinese offshore currency.


Trade fog (or trade vacillation) is on the rise as seen in this chart of V2X volatility.


The V2X index is above its various historic moving averages.


As Brexit negotiation crawl along and the US meets with China or tariffs, we continue to see “The Fog” until Brexit and tariffs are finalized. Throw in Federal Reserve policy errors and we have a party!


In Historic First, Greek Debt Carries Negative Interest Rate (Greeks PAID To Borrow!) Greece Sells E487.5M 91-Day Bills At -0.02%

Remember when Greek debt was a joke? Not anymore! Greece just held a T-bill auction and sold E487.5 million in 91-day bills at … drumroll … -0.02%.


Athens, Greece (AP) — More than a year after Greece exited its bailout programs, investors — in a historic first — have bought its short-term debt at a loss.

The country’s debt management agency said Wednesday it raised 487.5 million euros ($535 million) selling 13-week treasury bills, for which the yield was -0.02%.

That means investors will get back slightly less than they paid, following a trend in other European countries.

Greece’s last 13-week treasury bill sale, in August, carried a yield of 0.095%.
At the start of its financial crisis, in 2010, Greece was locked out of bond markets as investors feared they wouldn’t get their money back. Bondholders were in fact later forced to accept large losses on their investments.

From then till August 2018 Greece survived on international bailouts.

But it is a cautionary tale: A Beware of Greeks Central Banks like the ECB bearing gifts.

At least Greece’s GDP is growing at 1.9% YoY.


The ECB president, Mario Draghi. deserves all the plaudits for saving the euro, but the “doom loop” between large banks and sovereign debt hasn’t gone away.

You know we are in monetary Bizarro world when “investors” loan money to Greece with a debt to GDP ratio of 181.80%.

The last known photo of outgoing ECB President Mario Draghi.



A Horse Is A Horse … Fed Chair Powell Announces New QE … That Is Not QE?

A horse is a horse, of course, of course, but no one can talk to a horse, of course. Unless, of course, that certain horse is … Jerome Powell!

(Bloomberg) Federal Reserve Chairman Jerome Powell said the central bank will resume purchases of Treasury securities in an effort to avoid a repeat of recent turmoil in money markets, while hinting at the possibility of another interest rate cut.

“My colleagues and I will soon announce measures to add to the supply of reserves over time,” he told a National Association for Business Economics conference in Denver on Tuesday.

The Fed chief suggested that the purchases would be made up of Treasury bills and stressed the buying should not be seen as a return of the crisis-era quantitative easing programs that the Fed engaged in a decade ago to boost the economy. Three-month bill yields fell on the comments.


“I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis,” he said. “Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy.”

“In no sense, is this QE,” Powell said in a moderated discussion after delivering his speech.

The Fed has cut interest rates twice this year to shelter the U.S. economy from weak global growth and trade-policy uncertainty. Traders in federal funds futures are betting that the Federal Open Market Committee will reduce rates again at its Oct. 29-30 meeting from the current target range of 1.75% to 2%.

Another Cut
In the question and answer period after his speech, Powell compared the current period to two instances in the 1990’s when the Fed cut rates three times in a successful effort to keep an economic expansion on track.

Powell’s comments suggest the Fed is inching closer to reducing rates at the upcoming meeting “but it’s not a done deal,” said Michael Gapen, chief U.S. economist at Barclays Plc.

“Another rate cut as early as this month remains a real possibility,’’ agreed Sarah House, senior economist, Wells Fargo & Co., who attended the Denver conference.

Powell told the gathering that the actions the Fed has already taken “are providing support for the outlook,” which remains favorable but faces risks, principally from global developments such as trade and Brexit.

“The broader geopolitical risks are important right now,’’ Powell said. “You have to be watching those carefully and assess the implications.”

Slowing Economy
The economy has recently shown signs of slowing as weakness overseas has spread to the U.S. and moved from domestic manufacturing industries to services.

The job market has also downshifted, even as unemployment has fallen to a half-century low of 3.5%. Nonfarm payrolls grew by an average of 157,000 per month in the third quarter, compared with gains above 200,000 earlier in the expansion.

Powell said that work done by the Fed mining private-sector data suggested the most recent job gains may ultimately be revised lower, but that the pace would still be above the level needed to hold unemployment steady.

He voiced confidence though that the economic expansion would remain on track. “This feels very sustainable,’’ [That’s what she said!]

Repo Market
Money markets were roiled last month as a combination of corporate tax payments and the settlement of Treasury debt purchases temporarily sent short-term interest rates skyrocketing.

The Fed announced last week that it will extend through October the ad hoc liquidity lifeline that it’s been offering to U.S. funding markets since then.

“We will not hesitate to conduct temporary operations if needed to foster trading in the federal funds market at rates within the target range,” Powell said.

“As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves,” he added. “That time is now upon us.”

Well, maybe not right now.


The NEW logo for The Federal Reserve.