Another week has come and gone and corporate bonds continue to inch tighter into year end. The OAS on the Bloomberg Barclays Corporate Index opened the week at 99 and closed at 95 on Thursday. Spreads are now at their tightest levels of 2019 and the narrowest since February of 2018 when the OAS on the index closed as low as 85. Price action in rates was relatively muted during the week amid low volumes but Treasuries are set to finish the week a few basis points higher. The 10yr opened the week at 1.87% and is trading at 1.91% as we go to print.
As expected, the primary market during the week was as quiet as a church mouse. December supply stands at a paltry $18.9bln according to data compiled by Bloomberg. 2019 issuance stands at $1,110bln which trails 2018 by 4%. As we look ahead to 2020, we expect robust supply right of the gates in January but the street consensus for 2020 as a whole is that supply will be down 5% relative to 2019. Further, net supply, which accounts for issuance less the 2020 maturity of outstanding bonds, will be down substantially from prior years. If these forecasts come to fruition then the supply backdrop could lend technical support to credit spreads in 2020. Supply, however, is merely one piece of the puzzle.
According to Wells Fargo, IG fund flows during the week of December 12-18 were +$0.85bln. This brings YTD IG fund flows to +$295bln. 2019 flows are up over 11% relative to 2018.
The grind continues as the OAS on the Bloomberg Barclays Corporate Index breached 100 for the first time in 2019 with a 99 close on Thursday evening. The index has not traded inside of 100 since March of 2018 and has averaged a spread of 127 over the past 5-years and 113 over the past 3-years. Treasuries were again volatile on the week, especially Friday, which saw a range of 15 basis points on the 10yr Treasury. However, as we type this during the late afternoon on Friday it appears that the 10yr is going to end the week almost entirely unchanged from the prior weeks close.
The primary market has entered year-end Holiday mode. Less than $4bln in new debt was brought to market during the week. The first half of next week is the last chance for meaningful issuance in the month of December. According to data compiled by Bloomberg, 2019 issuance stands at $1,110bln which trails 2018 by 4%.
According to Wells Fargo, IG fund flows during the week of December 5-11 were +$5.4bln. This brings YTD IG fund flows to +$282bln. 2019 flows are up over 10% relative to 2018.
Credit spreads are set to finish the week generally unchanged but may be a touch wider in some spots when it is all said and done. The spread on the Bloomberg Barclays Corporate Index opened the holiday shortened week at 105 and closed at 106 on Thursday. There is positive sentiment in the markets on Friday morning amid China-US trade innuendo out of Washington. For the second week in a row we have seen a relatively significant move in treasuries; last week it was higher rates and this week lower. The 10yr Treasury closed the prior week at 1.94% and is now 1.83%, 11 basis points lower on the week as we go to print.
The primary market posted an impressive haul this week, especially considering the fact that the market was closed on Monday. It was the second largest volume week of the year thanks to a big boost from AbbVie, which printed a $30bln deal that featured 10 different maturities. With one deal pending this morning, weekly issuance will come in at the $50bln mark. Oddly enough both the largest and second largest issuance weeks in 2019 have both come on holiday shortened weeks. The largest volume week was the week of Labor Day when nearly $75bln of new debt was priced in just four days. According to data compiled by Bloomberg, 2019 issuance stands at $1,065bln which trails 2018 by -4.4%.
According to Wells Fargo, IG fund flows during the week of November 7-November 13 were +$2.8bln. This brings YTD IG fund flows to +$252bln. 2019 flows are up 9.5% relative to 2018.
Bloomberg) AbbVie Propels High-Grade Issuance to Year’s Second-Biggest Week
It’s the second-biggest week of the year for U.S. investment-grade issuance, which at about $50 billion in volume trails only the record-setting start to September.
AbbVie’s $30 billion deal on Tuesday clocked in as the year’s largest bond sale and the fourth-biggest ever, helping to establish this week’s second-place finish
Supply for the week stands at $49.4 billion as of Thursday with more deals potentially coming Friday given a shorter window to sell debt after Monday’s Veteran Day close
The first week of September saw $75 billion of high-grade bond sales, the most for any comparable period since records began in 1972
This week overtook the five days to May 9, when IBM and Bristol Myers brought $39 billion in acquisition-related supply in a 24-hour span
(Bloomberg) Here’s How KKR Might Just Pull Off the Biggest LBO in History
One of the private equity industry’s titans called it a “stretch,” and it’s been dismissed as a pipe dream by a bevy of analysts.
Yet interviews in recent days with debt-market specialists suggest that KKR & Co. could find a narrow path to finance what would be the biggest leveraged buyout in history: a potential take-private deal for pharmacy chain Walgreens Boots Alliance Inc. that analysts have estimated would need to be funded with at least $50 billion of debt.
The challenge for any Walgreens suitor will be raising the necessary money via the markets of choice for private equity firms — junk-rated loans and bonds — which have become fragile after an unprecedented borrowing binge left investors with a hangover. Debt funds that financed more than $3.5 trillion of leveraged buyouts in the past decade have become pickier, leaving banks stuck holding more than $2 billion of unsold loans on their balance sheets as recently as last month.
But a road map may be hidden in two other recent debt-fueled takeovers: Dell Technologies Inc.’s $67 billion takeover of EMC Corp. in 2016 and Charter Communications Inc.’s $78.7 billion acquisition of Time Warner Cable Inc. that same year.
Junk-rated Dell and Charter both borrowed heavily in the investment-grade bond market by issuing secured debt. T-Mobile US Inc. is going down a similar route to help pay for its purchase of Sprint Corp.
In Charter’s case, it pledged security to new and existing bonds issued by higher-rated Time Warner to ensure the debt remained investment-grade. Dell used a similar strategy when it bought investment-grade rated EMC. Walgreens’s debt could be segregated into two borrowing structures at a holding company level and an operating company portion, with investment-grade debt placed on the latter.
In doing so, Dell and Charter won access to the most stable part of the corporate debt market, where investors are still buying heavily as an alternative to low or negative-yielding assets elsewhere. At the same time, they limited their reliance on leveraged finance markets, where sentiment can shift quickly and prove costly.
Both companies did tap those markets, but with more manageable offerings. Bankers who asked not to be identified estimated that Walgreens would be able to raise between $10 billion and $20 billion of junk-rated debt to fund a buyout.
Other market participants, who asked not to be named because they weren’t authorized to speak publicly, said KKR still might need to find a deep-pocketed third-party investor to help put more equity into the deal.
Or it may seek to spin off a portion of Walgreens to lessen its financing needs. The company’s European operations could potentially bring in $18 billion to $20 billion, CreditSights analyst James Goldstein said in a phone interview.
Credit spreads were tighter during the week and are now at the tightest levels of 2019. The spread on the Bloomberg Barclays Corporate Index closed at 105 on Thursday and there is a positive tone in the air on Friday morning which could lead to an even tighter close as we head into the long weekend –the bond market is closed on Monday in honor of Veteran’s Day. The move in Treasuries during the week has more than overshadowed tighter credit spreads. It has been a quick and violent move higher in rates. As we go to print the 10yr Treasury is over 22 basis points higher on the week while the 30yr is 21 basis points higher. Unpredictability in rate moves is the principal reason that we are “rate agnostic” at CAM and instead focus on credit risk while avoiding interest rate speculation by always positioning investor portfolios in intermediate maturities.
The primary market got a decent start to the month as $21.8bln in new debt came to market. The pace should pick up substantially as soon as next week due to pending M&A funding from AbbVie which could total near $30bln. 2019 issuance has now passed the trillion dollar mark and it stands at $1,014bln which trails 2018 by -7%.
According to Wells Fargo, IG fund flows during the week of October 31-November 6 were +$3.2bln. This brings YTD IG fund flows to +$249bln. 2019 flows are up 9.5% relative to 2018.
Bloomberg) Global Bond Sell-Off Persuades Some Investors to Buy the Dip
Recent losses in Treasuries, which crescendoed Thursday into one of the worst days since Donald Trump was elected president, look like a buying opportunity for many investors who have a grim view of the economy’s prospects.
And it appears some are pouncing, with traders cashing out bearish wagers and buy-the-dip buyers rushing in. The rekindled interest in the safety of bonds nudged yields on the 10-year, which had climbed to a three-month high of 1.97% on Thursday, down to as low as 1.89% in early European trading Friday before bouncing back to around 1.94%. European bonds rebounded after French and Belgian yields had climbed above 0% Thursday.
Signs of progress in U.S.-China trade talks have thrashed bonds for days, and the two countries agreed Thursday to roll back tariffs on each other’s goods if a deal is reached. The Treasury market has seen a huge turnaround since August, when fears that global growth is slowing prompted the biggest monthly rally since 2008.
(Bloomberg) U.S. Says Phase-One China Deal Would Include Tariff Rollback
The U.S. and China have agreed to roll back tariffs on each other’s goods in stages as negotiations continue over resolving the more than yearlong trade war, officials on both sides said.
“In the past two weeks, top negotiators had serious, constructive discussions and agreed to remove the additional tariffs in phases as progress is made on the agreement,” China’s Ministry of Commerce spokesman Gao Feng said Thursday.
White House economic adviser Larry Kudlow confirmed the advance in negotiations. “If there’s a phase one trade deal, there are going to be tariff agreements and concessions,” he told Bloomberg.
An agreement to ratchet back tariffs would pave the way for a de-escalation in the trade war that’s cast a shadow over the world economy. China’s key demand since the start of negotiations has been the removal of punitive tariffs imposed by Trump, which by now apply to the majority of its exports to the U.S.
“If China, U.S. reach a phase-one deal, both sides should roll back existing additional tariffs in the same proportion simultaneously based on the content of the agreement, which is an important condition for reaching the agreement,” Gao said Thursday.
Credit spreads were turbulent during the week. The first half of the week saw tighter spreads, and the OAS on the Corporate Index closed at 106 on Tuesday, the tightest level of 2019. Spreads traded wider from there on the back of Fed commentary on Wednesday which was followed by a surprisingly weak Chicago PMI reading on Thursday morning leading to a close of 110 for the index on Hallows eve. The economic news continued to roll in on Friday morning, but this time it was received in positive fashion as employment numbers beat market expectations. As we go to print amid lighter volumes in corporates most bonds are trading 2-4 tighter which should see the index close right around 108. If we do close at 108 then spreads will have finished the week unchanged. Rates too were volatile during the week with the 10yr closing at 1.84% on Monday but it is now trading at 1.73% on Friday afternoon. This is lower on the week, as the 10yr finished the week prior at 1.79%.
The primary market was somewhat more active this week but finished the month well shy of expectations. October volume closed at $68.6bln versus dealer projections of $85bln according to data compiled by Bloomberg. 2019 issuance stands at $992bln which trails 2018 to the tune of -6%.
Demand for corporate credit continues to remain robust. According to Wells Fargo, IG fund flows during the week of October 24-30 were +$4.2bln. This brings YTD IG fund flows to +$246bln. 2019 flows are up over 9% relative to 2018.
(Bloomberg) Credit Risk Gauge Drops to Six-Week Low on Bullish Jobs Report
Investors pushed the cost to protect a basket of investment-grade company debt against default to the lowest level since Sept. 19 following the unexpectedly strong U.S. jobs report on Friday.
The Market CDX Investment Grade index spread fell as much as 2 bps to touch 52.96 bps Friday morning in New York before paring some of the gains to trade at 53.67 bps at 12:30 p.m, according to ICE Data Services. The index narrowed by the most in almost three weeks, data compiled by Bloomberg show.
Excess demand for higher-quality bonds and low supply have propelled gains in corporate investment-grade markets. October new IG issues ended at $68.6 billion, falling short of the $85 billion dealer projections by nearly 20%, while cash continues to flow intohigh-grade bond funds.
(Bloomberg) Riskiest Junk Debt Still Isn’t Cheap Enough to Lure Buyers
Notes rated in the CCC tier, essentially the lowest level in the junk bond market, have grown cheaper since May even as most of the market has grown stronger. Risk premiums, or spreads, on the debt are close to their widest level relative to the tier just above them since mid-2016, according to data compiled by Bloomberg.
The weaker performance of the lowest-rated debt underscores how even as investors are reaching for higher returns as the Federal Reserve eases interest rates, they’re still wary of a potential economic downturn and fear that defaults could start to tick higher. The highest tier of junk bonds have gained 13.5% this year, and overall high-yield corporate bonds are up 11.9%, while those rated CCC have gained just 5.7%.
CCC debt doesn’t usually perform like this. Because the companies that sell the notes are already so close to defaulting, CCC bonds are typically hit harder than the broad market during a market downdraft. When the market recovers, the securities often perform much better. The debt plunged in early 2016 when energy prices dropped, but went on to notch huge returns for the year — 31.5% to the broader market’s 17.1% — as oil prices started recovering.
This year, CCC bonds are performing worse than the market even as the overall supply of the lowest-rated notes has been shrinking. There are about $156 billion of those bonds outstanding today, down from $167 billion in February. So far this year, CCC rated companies have sold around $24 billion of debt, less than the same period for each of the previous two years, according to data compiled by Bloomberg.
Bloomberg) Top Fed Officials Hammer Home Message That Rates Are on Hold
Federal Reserve Vice Chairman Richard Clarida reinforced the central bank’s new message this week that interest rates are on hold, saying that both monetary policy and the U.S. economy are “in a good place,” though some risks remain.
“We have a favorable outlook for the economy,” Clarida said Friday in an interview with Jonathan Ferro and Tom Keene on Bloomberg Television. “We think the economy is in a good place, we think monetary policy is in a good place.”
He repeated that message in a lunchtime speech at the Japan Society in New York, with Fed Vice Chairman for Supervision Randal Quarles delivering a similar signal at an event at the same time at Yale University in New Haven, Connecticut.
The vice chairs’ overlapping remarks hewed closely to what Chairman Jerome Powell said earlier this week after the Fed cut rates for a third time this year, signifying a strong consensus at least among the Board of Governors. The Fed has acted to protect a record U.S. economic expansion amid headwinds from trade uncertainty and global weakness, while the domestic economy has been holding up.
Spreads are tighter to the tune of several basis points on the week while Treasury rates crept higher. The OAS on the Bloomberg Barclays Corporate Index was 110 on Friday morning after having closed at 112 the week prior. Spreads have continued to grind tighter throughout the day as we go to print on Friday afternoon and the close on the index OAS is likely to come close to touching the year-to-date tight of 108. Treasury rates are set to finish the week higher with the 10-year up 5 basis points on the week.
The primary market continued its October trend with another week of lackluster supply. Weekly new issue volume was just shy of $14bln pushing the monthly total to $39.5bln according to data compiled by Bloomberg. 2019 issuance stands at $963bln trailing 2018 by nearly 8% on a relative basis.
According to Wells Fargo, IG fund flows during the week of October 17-23 were +$4.4bln. This brings YTD IG fund flows to +$242bln. 2019 flows are up 9% relative to 2018.
Bloomberg) Bond Funds Learn to Exploit Ratings System to Buy Riskier Debt
In today’s low interest-rate world, investment-grade bond funds face an all-too-familiar trade-off: buy risky debt to improve returns or play it safe and underperform.
In particular, funds are loading up on bonds where ratings firms are split on whether they’re investment grade or junk. While reasonable people can disagree about which one is right, for a growing number of firms, the answer is always the same: the higher one.
The practice has obvious advantages. With high-grade corporate bonds yielding less than 3% on average, managers can pick up an extra half-percentage point on split-rated debt. And funds can say they’re invested in safe assets while running a portfolio that actually looks a lot like a junk bond fund.
Granted, managers have always had the discretion and the flexibility to choose which ratings standards to follow. The methodology is there for all to read in the fund’s prospectus, though it’s often tucked into the fine print. Then, there’s the question of how much stock to put into ratings anyway. Many managers lean on their own analysis to determine a bond’s credit risk.
That extra yield comes with a price. Historical data from S&P shows that lower initial ratings correspond with higher rates of default. The gap is notably stark in the divide between investment grade and junk. Ten-year default rates on bonds with BB ratings are double those with BBB grades.
(Bloomberg) Corporate Bond Syndicates Yawn Amid Sleepiest October in Years
S. investment-grade debt sales are expected to miss estimates for October — by a lot.
Just $39.5 billion of new debt has been sold as of Thursday, compared to initial forecasts calling for $85 billion. This projection, put together by compiling dealer estimates, was revised lower mid-month to around $65 billion and now even that may be a stretch.
Volume is the lowest since October 2013, when $41.9 billion of blue-chip company bonds was sold. There are still five trading days left, but that narrows to two when you consider Fridays are often blank, Wednesday is a Fed decision day and Thursday is Halloween.
The following factors likely play a role.
Big banks have been absent. Of the top 10 U.S. banks, just Bank of America Corp. and Wells Fargo & Co. have issued new debt, together totaling $10. 5 billion. Typically there is more, especially when financial institutions report better-than-expected earnings as Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co. have.
Earnings season. Issuers and investors want to see how well companies have been doing. Buyers want to know about the recent quarter and fourth quarter outlook, considering the geopolitical risks such as the U.S.-China trade war and Brexit
Muted merger and acquisition activity. It’s widely understood that M&A issuance is down, but overall the calendar just seems lighter. Every once in a while there is a whisper about T-Mobile USA Inc., but at the moment that is looking more like a 2020 story.
Restart
Issuance will begin to pick up next week, albeit from a pretty low bar set in the last few weeks. Desks are expected to front-run the Fed and complete the bulk of next week’s debt issuance on Monday and Tuesday.
There are a plethora of companies expected to report next week. The week after next, earnings will subside and with the bulk of the reports released, more candidates will consider selling debt. The first week of November is when the real ramp up should occur.
The fact that October is running about 54% behind estimates doesn’t come as a surprise since actual supply has been missing weekly estimates for five weeks in a row. That trend is going to break as Wells Fargo’s $6.5 billion deal catapulted this week to $13.7 billion, in line with estimates of $15 billion area.
Spreads are tighter on the week amidst positive vibes in risk markets and the lack of meaningful new corporate supply. The OAS on the Bloomberg Barclays Corporate Index is 113 on Friday morning after having closed at 115 the week prior. Treasury rates have risen substantially since the beginning of October and the 10yr spent much of the week wrapped around 1.75%.
The primary market was subdued during the shortened week as the bond market was closed Monday for a federal holiday. Weekly new issue volume was $10bln pushing the monthly total to $25.8bln according to data compiled by Bloomberg. 2019 issuance stands at $949bln.
According to Wells Fargo, IG fund flows during the week of October 10-16 were +$4.3bln. This brings YTD IG fund flows to +$238bln. 2019 flows are up 9% relative to 2018.
(Bloomberg) Chief of Exelon Utility Business Retires Amid Federal Probe
The head of Exelon Corp.’s utility unit has abruptly retired amid a federal probe involving its lobbying in Illinois.
Anne Pramaggiore, senior executive vice president and chief executive officer of Exelon Utilities, is leaving “effective immediately,” the company said in a statement Tuesday. Calvin Butler Jr., chief of Exelon’s Baltimore Gas and Electric utility, was named as her interim replacement.
Pramaggiore’s departure comes less than a week after Exelon disclosed in a regulatory filing that it received a subpoena from federal prosecutors asking for information related to communications with Illinois State Senator Martin Sandoval. In July, Exelon disclosed it received a subpoena related to its lobbying activities in Illinois.
The Chicago Tribune reported earlier this month that federal agents had raided Sandoval’s office and were searching for information related to concrete and construction businesses and lobbyists and public officials. Officials were also looking for “items related to any official action taken in exchange for a benefit,” the Tribune reported, citing documents released by the Illinois Senate.
Exelon’s statement on Pramaggiore’s retirement Tuesday didn’t reference the subpoenas. Nor did it give a reason for her departure.
“We thank Anne for her valuable service,” Exelon CEO Chris Crane said in the statement. “We are confident this will be a smooth transition.”
(Bloomberg) High-Grade Corporate Bonds Trade Tighter as New Debt Sales Slump
Spreads on new high-grade corporate bonds tightened in secondary trading as debt issuance missed estimates for the fourth straight week.
Further outperformance in a market that has already enjoyed a 13% return this year should continue given the dearth of new supply and consistent fund inflows
Investors added $2.9 billion for the week ended Oct. 16, Refinitiv’s Lipper US Fund Flows data show, adding to $1.8 billion the prior period
All eight of the fixed-rate tranches sold this week are trading tighter, according to Trace data reviewed around 10 a.m. on Friday
Primary market sales disappointed again this week, with just $10 billion priced against estimates calling for $15 billion to $20 billion
40% of this week’s volume was from one borrower — Bank of America’s $4 billion priced in two parts
Seven of eight bonds sold this week were from financial companies
Next week’s preliminary forecast calls for a total in the $15 billion area, with the possibility for an upside surprise should more banks come to the market
With 27% of the S&P 500 index companies reporting earnings next week, more corporate issuance is expected
Spreads and Treasuries were range bound during the week and look likely to finish the week relatively unchanged. It was a quiet week for credit which is unsurprising given that we are headed into quarter end.
The primary market kicked off September with its busiest week ever but the torrid pace of issuance has cooled considerably heading into month end. Weekly new issue volume was $14.5bln pushing the monthly total to $154.9bln according to data compiled by Bloomberg, the fifth busiest month of all time. 2019 issuance trails 2018 by 3.9% on a year over year basis.
According to Wells Fargo, IG fund flows during the week of September 19-25 were +$2.9bln. This brings YTD IG fund flows to +$216bln. 2019 flows are up 8.2% relative to 2018.
(Bloomberg) Sizzling Bond Market Draws Record Number of Blue-Chip Companies
This month has seen a record number of bond sales by blue-chip companies, incentivized by low interest rates and supercharged investor demand to refinance debt.
The market priced 127 deals, surpassing September 2017’s 110 offerings as the busiest month, based on Bloomberg records began going back 20 years. Total volume of $154.9 billion is still short of the $177 billion record set in May 2016. But with two days remaining in September, sales are poised to be the third-highest ever.
The surge in supply came as a growing pile of bonds offer negative yields overseas, driving investors desperate for higher returns into the U.S. corporate credit market. It marks a rare spike in borrowing that’s fueled by a broad-based rush to extend maturities, not driven by large M&A financing.
The first week of the month saw the highest weekly sales volume ever. Almost $75 billion was priced, led by bond sales for Walt Disney Co. and Apple Inc.
September is by far the most popular month for issuers, accounting for the top three months by deal count over the past 20 years. This month’s 127 total high-grade sales compares with 110 in 2017 and 100 in 2016, the second and third busiest months over the past 20 years.
The average deal count for September over the last 10 years is 88.
Spreads are tighter on the week and Treasuries are lower. The OAS on the corporate index opened the week at 116 and is 114 as we go to print on Friday morning while the 10yr Treasury is at 1.767%, 12 basis lower from the previous Friday close. In other news, as expected, the Fed cut the target rate on Wednesday by a quarter-point to 2%. The direction of future cuts is much less clear with plenty of debate as to whether or not the Fed will cut again this year. We tend to think it comes down to economic data and the Fed has been quite clear about this in our view. The Repo market made headlines throughout the week due to a spike in repo-rates amid a supply-demand mismatch. The Fed has since intervened and gotten the rates under control. It remains to be seen as to whether this is much ado about nothing but so long as the Fed liquidity injections can manage to keep rates within the targeted range then we believe that this topic will go by the wayside.
In what seems to be a recurring theme, the primary market had yet another strong week. Monthly volume has topped $140bln for September making it the 8th busiest month in history with more than a full week to go. Year-to-date supply is now $905bln which is down a smidge less than 4% relative to 2018 supply at this juncture. While it was a busy week in the primary market it was not quite as robust as the previous two –if $37bln manages to price by the end of the month then September 2019 would become the busiest month on record but with just 6 trading days left and quarter end looming we are probably not likely to see enough supply to topple the all-time high.
According to Wells Fargo, IG fund flows during the week of September 12-18 were +$2.5bln. This brings YTD IG fund flows to +$213bln. 2019 flows are up 8 % relative to 2018.
(Bloomberg) The Repo Market’s a Mess. (What’s the Repo Market?): QuickTake
When plumbing works well, you don’t need to think about it. That’s usually the case with a vital but obscure part of the financial system known as the repo market, where vast amounts of cash and collateral are swapped every day. But when it springs a leak, as it did this week, it rivets the attention of the U.S. Federal Reserve, the nation’s largest banks, money-market funds, corporations and other big investors. The Fed calmed things down by pumping in billions of dollars, but it may have a lot more work to do on the pipes.
What’s the repo market?
It’s where piles of cash and pools of securities meet. Repo is short for repurchase agreements, transactions that amount to collateralized short-term loans, often made overnight. Repo deals let big investors — such as mutual funds — make money by briefly lending cash that might otherwise sit idle, and enable banks and broker dealers to get needed financing by loaning out securities they hold in return. A healthy repo market is more than the world’s biggest pawn shop: It helps a wide range of other transactions go more smoothly — including trading in the over $16 trillion U.S. Treasury market.
How is the Fed involved in it?
In a number of ways. For years, central banks around the globe have used their own repo markets to extend credit in tight markets, stabilize financing costs and guide interest rates. But the relationship changed when the U.S. repo market melted down in September 2008, a crucial part of that year’s financial panic. Since then, the Fed has worked with other regulators to put in new rules to prevent a recurrence. And since 2013, the Fed has entered the repo market on a large scale, using transactions there to put a floor under rates.
What happened this week?
A lot of cash flowed out of the repo pipes just as more securities were flowing in — meaning that suddenly there wasn’t enough cash for those who needed it. That mismatch drove overnight repo rates from about 2% last week to over 10% on Tuesday. Perhaps more alarming for the Fed was the way volatility in the repo market pushed the effective federal funds rate to 2.30%, above the 2.25% upper limit of the Fed’s target range — just as the Fed was preparing to drop that ceiling to 2%.
Why did that all happen?
In one view, different events that acted as catalysts just happened to land at the same time and push in the same direction. A big swath of new Treasury debt settled into the marketplace, landing on dealers’ balance sheets just as cash was being sucked out by quarterly tax payments companies needed to send to the government.
What did the Fed do?
In its first direct injection of cash to the banking sector since the financial crisis, it laid out about $200 billion in temporary cash over several days to quell the funding crunch and push the effective fed funds rate down. In what are known as overnight system repos, the Fed lent cash to primary dealers against Treasury securities or other collateral.
Was that enough?
It did calm the markets, eventually bringing the rates down around 2% on Thursday. And the action may be sufficient for a temporary patch, if the liquidity squeeze really just reflected the corporate tax payments and Treasury settlements falling on the same date. But most strategists and economists believe the turmoil is a sign of a longer-term problem. To some, one factor is that the rules regulators imposed to make the market safer led dealers to pull back on their involvement, reducing overall liquidity. And many think these distortions will continue as long as government spending and Treasury’s debt issuance continues to rise. More broadly, some observers say that the repo troubles show that there aren’t enough reserves — excess money that banks park at the Fed — in the banking system to give markets the buffers they need at times of stress.
What does that mean?
To some market observers, it might mean that bank reserves, which currently top $1 trillion, still don’t amount to having enough money in the system. They think the Fed may have to start buying bonds again as a way of boosting reserves. This time the purchases would not be like the quantitative easing of the past, meant to support the broader economy, but just to clear up the mechanics of its balance sheet. As with any corporation, the Fed’s assets and liabilities must balance. The Fed’s liabilities mainly come in the form of currency in circulation and bank reserves. As the nation’s economy expands, as it has since 2009, the amount of currency in use has been growing, too. Without action by the Fed to add to its assets, the growth of currency would reduce the liability represented by reserves.
What can the Fed do about the repo squeeze?
It did one thing at its September meeting, and two other steps are being discussed. It lowered the interest rate it pays on so-called excess reserves — the cash banks park at the Fed beyond what’s needed to meet regulatory requirements — to 1.8% from 2.1%. Lowering the IOER rate — interest on excess reserves — gives banks an incentive to lend out more of their money, which would keep repo and the effective federal funds rate more within the Fed’s target range. The Fed has also considered introducing a new tool, called a standing overnight repo facility, which would amount to a standing offer to lend a certain amount of cash to repo borrowers every day. The most drastic step would be for the Fed to create more bank reserves by expanding its balance sheet and thereby buoying bank reserves. Fed Chairman Jerome Powell said Wednesday that the central bank is monitoring when it’s appropriate to start expanding the balance sheet.
Spreads are set to finish the week modestly tighter while Treasuries are at the forefront with the 10yr now 30 basis points higher from last Friday’s close of 1.560%. The OAS on the corporate index closed at 117 on Thursday after closing the prior week at a spread of 119. Equity indices are trading near or above all-time highs as risk markets cling to any glimmer of hope or positive headline that might indicate U.S.-China trade progress. At CAM we remain skeptical of a near term trade resolution and are cautious in our positioning as a result.
The primary market had another strong week after posting its busiest week ever in the previous weekly session. Nearly $42bln of new corporate debt was brought to the market making it the 3rd busiest week of the year according to data compiled by Bloomberg. Monthly volume has topped $116bln while year-to-date corporate supply stands at $882bln. After having trailed 2018 issuance by as much as 13% in June, 2019 year-to-date issuance is now down just 2% from the prior year. It will be interesting to see how the violent move higher in rates may affect the primary market going forward as higher rates may serve to delay some issuance as borrowers weigh funding costs relative to long term capital allocation plans.
According to Wells Fargo, IG fund flows during the week of September 5-11 were +$7.2bln, the second largest inflow on record. This brings YTD IG fund flows to +$209bln. 2019 flows to this juncture are up 8 % relative to 2018.
(Bloomberg) Investment Grade New Issues Trade Tighter Despite Supply Surfeit
Demand for U.S. investment-grade credit is robust, with this month’s avalanche of high-grade bond sales trading mostly stronger, data compiled by Bloomberg show. Spreads on the vast majority of deals priced last week and sized at $1 billion or more are tighter.
20 out of 21 bonds sampled were tighter as of Friday morning
Average change in spread was 8 basis points
(Bloomberg) Fed Seen Cutting Rates Twice More in 2019 Before Holding Steady
U.S. central bankers will trim interest rates by a quarter percentage point next week, and again in December, before leaving the target range for their benchmark rate at 1.5%-1.75% for an extended period, according to economists surveyed by Bloomberg.
In the Sept. 9-11 poll of 35 economists, respondents lowered their projections for the path of U.S. rates compared to a similar survey in July. However, they firmly rejected the idea the Federal Reserve had begun a series of moves that will prove more prolonged than the “mid-cycle adjustment” that Chairman Jerome Powell predicted in July, when the Federal Open Market Committee cut for the first time in more than a decade.
(Bloomberg) Elliott’s $3.2 Billion AT&T Bet Signals ‘There Will Be a Fight’
AT&T Inc.’s sweeping transformation from Ma Bell to a multimedia titan has gone both too far and not far enough for Elliott Management Corp.
Billionaire Paul Singer’s New York hedge fund disclosed a new $3.2 billion position in AT&T, taking on one of the nation’s biggest and most widely held companies with a plan to boost its share price by more than 50% through asset sales and cost cutting.
Elliott outlined a four-part plan for the company in a letter to its board Monday. The proposal calls for the company to explore divesting assets, including satellite-TV provider DirecTV, the Mexican wireless operations, pieces of the landline business, and others.
AT&T is the most indebted company in the world — not counting financial firms and government-backed entities — with $194 billion in total debt as of June, a legacy of Stephenson’s steady clip of large acquisitions. The CEO used to keep a spreadsheet of a few dozen companies that he studies on his tablet to plan his next big deal, people familiar with the matter told Bloomberg in 2016.
(Bloomberg) The Repo Market’s a Mess. (What’s the Repo Market?): QuickTake