Chinese 10-Year Sovereign Bond Yield Surges By Record Amount

Yields on Chinese 10-year sovereign bonds soared by a record 22 basis points on Thursday hitting a 16-month high of 3.4%, prompting authorities to halt trading in some futures contracts. 10-year and 5-year government-bond future prices plunged by a record 2% and 1.2% respectively in early trading, leading yields to soar.

The global market selloff was sparked by comments from the Fed signaling a vigorous clip of interest-rate increases for 2017 and a plummeting yuan. While Wednesday’s announcement that the Fed would raise the benchmark policy rate by 0.25% had been foreseen, its promise to introduce three more next year caught many off guard.  Other factors exacerbating the selloff include concerns of frothy asset markets, accelerating capital outflows, and a liquidity crunch.

“The market was not expecting a change,” said Mike Amey, a portfolio manager at Pacific Investment Management Co., regarding Fed’s announcement to the Wall Street Journal. “You can see that in the reaction in the market.”

The Chinese bond selloff is part of a global trend. US Treasuries have also declined amid expectations of interest rate hikes, adding negative pressure to the yuan and making Chinese bonds all the less attractive to investors.. Germany and Australian government bond yields have jumped by 0.062% and 0.2% respectively. UK yields, in contrast, declined slightly on the back of a Bank of England announcement that it would keep interest rates stable.

Bloomberg adds other factors that have reduced the appeal of debt. Both globally and in China, inflation is expected to accelerate, driving up consumer and producer prices. Moreover, the People’s Bank of China has been driving up money-market rates to spur deleveraging. In response, Chinese banks have begun deleveraging and selling off bond holdings as assets have become more expensive to fund. Bond yields, in turn, have been following money-market rates.

Overall, the short-term outlook on global economic growth has brightened since Trump’s election, given expectations of deregulation, lower taxes, and higher spending. This has also encouraged investors to move away from bonds.



US Stocks Slump On Weak Chinese Export Data

US stocks have slumped following worrying news out of China that its exports in September had fallen 10% year-on-year, marking the sharpest drop since February. Chinese imports also fell 1.9% in September, after rising 1.5% in August. The steep decline in exports was greater than forecast, intensifying long-standing concerns about the slowing growth of the world’s second-largest economy and reflecting weak global demand for goods, which, in turn, bodes ill for global economic growth.

“Weaker-than-expected Chinese trade readings have increased concerns that the pace of global growth will slow further,” said Dennis DeBusschere, a macro research analyst at Evercore ISI, to the Wall Street Journal.

The Dow Jones Industrial Average fell 45.26 points, or 0.25%, to 18098.94 points. The S&P 500 dropped 0.3%, or 6.63 points, to 2132.55, while the Nasdaq Composite Index fell 0.5%, or 25.69, to 5213.33.

Traders sought refuge in government bonds, the yen, and gold, as Treasuries rebounded from a four-month low. The yield on benchmark 10-year Treasuries fell 3 basis points, or 0.03%, to 1.739%, reflecting higher demand. According to Bloomberg, the US Treasury sold $12 billion of 30-year debt on Thursday. Conversely, raw materials and energy stocks fell out in anticipation of weakening demand.

The weak data coming out of China has precipitated some doubts as to whether the Fed will indeed raise interest rates by its December meeting, though the market-implied probability rate of such an eventuality is still 66%. The consensus among traders and investors is that the Fed will proceed with raising the interest rate, despite the news.

“It’s going to take some pretty lousy data to persuade the Fed to not raise rates,” said Art Hogan, of Wunderlich Securities to Bloomberg. “The Fed’s letting us know that December is something they have to be talked out of, not into.”


Consumer Credit Grows Record 8.5% in August

This month’s Federal Reserve consumer credit release showed that household borrowing had grown at a seasonally adjusted rate of 8.5% in August, the fastest rate in a year, up from 5.9% in July. The surge represented a $25.9 billion rise in total consumer spending to $3.69 trillion, and occurred as demand for everything from cars to education and credit cards picked up.

Revolving credit grew at an annual rate of 7% to $974.6 billion, while non-revolving credit rose 9%, or $20.2 billion, to total $2.71 trillion. Federal government holdings of student loans comprise the greatest share of non-revolving credit, representing a 38% portion of outstanding credit, while depository institutions and financial companies are the second and third largest, respectively.

Greater willingness to borrow on the part of American consumers, with decent consumer balance sheets, points to confidence about future earnings, driven by steady income and job growth. Indeed, the economy added 156,000 new jobs in September, posting another month of steady gains, although the figure was slightly lower than previously forecast. Unemployment grew slightly from 4.9% to 5% as more discouraged workers re-entered the market looking for work, though overall, unemployment claims remained at 40-year lows. Wages also increased 2.6% in September, compared to a year ago, overtaking the inflation rate.

“It turns out that Goldilocks is real: The labor market is not too hot and not too cold,” says Douglas Holtz-Eakin, a former director of the Congressional Budget Office, according to CNN Money.

In combination, job growth, income growth, and increased household borrowing, all suggest that the consumer discretionary sector, including retailers, car manufacturers, and other domestically-oriented consumer industries, may be poised for a moderate recovery. The increases in the stock prices of GM, Ford, and Gap, also support this view.


Spotlight on U.S. Treasuries

7.26.16 | By Rusty Tweed team

What are U.S. Treasuries?

U.S. Treasury securities (also known as U.S. Treasuries) are debt obligations that the U.S. government holds. They take the form of bills, notes and bonds. If you purchase a U.S. Treasury security, you effectively lend money to the federal government for a pre-determined amount of time.

U.S. Treasuries are generally thought to be the safest of all investments. The market perceives them to have almost no credit risk i.e. your interest and principal will almost certainly be paid in full and on time.  As they are backed by the “full faith and credit” of the government, they are trusted because the government can raise tax revenues and print currency if necessary.

As a result of the safety of the investment, interest rates are generally lower on U.S. Treasuries than for other riskier debt securities like corporate bonds that are more widely traded.

U.S. Treasuries by Rusty Tweed team

What is the Relationship Between U.S. Treasuries and the Federal Reserve?

The Fed creates “Federal Reserves” i.e. electronic money that it uses to purchase loans held by financial institutions such as banks, therefore injecting those reserves into the economy. The loans which the Fed holds are traditionally U.S. Treasuries. Therefore, as PBS economist, Paul Solman, explains, “the Treasury is the borrower and the Fed, the lender, however indirectly.”

During the 2008-2009 financial crisis, according to Federal Reserve Bank reporter, Paul J. Santoro, “the Treasury altered its cash management practices to facilitate the Fed’s dramatic expansion of credit to banks, primary dealers, and foreign central banks.”

Santoro elaborates, “Understanding the relationship between Federal Reserve credit policy and Treasury cash management is important because the relationship illuminates an important but sometimes unappreciated interface between the Treasury and the Fed. It also underscores the symbiotic relationship between the two institutions, in which each assists the other in fulfilling its statutory responsibilities.”

Why Doesn’t the Federal Reserve Purchase Treasury Securities Directly from the U.S. Treasury?

The Federal Reserve Act indicates that the Federal Reserve may buy and sell Treasury securities solely in the “open market”. This supports the independence of the central bank in conducting economic policy. Moreover, the Federal Reserve conducts its purchases and sales of securities primarily through transactions with primary dealers – a group of major financial firms that have a long established trading relationship with the Federal Reserve Bank of New York (FRBNY). Private market demand sets the prices on new Treasury Securities. However, the majority of the Treasury securities that the Federal Reserve has purchased are “old” securities that the Treasury issued some time ago.

References for U.S. Treasuries by Rusty Tweed team:

Understand the Fed & Interest Rates

7.19.2016 | The Fed & Interest Rates – Rusty Tweed team

Why Does the Federal Reserve System Set Interest Rates?

In the same way that consumers and governments owe money to others, businesses also use debt to finance day-to-day expenses and long-term investments. Interest rates play a critical role in the success or failure of businesses. When interest rates increase, companies have less money to hand for more productive uses like investing and hiring. If there is a sudden increase, businesses may fail. For this reason, in countries like the U.S. that use a centralized banking model, the market and its laws of supply and demand do not randomly set interest rates. 

The Fed & Interest Rates - Rusty Tweed team

How Does the Federal Reserve Set Interest Rates?

The Federal Reserve System uses a variety of tools to set interest rates in order to control the country’s money supply and maintain economic stability. When inflation is rising, the Fed seeks to contract the money supply to cut it off. When the economy is struggling and unemployment is increasing, the Fed increases the supply of money. It does this to encourage companies to invest and consumers to spend.

Since retail banks tend to be the first financial institutions to expose money to the economy, they are the main instruments used by the central bank to manipulate the money supply. By adjusting the interest rates it lends to or borrows from the retail banks, the Fed can regulate the supply of money to the end user (individuals and companies).

Is the Fed Likely to Raise Interest Rates this Year?

According to CNBC, the Fed could surprise markets with at least one raise later this year. Fed funds futures anticipate a 40% chance of a rate hike this year. However, while economists agree that the Fed is taking the summer off, they do not otherwise agree on the timing. Rick Rieder, chief investment officer of global fixed income at BlackRock, believes, “the Fed would like to get a rate hike in and the question is are you going to get the opportunity to do it [balancing complex international and domestic issues], but I think the dynamics made it significantly more difficult.”

Reid predicts that if the Fed does increase interest rates this year, it will do it in December. He anticipates rates increasing then rather than during its September meeting, if Europe settles down and China looks more stable. 

References for The Fed & Interest Rates – Rusty Tweed team: