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May 2014

Major Economic & Central Bank Events on Horizon

May 30, 2014 by EconMatters   Comments (0)

By EconMatters  

Since the last Employment report things have been relatively quiet on the economic and Central Bank front but all that is set to change over the next three weeks. Volatility should pick up and many of these events could be potentially market moving for certain asset classes.


Week One Events
On Monday June 2nd we have some construction and manufacturing economic reports, and these have been coming in slightly ahead of expectations. However, on Wednesday the ADP Employment Report will be a precursor at least in theory to the Friday Employment Report, and traders often position themselves based upon the outlook provided by ADP. 
Thursday, June 5th will be dominated by the ECB Meeting and what Mario Draghi`s actual stimulus announcement is and this has been much telegraphed to the markets, but no real fine details seem to be known for sure by markets. There has been a lot of positioning prior to the event that markets could react in a myriad of ways to the announcement. Is it fully priced in, is it more groundbreaking than markets expected, a disappointment, sell the news event? This is hard to call but my best intuition is that far too much positioning went on in bonds in Europe before the event, and I expect they sell off in reaction to the news.
On Friday is the big employment report for the US, a high frequency and co-location`s wet dream as they are guaranteed to make money by speed alone on any news. We expect another 200k plus report but the doom and gloom crowd will look for any weakness in the report to justify their positions on the market, so some of the inner workings of the report might be more relevant for this crowd. If we see improvement in the labor participation metric or wages these might be more important for bulls than the headline number and the unemployment rate. Of course the Algos immediately trade on the headline number, but the staying power of any directional moves comes from the complete report with its underlying metrics.
Week Two Events
The following week gives traders a couple of days to digest two really big market moving events, and some repositioning might occur in portfolios. On Wednesday, June 11th the 10-Year Note Auction occurs in the middle of the day and this is going to be an especially important auction given where rates are in relation to the previous week’s news. This is followed by Retail Sales and Jobless Claims numbers on Thursday June 12th; and on Friday PPI comes out and this is important given some of the higher than expected inflation numbers of late in other economic data. Again I think this week will have a pivotal impact on the bond market depending upon where technical levels are in relation to hotter or colder data results in these reports.
Week Three Events
The following week on Monday June 16th has the Empire State Manufacturing Survey with Industrial Production and the Housing Market Index, more Econ news than usual for a Monday. On Tuesday June 17ththere is the CPI and Housing Starts data that hits the wire as the FOMC Meeting begins. A hot CPI the day the Fed meets should have more impact given the recent hotter CPI reports, maybe even getting mentioned in the Fed Statement the following day. On Wednesday June 18th the FOMC Meeting Announcement is followed by the FOMC Forecasts and Chair Press Conference with many potential market moving messages coming out of those three events. 
Inextricably Linked Events
The interesting part is how the Econ Data and Central Bank events for the next three weeks all directly affect the next event, and how the market digests all these events as a whole. A couple of hot PPI & CPI Reports for instance affects the way the FOMC message is tailored, a strong Employment Report and better than expected Retail & Vehicle Sales may convince the doom and gloom crowd to reposition some of their portfolios relative to economic growth. 
Summer Boredom Breakouts
I would expect volatility to pick up and markets to move on many of these events, and after several weeks of relative ‘snooze fest’ things should get quite interesting for financial markets, and certain asset classes and portfolio rebalancing towards the end of the quarter might need more than a little fine tuning.

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The Party Is Over In The Treasury Market

May 30, 2014 by EconMatters   Comments (0)

By EconMatters


Last Hurrah
Everybody knew the GDP number was going to be revised down on this reading, and that it probably gets revised up for the next reading, and Bond Traders used the Revision in first quarter GDP to take the 10-Year Yield down to 2.4% on a nice push, but this required a whole lot of ammunition, and as soon as Europe started to close at 10 am central time (Europe close is 10:30 am for practical purposes) the Traders needed to start closing some of these positions.


Bottom in the Bond Market
The 10-Year then went 7 basis points higher to actually end the day up, which in trader`s terms is an outside reversal, or a very bullish sign for 10-year yields going forward, this effectively is the bottom for the 10-year bond yield for 2014, 2015, 2016 and beyond. 
Mark this date in your calendars as the last time the 10-year Yield was this low, we mentioned in an earlier article about this market being a coiled spring, well just sit back and watch the carnage as everyone tries to run for the exits at the same time in the bond market. Grab some popcorn because this is going to be funny over the coming months and years as yields continue to rise, some poor sap actually bought a 10-Year Bond today at 2.41% Yield, and thought this was a good investment.
Stop Trading on 3 Month Old Data
Bonds should have never gotten this low, everyone and their mother is underestimating inflation going forward, and the idiots on the Federal Reserve are so behind the curve, still talking about data 3 months old. By the time they realize we not only have food and energy inflation, but that wage inflation is coming in the next three months if not sooner, the absolute wrong-footed Federal Reserve & Bond Market are in for the shock of their lifetimes.
Massive Outflows Coming in Bond Funds
Literally bond funds are going to see such outflows, there are going to be money managers and hedge funds going out of business on this chasing yield trade blowing up in their faces. Margin clerks will be tapping a bunch of folks on the shoulders the next 6 months and beyond on this massive unwind in bond markets. 
I have never seen a market where so much money, and the consensus view is so wrong on this trade; the unpreparedness, the fact that not only do these people Not have an Exit plan, they don`t even know they need one on this trade. 
This is like the housing market can never go down logic; that interest rates will never go to 4% in their lifetime unpreparedness. Remember the Fed Funds Rate was 5.5% right before the financial crisis in 2007, this is hardly a century ago, it occurred in the last 10 years.
Federal Reserve Members are Clueless
I used strong language when I called the Federal Reserve members idiots, but the more I hear these people talk about the economy, this includes Bernanke now that he is retired, I cannot believe these are the best and brightest economists that America has to offer, because they are totally clueless. Even the hawks on the Fed are behind the data curve by at least 3 months, inflation is here, they better start raising rates next week.
Equities Running on Inflation Power: Forget Valuations at this Stage
This is what the stock market is telling everyone, and I like everyone was waiting for a summer pullback, a bunch of Hedge Funds starting shorting the market in anticipation, going long bonds; but inflation cannot be held back once it takes hold, and equities are off to the races, there will be a short squeeze in equities going forward. 
Once people realize what is going on with the reality that this cheap money has finally reached escape velocity with nowhere to go, and bonds are no longer an option once the realization that inflation is going to force the Fed`s hands, all this money is going to finally rotate out of bonds and into equities. We could literally see 2500 in the S&P 500, while the Fed tries to soak up this excess liquidity in the financial system. 
I am not sure how it will play out in equities once Bond yields spike, but where does the money go? Does everyone just run to cash? There are two things I am solid on however, one is that bond yields are going to explode higher, and the other is that volatility is also going to go much higher, so who knows how this is all going to play out in the equity markets. Maybe bonds and stocks sell off together.
Yield Trade Pushed Down Volatility
The abundance of money chasing the yield trade has pushed down volatility, and as the yield trade unwinds there are going to be some volatility traders that go out of business as well. I just cannot fathom how so many investors and traders are currently poorly positioned for one of the biggest moves in markets coming down the pike since the tulip market collapse. 
Bond yields are in a bubble all over the planet, and first you have food and energy inflation, then you have wage inflation to pay for the rising food and energy costs due to the final piece of the puzzle in the tightening labor market. The US exported a bunch of inflation to emerging markets over the last five years, now it is our turn to experience inflation as a result of too much cheap money in the system. 
We are currently right at the tipping point of inflation, and nobody sees it at the Federal Reserve, why do you think there are all these minimum wage initiatives? It is because a loaf of bread costs $3-$5 dollars in the United States depending upon the market. Of course wage inflation is going to be the next shoe to drop! 
Talking about an Exit Strategy, Isn`t an Exit Strategy
I am sorry it is very apparent that not only is the Fed behind the inflation curve, they literally are making Fed policy up as they go along, they have no exit strategy whatsoever, and more painfully obvious is that Wall Street doesn`t realize that the Fed has no exit strategy. The learning curve is going to be painful as always for Bond Holders, who will be the last fool to own a bond in their portfolio? There will always be some Bag Holder in financial markets, and this time it is Bond Investors or should I say Yield Chasers!

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The U.S. Job Market is Gaining Traction

May 29, 2014 by EconMatters   Comments (0)

By EconMatters  

Claims Data
The Jobless claims data came out on Thursday and the trend is still in place and bodes well for the May Employment Report coming out next Friday as jobless claims fell sharply in the May 24 week, down 27,000 to 300,000. The 4-week average is down a significant 11,250 to a new recovery low of 311,500. Continuing claims are also down, falling 17,000 in data for the May 17 week to a new recovery low of 2.631 million. The 4-week average is down 33,000 to 2.655 million, also a recovery low. The unemployment rate for insured workers, also at a recovery low, came in at 2.0 percent. Notice a pattern here, new recovery low, new recovery low, and new recovery low.

Headhunters Buzzing Right Now

I can tell the job market is really on fire through a couple of the measures I interact with in my daily life which shows a couple of things, first that wages are going up, and second that headhunters are really calling a bunch of my colleagues in Corporate America with multiple job opportunities. 
But it is just not corporate jobs as the businesses in my area post job openings along with wage info on their billboards when they really need people, like cashiers, installers, and Car Wash Sales positions and going by the rise in wages posted on these billboards the job market is tightening for workers at this level as well. 
Albeit we reside in an area that outperforms the overall economy, and in some cases economies are subject to local pressures, but this area has always outperformed, and the level of increased activity is quite noticeable, which means business is picking up relative to previous levels. 
Strong Employment Report
We expect a strong Employment report next week for another new recovery record for consecutive months of jobs added at these levels of 200k plus, and we expect the unemployment rate to drop below 6% sooner than most believe at this pace. 
I know the doom and gloom crowd will focus on those who have left the workforce, and sure that is an area for improvement, but it starts by employing as many people who are in the workforce first, and then as conditions tighten further in the job market, enticing people to work and come back into the job market. This is related to a tightening job market where employers lower some of their standards and wages rise, both of which we anticipate coming down the pike over the next six months as the job market continues to strengthen. 
Wage Pressures & Inflation
But from an inflation standpoint if those workers never come back to the workforce for various reasons, the pool of talent available who are looking for a job is fought over by employers needing to fill positions, and in some cases attracting workers to switch jobs or companies, we also have seen an uptick in this area in the Corporate world. 
Consequently what really matters for jobs is the pool who are in the market looking for work, and if this is shrinking that is bullish for workers’ opportunities and salaries, bad for inflation and companies needing to fill those positions, but overall leads to a tightening job market where the Fed will need to start normalizing interest rates to avoid runaway inflation. 
Elevated inflation would be fueled by wages rising substantially all along the wage continuum for the first time in the post recovery world, and the inflation numbers start trending well above the Fed`s target, we anticipate this occurring once these wage pressures start showing up in the data set. 
Labor Starting to Gain Negotiating Power
Tightening in the job market carries over to all types of positions, if an employer who used to get away with hiring contract workers to lower costs, now has to change these positions to full-time hires and raise the salaries to attract the talent they need to complete projects, contract salaries end up going higher as well. 
This is the area we haven`t seen a significant spike since the recession, and we feel the entire market and employers are behind the curve on and have become too complacent with the status quo. Employers and HR are in for a real shock when they need to start refining their budgets and raising wages to fill positions, they are used to always negotiating from a position of strength, we see the tables turning in this area as the labor market continues to tighten.
The Employment Trend is Bullish
Despite all the doom and gloom in the market, we would have loved to have these employment numbers three years ago, jobs and the economy are trending higher, and better times are ahead for those looking for work, and those not looking for work, don`t be surprised if you find your services in demand once again, as companies reach out of their comfort zone to fill positions.

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The Bond Market Explained Part II

May 28, 2014 by EconMatters   Comments (0)

By EconMatters

Addendum Needed
Since so many people are still slightly confused about how all the pieces come together in this move lower in yields we feel the need to add some further commentary on the subject which should help investors better understand the behind the scenes dynamics of the bond market. 


Filling in the Details
So the High Yield Carry Trade is what has brought the 10-Year down to the 2.62% area, Hedge Funds started realizing what was going on in the Bond market, and started getting involved when yields were around 2.8%, but they are just jumping on the tails of the High Yield crowd with the size required to move this market 50 basis points.
Once we settled into the 2.62% area hedge funds made a run for the 2.58% area lows, then covered and we were back up around 2.65% yield. From there European Bonds started rallying in price, going down in yield on the belief that Mario Draghi was going to do some kind of stimulus program involving bond buying, investors wanted to front run this event, this led US Bonds to also rally in price and go down in yield which is the move down to 2.47%, then the traders covered and we retraced back to the 2.56% area yield. 
From there traders waited until the econ news came out on Tuesday where yields rallied, and then with no econ data to worry about made the next push down to the 2.43% area on Wednesday in a relatively light volume trading environment. This is straight out of the trend trading handbook, and traders have yet to cover this latest push down hoping for additional profit with protective stops in place. 
Make no mistake this is just a trade for these folks with no long-term conviction regarding where bond yields should trade relative to the economic fundamentals. These same traders will be pushing in the other direction in a couple of months; this is how momentum trading works these days.
Market Moving Events Next Week
There is economic data on Thursday with GDP revisions and Jobless Claims numbers, but relatively speaking, next week is where the rubber meets the road on this trade. Hedge Funds are piling into this trade trying to push some technical areas in a light volume week, see where yields end up next Friday for any commitment to this trade by Hedge Funds. 
My guess is that there is major covering or closing out of positions by the end of next week similarly to how the Hedge Funds all ran out of the Natural Gas trade, sending NG Futures down two bucks in two days as nobody wanted to take delivery of said natural gas in their largely paper world. 
Lots of Stops Protecting Profits
Therefore, to sum up the High Yield chasing environment fueled via Low Interest Rates for Borrowing are the reason all rates are this low, but this last move down in bond yields has been due to front-running the ECB decision on June 5th, and hedge funds piling in as they always doing smelling blood in a hot market for technical damage. 
As an aside, these aren`t high yields all things considered, but high relative to essentially zero percent borrowing costs once you factor in the kind of leverage being used in this trading strategy.
It might be worth pointing out that the bond market is tightening like a coiled spring and can explode higher in yields an easy 20 basis points at the drop of a hat, look for the ECB Meeting or the US Employment Report to be a potential catalyst next week!

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European Bonds Front Running ECB Setup for Disappointment

May 28, 2014 by EconMatters   Comments (0)

By EconMatters

June 5th ECB Meeting

There has been a lot on Bond Buying in Europe and that enthusiasm has transferred over to the United States with the thought that European Central-bank President Mario Draghi is going to embark on some massive bond buying stimulus program similar to the US Federal Reserve`s Bond Buying stimulus program. These moves in some of these European Bonds and even the US 10-Year Yield moving 20 basis points ahead of the announcement sure are setting bond markets up for some massive disappointment compared to the actual much hyped bond buying program announcement scheduled for June 5th.

European Yields & Upside Risk

This sure seems like a buy the rumor, sell the news event if there ever was one in financial markets given the fact that Mario Draghi and the ECB has been a serial disappointer for actually delivering on his rhetoric with actual policy actions. Spanish 10-year yields being close to 2.80%, Germany 10 Year Bond Yields at 1.33%, Italy 10 Year Bond Yields at 2.93%, Belgium 10 Year Bond Yields at 1.87% and France 10 Year Bond Yields at 1.72%. These sure seem out of whack with the solvency reality circus of just three years ago. Did these countries all the sudden become balance sheet healthy and solvent overnight? What kind of risk is there in owning these notes long-term? This cannot possibly be sustainable, talk about bubbles in financial markets and mispricing of risk!
Debt to GDP Ratios
There has got to be a lot of money made by taking the other side of this trade, this is money spending European governments we are talking about with more social programs than you can possibly imagine governments spending their tax dollars on. There are two issues here one may be a supposed deflation in Europe the other is that these countries are going the other direction in terms of solvency issues with climbing Debt to GDP Ratios. Are these low yields really going to hold over time? Are these investors being paid a high enough yield on these bonds for the solvency risks they are taking? 
European Yields Higher in 3 Months

I imagine this is just traders being traders and trying to front run an economic event, but some of these yield levels just don`t jive with the fundamentals of these countries financial ability to pay off their debt, and the situation seems to be getting worse not better. But I realize this isn`t about solvency issues, these trades are put on to make money in the short term. Well, they have succeeded in making a lot of money, but they still have to sell these same bonds at some point. Just like in Gold shorting attacks, we will see where price shakes out after closing out these positions. My bet is that European yields are higher three months from now, and maybe even right after the Draghi ECB announcement. When in doubt buy the rumor, but sell the actual news in financial markets! 

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The Bond Market Explained For CNBC

May 28, 2014 by EconMatters   Comments (0)

By EconMatters

Questions – Low Yields
We occasionally turn the volume up on the TV`s just to hear what others are thinking in mainstream business media with the Sales & Name Game that is business television these days and CNBC asked the following question: “Why if everybody is talking about inflation is the bond market not moving?”
Frankly, there is so much market illiteracy even among the professionals in the financial market as witnessed by the conversation revolving around high frequency trading, even by the so-called experts who commented publicly on the issue it should be expected that many market participants fail to understand the bond market dynamics regarding why yields are so low relative to expectations at the beginning of the year.


Answers Provided
So here goes: 1) Bond yields rallied to the close of 2013, and they were at very elevated levels. 2) Equities were also at all-time highs. 3) The first quarter was tough for two reasons weather, and an exceptionally front loaded 3rd and 4th quarters that left slack in the inventory and spending cycle. 4) Lots of low interest money available from many fronts, see Japan, China, US and Europe. 5) Makes sense given the cheap money available, yields at relative trend range highs, equities range bound, and economic data suffering because of an extremely debilitating winter and Growth Pull from Robust 3rd & 4th quarters, to put on massive yield chasing conservative carry trades. These were conservative given the aforementioned unique set of points coming together just right.
The High Yield Carry Trade Explained
Here is the trade borrow at rates from 10 to 25 basis points, and I mean borrow in exceptionally large terms (leverage), then depending upon the currency one borrowed in (there may be currency machinations involved in getting into the currency where wanting to invest this cheap loan, i.e., sell Yen and buy Dollars), then pick a ‘perceived’ low volatility asset that pays some form of Yield, i.e., 10-Year at 3%, Utility Stocks with High Yields, etc. buy this yielding asset and sit back and rake in the delta each day, week and month!
It is important to remember these key points regarding this trade 1) Low volatility instruments 2) Exceptionally Low Short-term Borrowing Rates 3) Leverage, Leverage, and more Leverage. This is why Gold has been out of favor the last couple of years because it pays no Yield! When in doubt follow the money trail, and there has been a huge amount of money made by utilizing this trade setup. 
Another requirement has to do with the market going in the direction that these investors put their vast leverage to work (or at least stays within a defined range that investors are comfortable with before losing more principal than they earn in interest carry, i.e., utility stocks going higher or bond prices going higher with yields lower).  Also depending upon the currency borrowed in a Positive Carry enhances the trade and an extremely negative carry negates this trade altogether in many cases. Google this if interested but not the scope of this piece.
Big Banks Love Leverage Yield Plays
Many investors have put this trade on and off over the last five years of QE, and recently the Big Banks have been buying up a bunch of the treasuries that the Fed is no longer buying from the start of 2014 going forward. 
I imagine this is a way to offset other areas like mortgage refinancing where they were struggling with rising rates, and everybody already effectively refinanced. The Big banks are always looking to make money and this trade sure has helped their bottom line the first two quarters of 2014.
I might also add that bonds are seasonal in nature, and many hide in bonds during the sell in May Summer doldrums. But make no mistake the reason yields are so low right now is because there is money to be made from such a market dynamic. 
Carry trades are very popular in the history of modern finance and Big Banking, and the use of massive leverage is their go to strategy where they lack creative talent who can confer a competitive market advantage – Big Banks have no talent! This is an oversimplification but anybody who is really talented can make so much more money working in other places, compensation is off the charts in some cases. 
Summation
Thus to sum up the Carry Yield Trade is the main driver of why Bond Yields are so low and utility and other high yielding stocks are so high. This trade works until it doesn’t, and it is my guess that many Big Banks figure they have the entire second quarter before they need to start unwinding this trade.
I think they have much less time, and are pushing this trade trying to pick up pennies in front of a massive steamroller of inflation coming down the road. I think the writing on the wall may be as soon as 6 more trading days and the ADP Employment Report, I sure wouldn`t want to own a bunch of treasuries going into next Friday`s Employment Report or the Fed Meeting in a couple of weeks!
Exit Strategy
But at any rate, once the Fed starts to raise rates and usually they are forced to by rising inflation (they never do it until their hand is forced) all the sudden the cheap money dries up, but long before that happens investors all start to unwind the trade, other investors pile on in the direction of the unwind, and this is where the steamroller analogy comes into play.
As massive unwinds the size required to make this kind of trading strategy work are really hairy, and oftentimes cause more losses than the money made in the prior two quarters making money on this trade by the Big Banks. However everything is quarterly results oriented and being on bonus track on a daily basis at some firms so long range foresight is often lacking in trade configurations. Did I mention a lack of creative talent at the Big Banks who often substitute brut size and scale to make money in the markets as their best investment strategy?
Economy is Picking up Pace
So the High Yield Carry Trade is why Bond yields are where they currently reside, and is this saying anything structural regarding the economy? No! Will these low yields persist through year end? Again No! And remember when in doubt follow the money, and high yield chasing earns a lot of pennies until it gets steamrolled!

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Hot Inflation Reports to Dominate Next Fed Meeting

May 27, 2014 by EconMatters   Comments (0)

By EconMatters  

Important Econ-Inflation Events
The Federal Reserve meeting begins Tuesday June 17thwith the FOMC meeting announcement the following day Wednesday June 18thwhich will be followed by their forecasts and the Fed Chair press conference.
In the last Fed meeting a weak housing concern cropped up on the Fed`s agenda, but all the housing data has rebounded in the latest economic reports with the spring weather, and the new concern at next month`s Fed meeting will be inflation.


With two much hotter CPI & PPI reports the last two months and another hot set coming right before the Fed meeting with the PPI coming on Friday June 13th, and CPI coming out on Tuesday June 17th. We anticipate these reports to be on the high side of estimates with higher food, energy and rising wage cost pressures; and that the Fed will probably have to address these new inflation pressures in their statement and the following press conference by Janet Yellen. 
We also think the Employment Report which comes out next week will show some rising wage pressures which are the real push through on the inflation numbers. We think the Fed and the market at large is way behind this inflation curve, the market is still trading and making decisions on numbers that came out three months ago, all the latest economic inflation data has been very hot, and well above expectations, with the consensus just thinking these are temporary data blips. However, a third hot round of CPI and PPI reports right before the Fed meets is going to raise some eyebrows and establish the inflationary trend that we anticipate will be with us for the next 5 to 10 years.
Bond Market: Mispriced Asset Class
The fallout from this is obvious the Bond Market in the United States is the most mispriced asset class right now and this time they are wrong, and equities are telling you that inflation is full bore upon us. Look for the S&P 500 to hit 2200 much sooner than most realize with the 2500 area pinging on the radar as investors run out of bonds and into equities as inflation heats up and the Fed starts raising rates much faster than the market has currently built into their models.
The Trade
Valuations can be a concern regarding equities, and who knows what type of volatility hits that market once Bond Yields spike so the best place to be from a risk reward perspective is long 10-year yields. Bond Investors are dangerously asleep at the wheel with the chasing yield fervor reminiscent of a Gold Rush that the best play is in the Bond Market. Start building short positions in the 10-Year Bond exposure area either through Futures or Treasuries, and do it now while yield is so low relative to where we believe it is headed over the next six months and beyond. If playing Futures just build a position and have enough liquidity to stay in the trade for the long haul, and keep rolling over your short Futures Price and Long Yield trade over the next six months. 
This is one of the few times I am going to say this so pay attention, investors cannot lose on this trade if they get involved at these low yield levels in the 10-Year over the next six to nine moths time frame, this is essentially as free money as Wall Street ever gives investors, take advantage of it while it lasts. 
The Fed will continue tightening based upon the good manufacturing and housing economic data of last week, and with the upcoming hot Employment and CPI/PPI Inflation Reports, this is really going to push the Fed into a stronger tightening mode. However, the Fed is going to raise rates regardless as they normalize monetary policy over the next six to nine months, Don`t fight the Fed, make money being on the right side of this trade, which is long yield and short price from where we are right now relative to 10-year treasury yields. 
Positive EV & Risk Reward Profile
This is the best Risk Reward Trade on Wall Street right now but you have to get in while yields are mismatched with where the Federal Reserve is eventually going to be forced to go, so that your risk profile is better managed by having such an excellent relative entry price. 
Investors will start jumping on the trade when 10-Year Bond yields reach 2.8% and we break out of the recent range from 2.47% to 2.70%. But the beauty of getting in when the market is “sleepy” is that an investor has much more room to manage the trade to the upside, and really let the trade breath, i.e., let the trend develop by getting in early, and let your winners run. 
This isn`t a short-term trade, and an investor isn`t looking for a quick profit, i.e., nobody is concerned about inflation right now, hold the trade through when everybody is worried about inflation – this is how you really get paid as an investor for taking on the risk of the unknown. 
And as ‘Unknowns’ go this is one of the surest or knowable ‘unknowns’ the Fed is going to raise rates, inflation is going to rise and be a problem in the future, and 10-year bond yields are going to be higher in the future, and as an investor find a way to play this market and monetary normalization process. 
Inflation, Inflation, Inflation
But mark my words the topic de jure three weeks from now will all be about inflation and how the Fed needs to start raising rates much sooner than is currently priced in the market. Mark your calendar for the Employment Report next week, CPI & PPI Reports 13th and 17th, and the Fed Meeting Announcement on the 18th of June. Inflation pressures will be more than an economic blip, and these reports will reinforce this recent trend, and markets will have to adjust to this new paradigm. 
We have now entered the Inflation Paradigm of the Fed`s loose monetary experiment, it is time to pay the piper for all this excessively lax money printing complacency. We all knew this day would eventually come, ‘the boy cried wolf too many times’ we then let our guard down, and boom inflation smacks us and the Federal Reserve in the face, and nobody is prepared for the absolute carnage in the Bond Market!

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Coal: A 'Million Dollar Mile' Getting Longer In the U.S.

May 21, 2014 by EconMatters   Comments (0)

By EconMatters

With cheap domestic natural gas prices and tighter environmental regulations, U.S. demand for coal has fallen in recent years. So coal export has become ever more important to domestic coal producers. With accelerating growth in economy and power demand, Asia is the obvious new export target for U.S. coal. U.S. coal shipments outside the country in 2014 are expected to surpass 100 million tons for the third year (see chart below).


Data Source: EIA, U.S. Energy Dept.


East, Pacific Northwest, Gulf?

Typically, coal is transported via rail, truck to the port terminal and then exported by large dry bulk cargo ships. But the aging port infrastructure in the U.S. is already struggling with capacity issue. The capacity along the east coast is strained with increasing US coal exports to Europe.

Map Source: Platts 

Theoretically, Pacific Northwest would be the best location for new coal terminals to serve the booming Asian market. The western region (including the Power River Basin) is the top coal producing area in the U.S. according to the U.S. Energy Dept. However, active environmentalism in Washington and Oregon has managed to block almost every major proposal for now coal terminal.

Data Source: EIA, U.S. Energy Dept.

Frustrated, coal producers in the Powder River Basin are willing to pay a higher transit fee to use terminals in Vancouver, Prince Rupert, and British Columbia, Canada. But Canadian ports are also having capacity issue handling the surging coal export volume from the U.S. For now, Gulf of Mexico, where local governments and citizens are friendlier to the traditional energy and fossil-fuel industries, seems the best option where additional capacity in the near-term could be more likely.

China, Europe or South America?

As a result, some U.S. producers have shifted to target markets that are closer, such as Europe and Brazil. Europe is implementing more pollution-control measures on power plants to wean itself from nuclear power after Japan’s Fukushima disaster, as well as natural gas to reduce the supply dependency on Russia. In fact, UK was the top foreign buyer of American coal in 2013.

Increasing Global Coal Demand

According to IEA, although U.S. coal demand has dropped to 24-year low, the black rock is still the world’s fastest-growing energy source, forecast to rise 2.3 percent a year through 2018 and is the second-largest source behind oil.

World Energy Demand by Fuel
Chart Source: Coal Medium Term Market Outlook 2013, IEA 

The coal demand growth is driven mostly by non-OECD countries with China leading the way. China is world’s top coal producer, but the nation is also plagued by dangerous coal mining conditions and transport congestion. So China will continue to need more coal to feed its energy requirement. As long as China’s economy holds up, U.S. coal companies should benefit.

From NIMBY to NIYBY

However, a lot of the upside of coal export hinges on new export capacity gets approved and built in the U.S. and ocean bulk freight stays low.

Coal companies are eager to pour money into new terminals. Bloomberg reported that Oakland, California just recently rejected a coal export facility proposed by Bowie Resource Partners LLC despite the promise of ‘thousands’ of new construction jobs and a $3 million-a-year payroll in city. The message from Oakland: "Whatever the economic benefit would’ve been, it wasn’t worth destroying the planet over.” (Note: Oakland’s unemployment rate is higher than that of the national average as well as California.)

As the environmental cause has evolved from NIMBY (Not in My Back Yard) to NIYBY (Not in Your Back Yard), coal industry needs to address oppositions not only on coal dust from train, but also on potential global climate impact. So even though many producers are hopeful of new export facilities eventually coming online, status-quo seems more likely the near-term outlook.

Ocean Freight Could Bite

Currently, ocean freight rates are at historical low because of vessel overcapacity. This has allowed US coal to be more competitive in international markets. But freight rate will not stay this low for too long. By then, the U.S. coal will have a difficult time competing with producers in Indonesia, Australia and Russia that are closer to the Asian key markets.

According to WSJ, while shipping coal from a U.S. mine to a customer in Asia adds $50 to the per-ton price, Australian producers can get coal from their mines to China and other Asian markets for half that.

Near Term Outlook 

China will continue to import coal from U.S. mines via Canadian coal terminals operated by companies such as Westshore Terminals Ltd. Westshore has raised its annual handling capacity to 33 million tonnes this year from 24 million tonnes in 2007 and are sending as much as 3.76 million tons a month abroad.

In the U.S., CONSOL Energy (NYSE: CNX) has some export advantage over peers since the company owns the Baltimore Marine terminal.  Bloomberg noted this is the only terminal wholly owned by a coal company in the U.S.  Other coal companies will have to pay fees to CONSOL to use the terminal with 15 million tons a year capacity.

Rail companies like CSX (NYSE: CSX), Norfolk Southern (NYSE: NSC), and top U.S. coal companies Peabody Energy (NYSE: BTU), Alpha Natural Resources (NYSE:ANR), and Arch Coal Inc. (NYSE: ACI) also jointly or individually own a few terminals on the East Coast and Gulf of Mexico.

Houston-based terminal operator Kinder Morgan (NYSE: KMP) last year said it plans to invest more than $450 million in coal terminal expansion projects. That already caused air quality concerns at Houston Ship Channel among local environmentalists. This suggests U.S. Gulf Coast states may seem more accommodating to oil and gas in the past, the coal dust air pollution problem means new coal facilities may have a tougher road ahead getting approved.

A Million Dollar Mile Awaits

The recent trend suggests U.S. regulators are increasingly taking into consideration the global-warming impacts of coal pollution problem in Asia as they decide on new coal terminal proposals. But I see the logic more like this: The law of supply and demand means Asia will get its coal (oil and gas) from somewhere else, if not from the U.S., to feed its energy hunger.  Until Asian developing nations get their environmental standards and regulations together, the global warming impact will go on even if U.S. totally bans all energy export to Asia.

Bloomberg said CONSOL employees call a long coal train a "million dollar mile," which is a reference to the cargo's total value at current prices.  For now, until the coal industry can properly address the coal dust air pollution issue and get approvals for new export capacity, the line for the “Million Dollar Mile” could get even longer.

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The US is not Japan & Europe

May 20, 2014 by EconMatters   Comments (0)

By EconMatters

There has been a trend of late to compare European and Japanese Bond yields to that of the United States and England so I think it necessary to define some large flaws in these comparisons. 
Japan Comparison
Let us start with Japan, Japan has an aging demographic, little immigration, very limited natural resources, and have not been a major player in anything other than heavy industry specific nuclear applications and autos since the mid-1980s.


In fact, Japan has been on a steady decline since the 1980s, and mind you the world hasn`t been on a steady decline since the 1980s in terms of many of the industries that Japan once dominated like technology, South Korea has taken over the Pacific-Rim mantle in technological innovation where Japan once reigned supreme. Plain and simple, Japan just got old and became outdated and uncompetitive in most areas of technological advancement and innovation that were so prominent during their glory days of the 1980s era.
United States
Let’s juxtapose this with the United States who has a very vibrant demographic because of immigration both skilled and unskilled, an abundance of natural resources, and major players in energy, entertainment, technology, agriculture, financial markets, engineering, and architecture. Furthermore, the US is actually not on the decline in any of these areas but still very innovative and relevant, and may even be on the rise in areas of energy and manufacturing which have been areas of outsourcing for decades. 
To compare Japanese bond yields in order to justify an argument for US bond yields staying historically low once the Federal Reserve is completely out of the bond buying business is a failed comparison. Japan wishes they could wake up from their demographic and cultural malaise and have the US future from a competitive and opportunity standpoint. Shoot Japan with all their nuclear troubles would love just to have our natural gas reserves.
America still the Land of Opportunity
For all those who downplay America`s bright future and how the American Dream is dead, there sure are a lot of people around the world who want to immigrate to the US because it offers some of the best opportunities for those individuals motivated to achieve through hard work and creativity. This goes for skilled labor, unskilled labor and all levels of the social economic scale. America truly does offer a relatively high quality of life, and many types of opportunity. 
For example, the guy who installed our big screen TVs doesn`t have a college education, speaks less than stellar English, but probably makes over $250,000 net per year because he identified a market need, had the skillset to be efficient at supplying that need, and yes he wasn`t born here in the United States. 
The US still is the land of opportunity for those willing to work for said opportunity, and strive to better themselves. And our bond yields will reflect this fundamental difference between the US and Japan once the Federal Reserve normalizes monetary policy which they are in the process of undertaking. There is no comparison whatsoever between the US and Japan, and this short-sighted and uneducated view is patently false.
European Comparison
This brings us to the European comparison, Europe has been a slow growth to slightly negative growth, mature region for decades – this is nothing new for these countries as they have never had pro-growth capitalistic business underpinnings, and their economies have reflected mature, steady mere maintenance of the status quo with bastions of historic wealth and property retention passed from generation to generation. Most of these countries are un-competitive on a global scale, and haven’t been relevant for centuries not decades – this is social Europe we are talking about, they don`t have a capitalistic bone in their bodies. 
I could continue on with why any comparison between Europe and the United States is flawed, but Europe is a bastion of stored wealth and power, while the US was built and founded in response to a lack of opportunity in Europe for hard working, creative, free-enterprise individuals looking to better their standard of living and quality of life. These immigrants also had a vibrant sense of adventure and these same values are necessary for not being satisfied with the status quo and taking on risk for greater future reward. 
This fundamental philosophical mindset, even though critics believe some of this entrepreneurial spirit has died, is still fundamentally underpinning core values in the Unites States, and provides a nice backdrop for pushing the creative envelope in many industries in this country. 
If bond yields are forward looking and represent growth prospects for the next ten years, look at how many industries the US is dominant in, and getting stronger versus Europe. Again, there is no comparison to be made between the most capitalistic country on earth, and a region that prides itself in social programs and business stagnation. And for those who think Obamacare is a social program, it may have started out that way, it may have been the original intention, but once the lobbyists of the capitalistic healthcare industrial complex started putting their capitalistic imprints on the policy, in the end it is probably more capitalistic and pro-business principled than most would believe. 
The Yield Positive Carry Trade
The main reason bond yields are so low is because there has been so much cheap money available to lever up in enormous sums and chase the positive yield trade, plain and simple. Once the Fed gets out of artificially supporting this trade, which they are in the process of doing, the next step will be the raising of the fed funds rate, expected in 6-9 months if the current trend in economic growth and improvement in the overall economy continues on course. This trade works really well until investors start to be faced with the notion of losing more in principle versus what they can make in heavily levered yield trades in a stable, low volatility bond market environment. 
This Time Is Different Mentality
The world of finance just loves these trades, and they usually always end badly with everybody running for the exits at the same time, and this time will be no different. I know investors think this time is different with faulty notions like the US is Japan logic, to justify this as a good risk versus reward trade at this stage in the monetary, business, and economic cycle but they are flat out wrong. 
More money will be made by taking the other side of the “this time is different hubris” on the bond chasing yield trade as inflation and economic growth in the United States dictates that the Federal Reserve normalize monetary policy with a Fed Funds Rate target around 4 to 4.5 percent. 
That is a whole lot of principle to lose, and have at risk chasing a little yield, and the fact that so much leverage is used to make the trade profitable, the unwind is going to cause the biggest squeeze in exiting than any market repositioning we have seen since the sub-prime housing crisis reallocation of capital. In short, the Chasing Yield Positive Carry Trade unwind is going to be long, nasty and brutal for investors.

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Fed to Raise Rates in 9 Months

May 17, 2014 by EconMatters   Comments (0)

By EconMatters  

James Bullard Speech
The biggest news to come out of Friday`s financial market activity was James Bullard’s thoughts on when he expects the Fed to start raising rates, he believes the Fed will start raising rates sometime near the end of the first quarter of 2015. 


He also said, “While first-quarter GDP growth was weak, growth in coming quarters is still predicted to be robust,” according to slides for his speech. He added, “the average quarterly pace of growth in 2014 may still be an improvement relative to 2013.”
But the Fed may raise rates even sooner as we have thought that the market has become too complacent with regard to the Fed “talking down the market” which is at odds with the robust economic and inflation data of late, and the Fed will be forced to address the sharp rise in economic conditions of the second and third quarters “The FOMC would be ready and willing to get more aggressive if it was required,” including if inflation surged unexpectedly, he said. Another surging PPI report in the same direction fits this category in our opinion. 
The bond market is really asleep at the wheel right now in our opinion. With the recent surge in bond prices, right before a sea change that has been 6 years in waiting, the raising of the Fed funds rate is about to begin, and there are a whole bunch of folks on the wrong side of this trade, and all this money is going to have to come out of the bond market. 
Market Squeezes Go Both Directions
Jeffrey Gundlach of Doubleline Capital has been talking up the notion of a bond market squeeze which of course would be good for his fund and his current positioning of the last six months, but squeezes work in both directions Jeffrey Gundlach, and there is far more money long the bond market right now than short, and yields are very depressed right before a sea change in terms of raising rates by the Fed.
All this long money has to come out with rising rates, I am sorry Gundlach but the real squeeze is going to be in the other direction after six years of a near zero Fed Funds Rate, rates are going to be raised and normalized, and according to James Bullard and Janet Yellen the fed will be targeting a normal short-term policy rate of 4 percent to 4.25 percent.
Six Years is not a Lifetime: Historical Interest Rates as Contextual History Lesson
The writing is on the wall, after six years of extremely loose monetary policy rates are going the other direction in the United States; and England is going to follow suit as their economy and inflation concerns have been on the rise as well, expect rate hikes likewise coming out of England in our opinion. 
Thus all this money came rushing into the bond market right before actual rates are going to be raised, talk about great timing and squeezes, over the next five years this is going to be one of the massive squeezes of all time, and in the short-term the 10-Year yield is going to blow past 3% faster than you can say December.
Remember those PPI, CPI and Employment reports are going to be hitting the Fed with an inflating and accelerating economic reality, and the Fed may be forced to act even sooner than 9 months with a couple more hot PPI and CPI reports like last week, and several more 250k plus Employments reports, it is going to get downright ugly in the bond market as all those longs of six years run for the exits under a normalized rate environment. 
The Levered up Yield Trade & The Unwind of Fund Flows
Accordingly, thanks Jeffrey Gundlach for being mindful of squeezes in the bond market, because we are right at the precipice of the biggest Short yield squeeze in the entire history of the bond market with the actual raising of interest rates by the Federal Reserve after six years of extraordinarily low short term rates in terms of monetary policy that created artificially low yields that are about to adjust much higher or normalize.
Just think the amount of money levered up to chase yield because there has been so much cheap low interest rate money to borrow, and leverage up the yield trade, artificially pushing yields even lower, all this money has to be unwound with the raising of short-term rates – this is the worst carry trade in the history of financial markets right before a sharp upturn in short-term interest rates and a massive re-pricing of the entire interest-rate market! 
Calculate the massive amount of funds, derivatives and hedges that now have to start unwinding in the other direction – talk about wrong-footed and mispriced markets! 
Investors currently looking at the wrong market for being a bubble: hint it`s not Google
Everybody has talked about the bubble in the bond markets for six years, but with each passing year and near zero percent interest rates, more complacency has sunk in with the status quo thinking that this low rate environment is the “new normal”. But this couldn`t be further from the case if we review what constitutes normal short term rates, and this complacency was reinforced and even perpetuated by the Federal Reserve itself with their dovish talk and actions of the past six years. 
Now that the interest rate environment is about to change, and everybody should be on their toes, all the bond participants are in a sleep induced coma, and asleep at the proverbial wheel, not being prepared for the shock of their investing lifetimes. Yes short-term interest rates are going to rise in the United States and England in anywhere from six to nine months’ time - and the entire investing community is poorly positioned, and on the wrong side of the market. The bond market bubble is about to burst folks!

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