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David Fuller and Eoin Treacy's Comment of the Day
Category - Fixed Income

    Powell Sees Solid Economic Outlook as Rates 'Just Below' Neutral

    This article by Christopher Condon for Bloomberg may be of interest to subscribers. Here is a section:

    Federal Reserve Chairman Jerome Powell said interest rates are “just below” the so-called neutral range, softening previous comments that seemed to suggest a greater distance and spurring speculation central bankers are increasingly open to pausing their series of hikes next year.

    Treasuries and stocks rose, as Powell’s “just below” comment tempered remarks he made last month that markets had interpreted to mean that a larger amount of tightening was likely. Speaking at an event on Oct. 3, Powell said that “we may go past neutral. But we’re a long way from neutral at this point, probably.”

    In his speech Wednesday to the Economic Club of New York, Powell said the Fed’s benchmark interest rate was “just below the broad range of estimates of the level that would be neutral for the economy -- that is, neither speeding up nor slowing down growth.”

    If rates are closer to what policy makers ultimately judge is the neutral level, that could signal the Fed will tighten monetary policy less than previously projected. Eurodollar futures pricing reacted to Powell’s comments, reflecting even firmer expectations that the Fed will hike only once next year.

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    Email of the day on Europe and the UK

    Glad you had a good meeting in London the week before last. Would have been there, but still recovering from breaking a femur in June.

    Two things that might interest you.

    First, from a John Mauldin letter:

    Quick anecdote from my time in Frankfurt. I spoke for fund manager Lupus Alpha to approximately 250 pension fund managers, representing most of Germany’s retirement monies. I asked for a show of hands on whether they liked being part of the European Union. Almost everyone raised their hands. I then asked if they thought participating in the euro was a good thing. Probably 80% raised their hands. When asked who doesn’t like the euro, maybe 10% of the hands went up.

    Then the money question. I asked if they would be willing to take Italy’s debt and all the debt of every eurozone member and put it on the European Central Bank balance sheet, with caveats about controlling national budgets. Fewer than 20% of the hands went up.

    I then engaged the audience further, saying, the last two questions were essentially the same. If you want to keep the euro, you’ll have to do something about the imbalances between the countries and debts. No monetary union in history has ever survived without becoming a fiscal union as well. Even reminding them that failure to do this might cause the euro to break up and bring back the Deutschmark didn’t seem to change many opinions. I reminded them that a Deutschmark would mean a serious recession/depression in Germany as it would raise the price of all German exports by at least 50%. Mercedes and BMWs are expensive enough for Germany’s customers, let alone at a 50% price hike.

    This audience should have easily accepted the argument for putting all European debt on the ECB balance sheet. Imagine if I asked the typical German voter, especially those in rural areas. That tells me Europe could have a bumpier future than I thought.

    Second, a piece from the FT (as an attachment) about whether property is still a long-term bet for retirement. Conclusion: it's not.

    Thanks for all great recent pieces. I really liked the Ray Dalio discussion.

    Have a great Christmas.

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    RBC Wealth Management 2019 Investment Stance

    Thanks to a subscriber for this report which may be of interest. Here is a section:

    2019 US Equity Outlook: The Return of Risk

    Thanks to a subscriber for this report for Goldman Sachs which may be of interest. Here is a section:

    Email of the day on central bank balances sheets

    On the Morgan Stanley research document, you posted on Monday, there was "the most important chart in the world" as you describe it (QE globally). The "6-month rate of change" scale on LHS caught my attention. Recently, this QE tightening "rate of change" has moved upwards. Is this an early sign that CBs are starting to shy away from their QE tightening? If so, this is bullish for an equity market discounting future tightening. Maybe the tea leaves are not clear, but they must be monitored.

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    Ray Dalio Discusses Major Financial Crises (Podcast)

    I found this interview of Ray Dalio to be very educational and recommend it to subscribers.

    China Has More Distressed Corporate Debt Than All Other EMs

    This article by Selcuk Gokoluk for Bloomberg may be of interest to subscribers. Here is a section:

    China’s debt, both distressed and otherwise, account for a quarter of all securities included in the gauge, which tracks about 660 dollar notes with a par value of at least $500 million. The Asian nation is home to the developing world’s biggest bond market.

    The jump in China’s distressed bonds helped fuel an increase in borrowing costs for emerging-market companies to the highest level in more than two years. The impact of the trade war on the Asian nation has compounded pressure on developing assets, already reeling under the strain of higher U.S. interest rates and Treasury yields.

     

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    No More Junk in the Trunk

    This note from Riverfront Investment Group may be of interest to subscribers. Here is a section:

    As the high yield market has continued to strengthen, credit spreads have tightened to 381 basis points, which is near a 10-year low (credit spreads measure the extra amount of income required to compensate investors for default risk and are a common gauge for the overall health of the economy).

    There are two ways to look at the current level of credit spreads. The first is an optimistic view which would suggests the bond market is not signaling any stress in the economy. Historically, tight credit spreads (smaller premium for default risk) have reflected economy strength and a reassurance that a recession in the near-term was unlikely. In previous recessions, credit spreads have widened prior to equities falling and have therefore been an informative leading indicator for the economy.

    On the other hand, it’s easy to see why some investors have a more pessimistic view regarding tight credit spreads. Without lower coupon payments, there is a smaller margin of safety for default risk. In other words, investors aren’t protected as much in the event of a recession. Furthermore, with credit spreads near a 10-year low, it might seem like there is only one way for them to go, which is higher!

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    China cracks down on foreign currency transfers for property deals

    This article by Michael Smith for The Australian Financial Review may be of interest to subscribers. Here is a section:

    The decision to publish the cases, which involved millions of dollars in fines, is seen as a warning that the government is less willing to tolerate what is considered a grey area in the country's capital control rules. Liu Xuezhi, an economist at China's Bank of Communications, said this showed Beijing's crackdown on offshore commercial deals was being extended to individual investors.

    "The government regulation on foreign currency is becoming more thorough. They are extending supervision from corporates to individuals," he told The Australian Financial Review.

    "The tight control on foreign capital will be maintained for the next one or two years. This would bring an impact to the Chinese investors who are planning to buy properties overseas, including Australia."

    Zong Liang, a senior researcher with the Bank of China, said he expected the move to more closely monitor transactions would stay in place for the next five years and weaken the appetite for Chinese investors in Australian property.

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    Email of the day on the merits of buy-to-let

    Regarding your piece yesterday on balancing one's portfolio and finding safety, I would add a somewhat personal view. As I am in the finance industry myself, the restrictions on investing in listed securities is quite a burden and I'm finding traditional buy-to-let investing more and more compelling. It should work reasonably well also as an inflation hedge, since the rent can be adjusted with inflation and the real value of the principal generally moves with inflation. Of course this equation depends on things like whether your area has population growth and the yield curve of your respective currency, but at least in EUR the FIXED financing costs are so ridiculously low that it is hard to see how one can lose money on a say 60-70 percent financing over a 15-20 year horizon. A practical issue is that there is a (modest) amount of work when finding a new tenant, for example. For me, this also provides a nice additional retirement income, since the tenants have paid off the bank loans roughly at the same time as I'm about to leave the workforce, so that the rents become cash flow to me. Just a personal thought here, it may not be the best choice for everyone.

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