Door-Buster Deals

By: Michael Ashton | Mon, Nov 21, 2011
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Rates markets were relatively quiet today and appear to be running out of gas. The 10-year yield fell below 2% again, to 1.97%, but real yields actually rose 2bps on the day. This near-unchanged performance should be viewed in the context of another 1.9% fall in domestic equity markets and 3-4% declines in European equity markets.

Yes, Existing Home Sales reported above expectations, but the picture (shown below) doesn't change much as a result of today's 4.97mm print. I doubt that the Existing Home Sales data had enough dampening/counteracting effect to the equity dip that it is sufficient to explain why bonds were relatively weak.

US Existing Homes Sales
Existing Home Sales are merely vibrating around 5mm units.

I also don't think that the news that the Supercommittee isn't going to move mountains - which was hardly unexpected - should affect the Treasury's credit in the short run, especially given the shortage of other higher-safety locations at the moment. It may simply be that 2%, in the absence of severe dislocations and a flight-to-quality, is hard to get through.

There was one other element of the Existing Home Sales data that is worth noting, however. The inventory of homes available for sale dropped to near the lowest level of the last 5 years (see Chart below), with the seasonally weak months of November, December, and January still to come (inventory tends to fall in the winter because sellers take their homes off the market when the real estate market slows).

ETSLHAFS Index
On the other hand, declining home inventories is good news for housing, and bad news for inflation.

The current level of inventories, if sustained, is consistent with a rise in CPI-Shelter over the next 12 months of 1.9%. Since CPI-Shelter is currently around 1.8%, this suggests that for all of the carnage in housing the largest component of the consumption basket for most people will not be dragging much more significantly on core inflation than it already is. (What is more, my simple univariate regression of inventories versus CPI-Shelter neglects accounting for a changing level of underlying inflation, so I would actually forecast CPI-Shelter to be somewhat higher than that for next year because of the general rise in inflation).

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In the United States, die-hard shoppers diligently get to the stores early on "Black Friday" (the day after Thanksgiving) so as to be able to snag the best deals before other shoppers beat them to it. We seem to be seeing a similar dynamic unfold in Europe. Over the weekend, Hungarian Prime Minister Viktor Orban reportedly asked the EU and IMF for "possible" financial assistance. IMF chief Christine Lagarde confirmed today that the Hungarian government had made a request for what Hungary termed a "precautionary" loan. We also see this sort of behavior when a firm is facing imminent stress, such as when MF Global drew down all of its credit lines just days b efore it had to declare bankruptcy. Get the money while it is available, and especially if you need it from the EU and the IMF!

(Some less-diplomatic souls would point out that the Black Friday behavior also bears striking resemblance to a bank run, where you really want to be first in line to withdraw your money. But I prefer the image of jolly shoppers trying to get an outrageous deal before the rest of the shoppers have to pay inflated prices.)

Spain, too, began to make noises. The deputy leader of the People's Party (winners of the election over the weekend) declared that Spain needs "an agreement through a joint euro-zone operational strategy to save and guarantee our sovereign debt" because the country cannot continue financing itself at 7 percent. I said it before, when Greece first complained in 2010 about their interest rates rising: if the bid is really there at 7%, I'd recommend selling as many bonds are you can, right now. If you can't sustain your budget at interest rates that would have historically been quite reasonable, then your fisca l situation isn't going to be saved by a percent or two of carry. But my suspicion is that the only bid around 7% is from the ECB, and so the real question is whether Spain (and others) can finance itself at any level given the deficits being run.

This is even more poignant for Spain at the moment since over the weekend Spain's rescue fund stepped in to nationalize Banco de Valencia to the tune of €1bln in capital and an additional €2bln credit line.

Get these door-buster deals while they last!

On Tuesday, a revision to Q3 GDP will be overshadowed by the minutes of the FOMC meeting, due to be released at 2:00ET. There is some reasonable chance that the Fed minutes could be market-moving, since in all likelihood they spent some time discussing the Evans Rule and how and/or when to move towards QE3. While they did not implement QE3 at the last meeting, most observers didn't expect them to do that so soon after Twist. It will be illuminating to see how much discussion of QE3 and what the relationship is between QE3 and European conditions, in the Committee's minds. As I said, the case for QE3 based on domestic conditions right now is weak, especially with inflation rising; however, a winning coalition might be constructed around the risk of economic infection from Europe. I wouldn't lean against the equ ity see-saw right now on the basis of such an indication from the Fed, but I would think commodities and TIPS breakevens may get a bump on that news.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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