Risk-free alternative is not even close

Outlook:

We do not get any interesting releases in the US today, leaving Canada to run the show with November CPI. It’s expected to be a rise and a big one (core CPI at 2.3%, according to Reuters), which gives the BoC a headache because growth is tepid at best. The expectation of a cut lingers in the air. We also get the first Fed Pres to speak since the hike and it is hawk Lacker (Richmond Fed).

It looks like we have to start making our list of expected and unexpected outcomes from normalization. We wanted some punishment, so to speak, for the excess leverage and bubbles permitted by cheap money. Over the past few weeks the junk bond world got a comeuppance, even though some of those punished were not themselves using any leverage (BlackRock).

Now, according to the FT, investment grade bonds are getting the same treatment. “Investors withdrew $5.1bn from US mutual funds and exchange traded funds purchasing investment grade bonds — those rated triple B minus or higher by one of the major rating agencies — in the latest week, according to fund flows tracked by Lipper. The figures, the largest since Lipper began tracking flows in 1992, accompanied another week of $3bn-plus withdrawals from junk bond funds. Lipper put the total investor withdrawals from taxable bond funds in the week to December 16 at $15.4bn.”

The sell-off is a little strange since so-called risk-free bonds are yielding 2-3.5% and “Yields on both investment grade and junk bonds hit their highest level since 2012 this week, Bank of America Merrill Lynch data shows. Yields, which move inversely to price, eclipsed 9 per cent on the bank’s high yield index.”

In other words, the risk-free alternative is not even close. One reason may be that investors are not wild about the credit ratings. The FT is too polite to say so, but does report “Leverage has risen rapidly over the past five years as US companies issued debt to fund acquisitions, raise dividends and buy back stock. While banks have largely repaired their balance sheets since the financial crisis, the corporate debt burden in the US has climbed to $5.6tn, up 59 per cent from December 2010, according to Barclays Indices.”

Some analysts say this is a flash in the pan and we guess they are probably right. In the Treasury market, conditions are calm and a little boring, according to Market News, with attention paid to the tedious business of how many repos can dance on the head of a pin.

Another flash in the pan is the idea of a recovery in oil and probably other commodities. The IEA says the market will be oversupplied to at least end-2016. Given US production and Iran coming onstream sometime in Q1, it’s ridiculous to expect prices to rise back to $65, let alone $100. We probably won’t see $100 again for years, if ever, barring a coup in Saudi Arabia (or something equally dire). The price drop for the week is about 2% so far, but possibly accelerating if the US Congress moves to permit exports, expected today.

More oil industry companies will fail, to be snapped up by vultures or just to go away. The history of the oil industry is chock-full of such stories. It has always been an industry beset by turmoil. As for the big equity indices, the FT is more weighted by big oil, but aside from that, it’s hard to see why falling oil prices should contaminate the entire equity market. Some companies must benefit mightily from low and/or falling oil (airlines, truckers). We don’t buy that oil can or should drag down the whole shebang.
In FX, today is likely to see mopping up from the big rally but that should not mean the euro making it to 1.0900 again and it definitely should mean the dollar regaining its old rise against the yen. How far the dollar goes from here is still up in the air but an uptrend is expected all the same, even if we can’t yet identify the new driver that will push the dollar higher. Maybe just thinking about the Goldilocks Fed hike will do the trick to shift sentiment even farther in the dollar’s favor. Besides, notice how quiet the ECB is… surely Mr. Draghi is pleased to see the weaker euro. Devaluation beats QE every time. Don’t bet the ranch but don’t bet against the dollar, either. We fully expect to be reversing the euro and CHF signals on Monday.

Next week is Christmas week and we will stop publishing as of Wednesday, Dec 23.

Tidbit: The Dems debate on Saturday night on YouTube. It will be poorly attended. The last place people want to be on Saturday night is in front of a PC screen, especially people with desktops.
The Plub debate on Tuesday was appalling. Just about everyone told blatant lies (Fiorini said Obama fired “warriors” for advice he didn’t like—not true). Cruz wants to use a military tactic not used since VietNam (blanket bombing) that didn’t work then, either. Christie doesn’t know how no-fly zones are set up. Bush accused Trump of getting his international affairs information from TV shows (but his campaign cravenly begged for money afterwards). Trump is a lout and a boor but was the first to say out loud the Iraq war was a waste of $4 trillion that could have been spent at home on infrastructure, especially considering that we lost through post-war mismanagement.

Dems lie substantially less than Republicans, according to the fact checkers, bless them. But the voters historically like to kick the bums out after two terms. We are betting on the desire for change. Who knows, maybe Trump would be like Johnson, twisting arms in the back room but getting things done. Others will have to intervene to halt Trump’s unconstitutional initiatives, which may be just attention getters, anyway.