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In lieu of The Macro Show on Friday here is a special note from Director and Senior Macro analyst Darius Dale.
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Keith and I have spent much of the past four weeks on the road visiting with existing and prospective clients the world over (~35 meetings in total). As always, the buysider-to-[former]-buysider nature of such dialogues allows for a higher order of debate and critical thinking that both parties typically find invaluable.
Below is a summary of what I found to be the most important, thoughtful and/or consistent topics of discussion, organized by theme (all quotations paraphrased); hopefully you find it helpful as well. Any associated charts, research notes or presentations are hyperlinked below for ease of review.
EMERGING RISKS
A VERY IMPORTANT DISCUSSION:
CLIENT: "I haven't seen anyone talk about the stealth tightening that is the ~15bps back-up in 3M LIBOR over the past month. Everyone talks about where the Fed Funds Rate is headed next, but the reality is that global debt is priced off of LIBOR. I wonder how much the pending rule changes in the money-market fund industry have been and will continue to be a contributing factor to the tightening we've seen across the short and long end of several noteworthy yield curves globally over the past few weeks."
HEDGEYE: That's a very astute observation and one we do not yet have a proven answer for. Here's what we do know: The sharp backup in Japanese interest and inflation swap rates across the curve over the past few weeks (5Y and 10Y JGBs +19bps since 7/27; 20Y JGB +27bps and 30Y JGB +34bps since 7/6; and 5Y5Y Forward Inflation Swap Rate +20bps since 7/16) has caught our attention and is indicative of one of the following two outcomes.
On one hand, the market may be responding positively to the government's recently announced ¥28.1T ($277B) stimulus package and pricing enough of a recovery in Japanese economic growth to perpetuate an increase in risk-taking among Japanese investors.
Conversely, the market could be front-running the beginning of a global, politically-driven shift away from the dominance of monetary easing - which lowers interest rates by creating excess demand for sovereign debt securities - to fiscal stimulus - which may perpetuate higher interest rates via excess supply of sovereign debt (in the absence of helicopter money).
The fact that Japan's benchmark Nikkei 225 Index is down -2.5% since 7/27 is supportive of the latter [more-bearish] theory. Regardless of the underlying driver(s) of the aforementioned backup in Japanese rates, a lasting "JGB Tantrum" is likely to prove quite negative for now-crowded yield trades globally - just as the "Bund Tantrum" was before it. The $1.9B outflow from high-yield bond funds in the week to 8/3 - the first of its kind since June and the largest outflow in seven weeks - is evidence of said unwind risk.
Going back to aforementioned discussion of money-market fund rule changes, it's important that investors understand the drag on economic activity that may result from the associated tightening of capital markets. Specifically, the move to require prime money market funds to hold more short-term debt and allow their NAV's to fluctuate (versus remaining at $1) has perpetuated a $420B outflow from the industry over the past year, leaving the industry with assets below $1T for the first time since 1999.
This would seem to suggest companies reliant upon prime funds for liquidity are likely to have to find other ways to borrow, at the margins - either via costlier bank loans or long-term bond issuance. It's probably not a huge deal given that government money-market funds have more than absorbed the aforementioned outflow (AUM +$509B YoY to $1.5T), but it's just one more headwind to a U.S. economy that is facing cycle-peak comparisons for its lone growth driver (i.e. consumer spending) as far as the eye can see.
CLIENT: "Central planners are destroying the financial services industry. It's as if they do not want us to exist - and the reality is they probably don't. Yellen is critical of income inequality, no?"
HEDGEYE: Right...
Hopefully you've found these discussions helpful. Best of luck out there incorporating the aforementioned factors into your existing and respective research and risk management frameworks.
Happy Summer Friday,
DD
Darius Dale
Director
