Global Strategy Flash Weekly Cross Asset Views Deutsche Bank Markets Research
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Global Strategy Flash Weekly Cross Asset Views Deutsche Bank Markets Research
Deutsche Bank Markets Research Global Australia Canada United States Cross-Discipline Date 4 November 2014 Dominic Konstam Global Strategy Flash Research Analyst (+1) 212 250-9753 [email protected] Weekly Cross Asset Views Joseph LaVorgna Trade recommendations USD: Sell 6M 5Y5Y strangles vs. 6M5Y straddles. USD: Bullish on S&P, contingent on US rates (contingent call). USD: Bearish on EUR, contingent on US rates (dual digital option). U.S. Economics We are projecting +220k gains in both ADP and private payrolls, and +225k in headline nonfarm payrolls. We highlight the strong correlation between nonmanufacturing ISM survey and job growth, with the former pointing to a meaningful upshift in job gains in coming quarters. U.S. Rates All eyes are trained on the ECB. We think the most likely scenario is that Draghi recognizes concerns regarding current policy tools and perhaps downplays them but pre-commits to other measures if necessary including corporate bond buying, more attractive TLTRO conditions etc. There are still many uncertainties around, for example, a corporate bond purchase program. Some caution on the market’s reaction to this scenario might still be in order due to these uncertainties. Better to chase than to be side swiped, in our view. Japan Rates The BOJ’s increased pace of monetary base expansion and increased ETF purchases are likely to be further catalysts for yen depreciation and a rise in stocks, which should put upside pressure on swap rates. We expect this to result in JGBs outperforming in the super-long sector compared to swaps. Chief US Economist (+1) 212 250-7329 [email protected] Makoto Yamashita, CMA Strategist (+81) 3 5156-6622 [email protected] Francis Yared Strategist (+44) 020 754-54017 [email protected] Steve Abrahams Research Analyst (+1) 212 250-3125 [email protected] David Bianco Strategist (+1 ) 212 250-8169 [email protected] Agencies Federal Home Loan Banks will lead the market growth in 2015 as Fannie and Freddie shrink their debt by another 10%. The GSE market should enter a phase of renewed expansion starting in 2016. On the agency curve, we find the 2y sector has the best relative value after adjusted for spread risk. U.S. Credit Value has returned back to lower quality parts of the HY market (low single-Bs and CCCs), especially those between 2-4 years of duration, as well as to the 10-year segment in non-financial IG corporate paper. Mortgages As long as the Fed keeps holding an outsized share, MBS stands to keep rolling up good performance. We don’t expect any tapering in the Fed’s reinvestment before 2016, and therefore, the demand for MBS is likely to be good enough to absorb net supply if it remains at 2014 levels. ________________________________________________________________________________________________________________ Deutsche Bank Securities Inc. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/04/2014. 4 November 2014 Global Strategy Flash: Weekly Cross Asset Views U.S. Economics Even though the financial markets are bracing for Friday’s October employment report, today’s economic data are significant, because they, too, will provide us with important information on the state of the labor market and the broader economy. With respect to the ADP survey, we need to compare its initial value versus the initial reading on private payrolls. Over the last 12 months, the average absolute difference between the two series is a relatively small 44k. As an aside, private payrolls have tended to be revised higher—they have been revised up 11 out of the last 12 months by an average of 30k. We are projecting +220k gains in both ADP and private payrolls (headline nonfarm payrolls is estimated at +225k), and we will revisit our forecast if there is an outlier reading on ADP. The non-manufacturing ISM survey will also attract some attention because the employment subcomponent is another leading indicator of the labor market, and it also tends to be highly correlated with job growth. We expect the non-manufacturing ISM to remain at an elevated level in October based on the strength in the Richmond Fed services survey. If the non-manufacturing ISM employment subcomponent remains elevated, it would strongly suggest that the pace of jobs gains is on the cusp of a meaningful upshift. As shown in the chart below, the non-manufacturing ISM employment series averaged 57.2 in Q3, which ties the historical high from Q1 2005. This would also be consistent with the recent cyclical low in jobless claims. Given the relationship with ADP employment shown below, history suggests we should see faster job growth in the quarters ahead. Initial jobless claims recently pierced the 300k level to the downside. The current four-week moving average on claims is +281k, which is the lowest level in 14 years. If the recent downtrend in claims continues, payroll gains could accelerate to 250k-plus over the coming months. At that pace of job creation, the unemployment rate would be on track to breach 5% by the end of next year. In short, a number of labor market indicators are pointing to a healthier job market. Hopefully, this will be confirmed by Friday’s data. Regarding revisions to GDP, a wider international trade deficit and slightly less inventory accumulation than what the Bureau of Economic Analysis had previously assumed mean Q3 output is now tracking at 2.9% compared to its initial 3.5% reading. Next week’s retail sales and business inventory data will provide us with more information on Q3 revisions and the state of current quarter output growth, which we presently project at 4.2%. ISM employment index vs. ADP nonfarm employment Source: Deutsche Bank Joseph Lavorgna and Carl Riccadonna (+1) 212 250-7329/0186 [email protected],[email protected] Page 2 Deutsche Bank Securities Inc. 4 November 2014 Global Strategy Flash: Weekly Cross Asset Views U.S. Rates There is a lot of optimism that Draghi “will deliver”. There is less clarity as to exactly how he will do that. Moreover the front running of the Euro currency weakness relative to balance sheet emphasizes the vulnerability to any sense of back sliding on balance sheet growth. We would roughly think of three possible outcomes with the middle one the most likely, in that it keeps the balls in the air. The most negative outcome for risk is that Draghi simply reiterates what they have already committed to, without recognizing possible limitations that the market is aware of, including TLTRO take ups and ABS+covered bond purchases. The middle, more likely scenario, is that Draghi recognizes these concerns, perhaps downplays them but pre-commits to other measures if necessary including corporate bond buying, more attractive TLTRO conditions etc. The third most bullish scenario would be a more brazen commitment to sovereign QE. This is not likely in our view at this stage – although many investors believe it is inevitable for the end game and the only debate is whether it takes a German recession or risk off phase to achieve it. For now though we do not think it is necessary for sustaining the recent risk asset gains. Even in the middle scenario there are still many uncertainties around say a corporate bond program in terms of the skew towards specific issuers so as ever, assuming we go into the ECB, with elevated risk assets some caution on subsequent market reaction might still be in order. Better to chase than to be side swiped, in our view. It is important to appreciate why the dynamic of the stronger dollar and weaker oil potentially improves the economic outlook. When domestic demand (assets) are in danger of staying (becoming) weak due to disin(de)flation woes, a stronger dollar only imports into the US extra deflation. Weak oil may improve household balance sheets but if that “shadow” income is saved, it won’t be worth much for growth. If global demand is stronger, then a stronger dollar instead of importing deflation instead, relatively speaking, exports inflation. The difference is important. The former risks the Fed having to have additional accommodation at home; the latter allows the Fed to delay tightening. To repeat: one makes you worried about bull steepening with more emphasis on the bull, the other makes you embrace bull flattening, with more emphasis on the flattening. Trade Recommendations Sell $115mn 6M 5Y5Y 14bp wide mid-curve strangles vs. buy $100mn 6M5Y vanilla straddles at zero next cost. Sell $70mn 6M 5Y5Y 20bp wide mid-curve strangles vs. buy $100mn 6M3Y vanilla straddles at zero next cost. Buy 3M SPX 102.5% call subject to 5Y CMS < ATMF – 10bp, offer 0.64%, a 55% discount to vanilla at 1.43%. 3M Dual Digital US 5Y CMS < ATMF – 10bp & EURUSD < 1.2250, offer12.1%, an 8.3:1 leverage. Dominic Konstam and team (+1) 212 250-9763 [email protected] Deutsche Bank Securities Inc. Page 3 4 November 2014 Global Strategy Flash: Weekly Cross Asset Views Japan Rates JGB yields curve massively bull-flattened after the BOJ’s additional monetary easing on last Friday. The BOJ decided to accelerate a JPY10- 20 trillion on in the annual pace of monetary base expansion and a JPY30 trillion increase in the amount by which the central bank aims to increase its JGB holdings each year. The BOJ is also expected to double its allocations to the super-long sector—where it still absorbs a comparatively small percentage of issuance— from 3Q 2014 levels which dampen the yield more than 10y- sector. The BOJ’s increased pace of monetary base expansion and increased ETF purchases are likely to be further catalysts for yen depreciation and a rise in stocks, which should put upside pressure on swap rates. We expect this to result in JGBs outperforming in the super-long sector compared to swaps. The GPIF (Total asset is 127trn yen as of June) also formally announced a new allocation ratio last Friday. It will lower JGB holdings to 35% of its portfolio (from the current basic weighting of 60%) and raise domestic stocks to 25% (12%), foreign bonds to 15% (11%), and foreign stocks to 25% (12%). We estimate the decrease of GPIF's JGB holdings could be around 20trn yen. However, this change would just moderate tight JGB supply/demand balance, as the BoJ has ramped up its JGB purchases by JPY30trn. Makoto Yamashita (+81) 35156 6622 [email protected] Agencies As we prepare our 2015 agency market projections, three things stand out to us and are worth highlighting. First, the Federal Home Loan Banks will increase their lead in market issuance over the other participants during next year, and their total debt will for the first time surpass Fannie’s and Freddie’s combined. Second, Fannie and Freddie may begin to slow their pace of winding down given that their debt is already comfortably sitting 20% below the PSPA threshold for 2015. This should on the margin be positive (or less negative) for market liquidity. Finally, in 2015 the agency market will undergo its final year of contraction of around -1%. Under even conservative growth estimates, the agency market will begin expanding again in 2016 and beyond. Updating our recommendation from last week, we continue to see good value in the front-end, especially the 2y sector. On a one-year history, 2y and 3y spreads are 1.7 standard deviations wide and 1.9 standard deviations wide to their average respectively. However, after adjusting for spread volatility, 2y has the best return/risk ratio compared to rest of the curve. Steven Zeng (+1) 212 250 9373 [email protected] U.S. Credit BBs are 50bps wider since Jun 30th, while CCCs are 210bp wider. Now the normal historical spread betas are 0.8x and 1.5x respectively, so all else being equal, one would expect BBs to be 70bps wider and CCCs 135bp wider at the time when overall HY is +90bp. Not all else is equal however, as we have highlighted on a number of occasions the tightness of lower quality segments since early July. So we view this underperformance as a necessary part of readjustment in valuations that needed to have taken place. At their current Page 4 Deutsche Bank Securities Inc. 4 November 2014 Global Strategy Flash: Weekly Cross Asset Views levels, we believe CCCs and low single-Bs, especially those inside of 4yr durations, are beginning to look attractive for the first time in months. Within IG, the 10-year segment stands out to us as a sector for value across As and BBBs; high-quality front-end paper has cheapened up from 5th percentile levels but remains the least attractive on a relative valuation basis. Oleg Melentyev and Daniel Sorid (+1) 212 250-6779/1407 [email protected], [email protected] Mortgages Such sweet sorrow With the Fed announcing an end to QE last Wednesday, the MBS market enters a new phase where a third of outstanding securities remain out of reach for private hands and where no government portfolio drives marginal pricing. As long as the Fed keeps holding an outsized share, MBS stands to keep rolling up good performance. But the real risks get put off until that share starts to fall. The $1.7 trillion in Fed MBS leaves the rest of the market to shop in the remaining $3.5 trillion for meeting regulatory liquidity ratios, holding as margin against derivatives transactions, managing against US and global market index allocations, covering liabilities and other purposes. Demand is likely to be good enough to absorb net supply if it remains at 2014 levels. The Fed holdings also keep a source of volatility out of private hands. Even though the Fed holds a third of outstanding, through July the Fed held roughly half of outstanding MBS dollar duration – the Fed generally owning the part of the MBS market with the longest duration. This clearly keeps MBS duration out of the increasingly few hands that explicitly hedge it, primarily the managers of Federal Home Loan Bank portfolios and those managing the dwindling positions at Fannie Mae and Freddie Mac. More importantly, it keeps the duration off of the balance sheets of banks, insurers, pensions and other places where change in MBS duration often forces another parts of the balance sheet to compensate. As a result, broad market volatility should run lower than it would otherwise. Eventually Fed reinvestment of MBS principal should evolve into a dynamic of its own since any tapering of reinvestment could become a major supply of net MBS to the private market. That will put the spotlight on private market pricing of MBS and should start to lift volatility. However, any tapering in reinvestment is likely an early 2016 event at the earliest, and the process could stretch through 2017. Fed Chair Yellen said after the last FOMC that the committee would defer any tapering until it was comfortable with the impact of higher short rates and the outlook for inflation and employment. Given the complexities of its tools – interest on excess reserves, overnight reverse repo and effective fed funds – and the heightened risk of slowing the economy with rates near the zero bound, the Fed will likely proceed slowly unless the economy strengthens a lot faster than it has lately. The end of the Fed as a net buyer does hand the baton for marginal pricing to the private market. This will be the first time that the market will price without a bid from a growing Fannie Mae or Freddie Mac portfolio, where balances peaked in early 2009, or from the US Treasury or Federal Reserve. With the exception of the period between QE1 and QE3, a bid from at least one of these parties has been in the market since the early 1990s. This transition puts the market into hands with more expensive capital, less leverage or both. We should probably get good marginal demand from money managers as that Deutsche Bank Securities Inc. Page 5 4 November 2014 Global Strategy Flash: Weekly Cross Asset Views sector reallocates from underweight MBS toward neutral. But as more and more of the MBS market sits over time on private balance sheets, spreads, all else equal, have to go wider. So, the supply/demand equation now changes. It was net Fed demand against net primary market supply. As QE ends, it becomes net private demand against new primary supply and, eventually, net secondary supply from the Fed. We’re in the sweet spot now after QE but before any tapering in reinvestment. Enjoy it while it lasts. Steve Abrahams and Ian Carow (+1) 212 250-3125/9370 [email protected], [email protected] Page 6 Deutsche Bank Securities Inc. 4 November 2014 Global Strategy Flash: Weekly Cross Asset Views Appendix 1 Important Disclosures Additional information available upon request For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Dominic Konstam Deutsche Bank Securities Inc. 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