It’s generally considered that higher volatility in bond markets would accompany higher rates. Thus, if rates are falling, volatility will remain subdued. However, as the PIMCO Eurodollars liquidation showed, the market was already short. So the position liquidation is coming in a rally, rather than a sell-off. On top of that, inflation is falling and with oil under pressure should remain low. Meanwhile the Fed hawks evidently lost the argument to the doves in September, and their hand has been strengthened by the dollar rally. So the conditions are set for higher vol to accompany the fall in rates.
This could be the hidden message of Bill Gross’ departure...
By now it is clear to everyone that the force-feeding of free-money into financial markets by The Fed et al. has led to a scale of financial repression never before witnessed as bond yields for even the riskiest of risky names collapse to record lows and cheap-financed share buybacks raise leverage to record highs and support an ever more fragile equity wealth creation machine. As Blackrock (and many others) have recently proclaimed, the corporate bond market is "broken" and the risk posed by investors trying to dump bonds is"percolating right under" the noses of regulators; so it is with grave concern we suggest the following two charts - showing the massive out-sized holdings of PIMCO's funds in the high-yield and emerging market debt markets leave a bond marketplace in fear that forced sales via redemptions are the straw that breaks the 'central bank omnipotence' narrative's back...
Investors worldwide poured a net $15.8 billion into bond funds in the week ended Oct. 8. As Reuters reports, this is the biggest inflows in dollar terms since records began in 2001, according to EPFR Global. Money market funds also saw the biggest inflow since October 2013 as it appears the real great rotation is from stocks (biggest outflows in 9 weeks) into 'safe' assets. The up-in-quality, and up-in-capital-structure trade is alive and well, as BofA notes, investment grade inflows exploded as high-yield spreads widened further - now at one-year wides (despite small inflows). "Money is flowing out of PIMCO," warned one analyst but as BofA notes, PIMCO flows are reported monthly and so it is unclear as to the extent these flows are "overstated."
"Financial Markets Are Artificially Priced: What Do You Do?" - Bill Gross' First Janus Capital LetterSubmitted by Tyler Durden on 10/10/2014 12:37 -0400
Financial markets are artificially priced.... We have had our Biblical seven years of fat. We must look forward, almost by mathematical necessity, to seven figurative years of leaner: Bonds – 3% to 4% at best, stocks – 5% to 6% on the outside. That may not be enough for your retirement or your kid’s college education. It certainly isn’t for many private and public pension funds that still have a fairy tale belief in an average 7% to 8% return for the next 10 to 20 years! What do you do?
Curious how Bill Gross feels in his new digs at Janus Capital (aka old digs in Newport Beach)? Curious how much money he is managing now or how he will manage it? Curious why he has a band aid under his right eye? All should be revealed in the Janus Capital live webcast going on now.
- Five U.S. airports to screen for fever (Reuters)
- Danger, central banks trading with each other: Bipolar U.S. Stocks See Biggest Mood Swing in Three Years (BBG)
- Draghi Policies Blunted in Berlin as German Protests Grow (BBG)
- White policeman kills black teen in St Louis, triggering fresh protests (Reuters)
- Au Revoir to France’s Welfare Model as Socialists Cut Spending (BBG)
- Here comes Roberto Cavalski (Reuters)
- There are 49 U.S. venture-capital-backed companies with a valuation of $1 billion or more—the highest number on record (WSJ)
- Pressure mounts on Hong Kong leader over payout amid crisis (Reuters)
The most surprising data point in today's 10 Year auction was the plunge in Directs, which tumbled from 13.5% to only 6.6%, which was the lowest since August of 2012 when they ended up with 5.2%. Just how much of this lack of Direct interest is due to Bill Gross no longer being on the bid? And what happens to future auctions in a world without the Old "New Normal" Pimco?
The integrity of markets is clearly at risk. And we have long sought alternatives that offer much lower credit and counterparty risk. The time-honored alternative has been gold. As the chart below shows, gold has tracked the expansion in US debt pretty handily (the correlation between the two is a strong +0.86) and if one expects that relationship to resume (we do), then gold looks anomalously cheap relative to the rising level of US debt.
The central bankers have truly been the markets best friends and Draghi and Kuroda-san have been taking over where Ms Yellen has all but left off, but even they can do little in the face of protest and dissent by various members of the global populace and the continuing stupidity and arrogance of our “democratically” elected representatives.
It appears wherever one looks in the markets there are the skidmarks of PIMCO adjusting to life after Bill Gross. First it was MBS (and related derivatives), then CDS indices adjusted as redemption expectations raised risk premia, and now it is the short-end of the Treasury curve. As The FT notes, 3-month Eurodollar futures (instruments enabling traders to bet on the front-end of the yield curve and thus more accurately pinpoint their bets on Fed actions) saw asset managers (cough PIMCO cough) liquidate a record 868,853 contracts in the week to September 30 – the largest one-week change on record (each contract has a notional value of $1m). This dramatic shift suggests both a disagreement with Gross' "new normal" view of rates lower for longer (since liquidation is concentrated around the 2-year maturities) and a need to meet liquidity requirements from redemption requests.
While the biggest micro news of the weekend is certainly the report that Hewlett-Packard has finally thrown in the towel on organic growth (all those thousands laid off over the past ten years can finally breathe easily - they were not fired in vain), and has proceeded to do what so many said was its only real option: splitting into two separate companies, a personal-computer and printer business, and corporate hardware and services operations (which will certainly lead to even more stock buybacks only not at one but two companies) which in turn has sent its stock and futures higher, perhaps the most notable development in the macro world is Japan's realization finally that the weaker Yen is crushing domestic businesses, which has resulted in the USDJPY sliding to lows last seen at Friday's jobs report print, and also generally leading to across the board wekness for the dollar, whose relentless surge in the past 3 months is strongly reminiscent of the euphoria following the Plaza Accord, only in the other direction (and making some wonder if the Plaza Hotel caterer are about to see a rerun of September 22, 1985 in the coming weeks).
In the mid 1970's ,“experts” warned that gold would fall as interest rates rose. The opposite happened and as interest rates rose, gold rose more than 8 times in 3 years and 4 months - from $100/oz in 1976 to $850/oz in January 1980 (see chart). History does not repeat, but it frequently rhymes ...
I think this is a time where people will look back on us and see it as a period of practically central bank worship. The central bankers – Draghi, Yellen, Bernanke – have become almost celebrities in America. People have invested unreasonable hopes in what these central banks can know, and what they can do. I think that, sooner or later, the investing public will become disillusioned of these ideas.... I dare say that stock prices will not continue to rise uninterrupted at the same pace. That’s not a very interesting prediction, but the stock market is certainly a cyclical thing. I think it’s fair to observe that today’s ultra-low interest rates flatter stock market valuations. Stock prices are partly valued based on a discounted flow of dividend income. To the extent that the discount rate you use to value that stream of dividend income, which depends on interest rates, is artificially low, stock prices are artificially high. I think that the burden of proof is on anyone who would assert that we are in a new age of persistently and steadily rising stock prices.
Market weakness, as BofAML reports, has taken a toll on mutual fund and ETF flows, with stocks (-$9.56bn), HY bonds (-$1.56bn) and levered loans (-$1.17bn) all reporting significant outflows last week (ending on October 1st). There is a clear "up in quality" and "up in capital structure" rotation among investors as investment grade bonds saw huge inflows. Notably, most PIMCO funds, including the Total Return Funds, do not report flows weekly, and hence the bulk of this outflow was not reflected in the last week’s data. In a statement PIMCO said that outflows from the Total Return Fund totaled $23.5bn in September, so we will have to see just where that outflow hit.