Citi"s "What If?" Scenarios: Part 2

Yesterday we published the first set of 7 "What If" scenarios that didn"t make it into the Citi Credit team"s (already rather gloomy) year-ahead forecast. Because while Citi"s "base case" was clearly bearish (our summary can be found here), what was left unsaid was even more unsettling, if not troubling. As the bank"s credit team wrote "what about the outcomes that didn’t quite make it into our base case? The scenarios that aren’t central, but which aren’t entirely implausible either – both bullish and bearish." Citi then listed the following 7 scenarios in the first part of its quasi-forecast:

• idiosyncratic risk is returning to credit?


• European corporates get more aggressive?


• global growth & commodity prices disappoint?


• inflation accelerates as output gaps close?


• the US yield curve inverts?


• central bank tapering really is a non-event?


• the market doesn’t like the choice of ECB successor?"

A full discussion of the above scenarios was posted yesterday.

Today, we follow up with part 2, or the second set of 7 hypothetical questions for 2018, which shifts away from economics and finance, and focuses on politics and Europe. As Citi"s credit team writes "you tend to worry less about your leaky roof when the sun is shining. And at the moment the cyclical economic upturn is beaming across Europe. Yet there are clouds which might conceivably hold moisture – or as our economists have put it: political risk is not dead in Europe."

So to avoid a leaky roof turning into a flood, Citi once again set out some of the economic and fundamental scenarios for 2018 that aren’t in the bank"s base case, but which remain reasonably plausible nonetheless; specifically Citi looks at the list of "potential political dark horses for next year." These include the following "what ifs":

• … the market falls out of “amore” with BTPs?


• … Catalonia declares independence (and means it)?


• … meaningful EU reforms actually happen?


• … the UK leaves the EU without a deal?


• … Brexit is called off?


• … Corbyn becomes PM?


• … US tax reform fails?

While Citi concedes that there are many others it could have included, like Middle-East tensions, North Korea tensions, global trade relations, US mid-term elections, escalation in the South China Sea or relations between Russia and the West, these will have to wait for another time. Until then, here is a breakdown of the political "What Ifs" that would keep Citi at night if they were allowed to be part of the bank"s official base case.

1. the market falls out of “amore” with BTPs?

Markets seem largely to have grown comfortable with the idea of an unusually large number of different political constellations that are feasible after the next Italian general election. Legally, they must take place by May, but national newspapers have reported that a deal has been made to hold them on March 4.

Our economists see a centre-right victory as marginally the most likely outcome, but longer-term, big question marks remain over which individual party will dominate within the bloc and the true depth of ostensible EU-scepticism. A grand coalition over the middle also remains a possibility, albeit a fading one. Either would probably be seen as somewhat positive by markets in the immediate aftermath. However, with the M5S still gaining in many polls at the expense of a struggling PD, their involvement in a future coalition of the left remains a reasonable probability. Although M5S has certainly shifted its stance on the EU significantly, with its candidate for PM declaring he wants to stay in the EU and toning down his party’s opposition to the euro, other of their desired reforms would likely be seen as negative by the market. A less likely coalition between M5S and a party on the right, like Lega Nord, could potentially be more confrontational and even less marketfriendly.

While the moderation in stances and the cyclical upturn in Italy have diminished the probability of more extreme outcomes, demand for BTPs could still prove fickle amid the uncertainty and a reduction in ECB purchases.

Indeed, you could argue that private investors fell out of love with BTPs quite some time ago. As illustrated in Figure 1, just about every other major investor type has become a net seller (to the ECB) or a non-buyer of BTPs over the last couple of years. To change that behaviour, we think it remains pretty likely that there will need to be an adjustment in prices. As our rates strategists have pointed out, the ECB could counteract this through an “Italian Operation Twist” (lengthening the maturity of their BTP holdings), but such a response might not come immediately, given the ECB’s reluctance to favour individual countries, unless associated with the conditionality that comes with an economic adjustment programme.

To our minds, this remains one of the most significant political risks to € credit in 2018. Most likely the spillover on credit would be concentrated on Italian and other periphery names, banks in particular. The scenario of a full-on funding crisis is a much lower probability in our view, but would obviously have more systemic implications across the € credit market.

* * *

2. Catalonia declares independence (and means it)?

Then there is the question of Catalonia. Opinion polls suggest that the separatist and non-separatist camps are neck and neck. How the marginal mandates fall will have a very important bearing on what happens next. The scenario where nonindependence parties secure a majority would probably put the whole question on the backburner for the time being, even if they fail to form a formal coalition. Yet with risk premia already so suppressed we doubt that the reaction in the broader market would be discernible – it would not change our central scenario at all.

However, most polls still suggest a narrow majority of seats will go to the three independence parties. In recent statements, two of the three have moved away from a formal deadline for independence, and indicated more openness towards alternative solutions to independence, implying a moderation in their stance. As such, even if they secure a small majority of seats, there is a good chance a repeat of the standoff from October with the central government can be avoided.

Risks arise in the scenario where the more radical separatist parties do materially better than the polls suggest. In particular, if the independence parties were to achieve more than 50% of the overall vote (as opposed to a mere majority of seats). We think the probability has receded greatly in recent weeks, but in an outcome where tension with the government in Madrid escalates again and major protests break out in the region, a more assertive unilateral declaration of independence remains conceivable.

Although actual independence from Spain even in the long term would remain unlikely even under such a scenario, we’d expect a rise in Spanish risk premia especially on those companies with direct exposure to the region. We note that the main banks have already shifted legal domicile to ensure access to ECB liquidity. In all but the most extreme situations we would expect the broader reaction across € credit to remain muted, as it was in October.

We would assign no more than a 10-15% probability to such an outcome and for impact on the wider € IG market you have to move significantly further out on the tail.

* * *

3. Meaningful EU reforms actually happen?

Optimism about major EU reforms following Macron’s election were dealt a significant blow by German voters in September. Yet there seems to be widespread recognition among policymakers that Europe runs a high risk of another sovereign crisis whenever the ongoing cyclical upturn ends, unless the framework is reformed. Banking union remains incomplete, capital markets union remains an ongoing project and with limited scope for a major increase in the EU’s budget, a strengthened lender-of-last-resort mechanism for sovereigns, like the European Monetary Fund proposed by the Commission, would potentially increase resilience considerably.

The differing objectives in European capitals likely either imply protracted negotiations or watered-down compromises that fail to provide markets with much reassurance. Even beyond resources devoted to Brexit negotiations, tensions with several Eastern European member states (though outside the Euro area) also act as a distraction. Poland’s prime minister has stated that he expects the Commission to propose an article 7.1 determination as early as next week. Article 7 is intended to safeguard the values of the EU, which may ultimately result in a member state having voting rights suspended. 7.1 is a warning stage in that process.

As such, major reforms are not in our base case for next year, but are not  inconceivable either. We would argue that sovereign risk premia in European credit are minimal at the moment, limiting the upside from such a scenario to a handful of basis points. Evidently, a strengthened framework ought to have the biggest impact on periphery credit, especially those whose fortunes are tied to their sovereigns, most obviously the banks.

4. the UK leaves the EU without a deal?

In a strictly legal sense, it’s difficult for a “no deal” scenario to materialise next year. According to Article 50 TEU, the EU treaties only cease to apply either when a withdrawal agreement comes into effect or after two years have passed since activation, i.e. March 2019. In practice, though, even with the first phase of negotiations now agreed, the chasm between what many in the UK believe can be achieved on trade in a short space of time and what the EU seems likely to offer means that a complete breakdown of negotiations is a real possibility.

And realistically, to allow for ratification across member states a final deal will need to be reached before the end of 2018. The fact that the trade agreement with Canada was nearly prevented by opposition in Wallonia, while the EU-Ukrainian trade deal was delayed by a Dutch referendum, illustrates that ratification is by no means guaranteed. Article 50 does, of course, leave scope for an extension should more time be needed, but this too, requires unanimity of the EU27 (and the UK) in the Council – and as such may not be completely straightforward.

So if negotiations do break down to the extent that “no deal” becomes central scenario, that should be reflected in spreads already next year.

From a trade perspective, the particular weak spot would be those sectors of the UK economy with a high EU trade intensity while not being covered by WTO goods trade rules, like tech and transport. More than tariffs, we suspect the chief impact would come through increased friction, in the form of additional paperwork and lack of mutual recognition of standards.

The sector that is most obviously exposed is the heavily regulated world of financial services. Admittedly, all banks passed the rather strict “hard Brexit” stress test conducted by the Bank of England, but spreads on those UK banks and insurers that depend on Europe for a significant proportion of their revenues should still react to the considerable uncertainty associated with a “no deal” scenario,  if it becomes central late in 2019.

The broader impact of “no-deal” on domestic UK sentiment also needs to be considered. It would evidently depend on the policy stance adopted by the UK government. But given both the limited fiscal space it is already confronted with, together with the balance of Brexiteer opinion favouring a more protectionist “drawbridge” Brexit as opposed to the “Singapore-on-Thames” that some aspire to, the economic consequences for the UK would likely be severe and rapidly felt. Though some of the negative impact of a “no deal” would likely be offset by a weakening currency, we doubt that would suffice to counteract the otherwise deeply market-unfriendly implications.

A trajectory towards a no-deal Brexit probably has only limited implications for broader credit spreads, but it should still leave spreads on credits with material exposure to the UK, and UK-EU trade in particular, 10-30bp wider relative to our central scenario.

5. … Brexit is called off?

Calling off Brexit (Brexit-exit) entirely would, in practical (though not in legal) terms, almost certainly require another referendum – it is hard to imagine any politician doing without consent from the electorate. Until now a second vote hasn’t appeared very likely. But a Survation report for the Mail on Sunday last week found that 50% of voters now want a referendum on a final deal, while only 34% were against. As recently as in June, the same poll showed a majority against a second vote, so this is a significant shift, likely in response to the arduous negotiations.

However, we think a second referendum called by the current government remains unlikely unless there is also a significant shift in the polls on the likely outcome. Though even among Leave voters only a small minority (28%) now expect the UK to secure a “good deal” in its negotiations with the EU, YouGov data indicates that the decline in support for Brexit among UK voters is still quite small. Many polls still suggest the outcome of another referendum would be within the statistical uncertainty. However, as Gordon Brown has suggested, it is possible that this changes if more of Teresa May’s red lines are crossed next year.

If the UK did opt for a second referendum and voted to call off Brexit, between the ambiguity in article 50 and goodwill among other member states, we believe the rest of the EU would agree on surmountable terms.

All else equal, Brexit-exit should be a positive for UK assets, and would likely help £ spreads erase some of their YTD underperformance against € and $ credit (albeit the latter have been boosted by ECB buying and the prospects for US tax reform respectively). Even the scenario where the UK ends up staying in the Single Market and the Customs Union for all intents and purposes is probably a positive relative what is priced currently (unless it involves the scenario below also). And the probability of that happening is significantly higher than of Brexit-exit. Either would in our opinion be viewed as a positive for European cohesion as a whole, shaving perhaps 3-7bp of spreads from our base case scenario.

6. Corbyn becomes PM?

We assume that PM May will survive both the recent brouhaha over the Irish border, being voted down in Parliament and, more importantly, trade negotiations over the coming year. But not with great conviction. The status quo remains highly vulnerable: after all, the threat of a Corbyn government is probably one of the main factors that has held Ms May’s fragile coalition together thus far, in our  view. That logic should continue to hold over 2018, but even if the appetite for another election is miniscule within the Conservative party, the risk of a party split remains elevated. Recent opinion polls suggest that Labour is pulling ahead, with some suggesting they would potentially end up with an overall majority.

For markets, this would have mixed implications.

On the one hand, a Labour government would almost certainly mean a more flexible approach to Brexit. While the Labour leadership has not come down firmly in favour of continued customs union and single market membership (with their preference in favour of keeping the UK “in the customs unions and single market in the transition period and leaving the options on the table for after the transition period”, in the words of Labour Brexit spokesman Keir Starmer), a Corbyn premiership would certainly make that more likely.

At the same time, Mr Corbyn’s policy platform of higher taxes and nationalisations is unlikely to be welcomed by business. Shadow Chancellor John McDonald recently stated that shareholders in key utilities would be offered government bonds in exchange for their shares at rate determined by the government. In theory, government ownership should be positive for bondholders, but under the  associated uncertainty we doubt that’s how risk premia would react initially. And Corbyn’s strong rhetoric towards the City of late doesn’t portend a particularly easy relationship were he to be in power either.

Ultimately, a narrow mandate, a coalition or merely the responsibilities of government might demand a more pragmatic approach once in power. But in the run-up to an election where opinion polls show a Labour lead, we doubt markets would afford UK credit the benefit of the doubt. We’d put the probability of a Corbyn premiership in 2018 at around 15-25%, so it is already somewhat reflected in our base case for £ credit. This anticipates underperformance of names with a high degree of UK exposure, but in an election scenario there we still see further downside to our forecast numbers.

7. US tax reform fails?

As far as credit specifically is concerned, our previous principal worry over US tax reform, namely that the removal of interest tax deductibility would lead US companies to transfer more of their issuance to overseas entities, potentially driving up reverse yankee supply significantly, has largely been dealt with by the current plan’s allowance for interest to be tax deductible up to 30% of earnings. But to the extent that the envisaged mandatory repatriation lowers US corporates funding requirements (a prospect our US colleagues are admittedly more sceptical of than most), failure to pass tax reform would increase the funding requirement in US credit next year, potentially adding to reverse yankee issuance too. On its own this would be a somewhat bigger spread negative for the US, and a smaller one for euro credit, especially for existing reverse yankee bonds.

Failure to get tax reform through would also curtail the earnings boost that European multinationals (concentrated in the health care, consumer staples, industrials and commodity sectors) can expect to see from a reduction in tax rates on their US subsidiaries (estimates we have seen put this in the range of 2-4%). This would be a bigger deal for equities than credit, and it’s not clear how much the assumption of a tax reform-driven boost to earnings have been factored into consensus expectations yet anyway, but at the margin this would also be a small negative for the companies that stand to benefit most.

Overall though, a failure to get tax reform through, after health care reforms had to be shelved earlier this year, would call into question the feasibility of the Republicans’ legislative agenda. Our economists have factored in a 0.4% boost to US growth next year from tax reform, and a scaling back of US growth expectations. We think the spillover on global risk appetite would likely lead to at least 5bp of widening from current levels.

So ‘what if’ then?

As mentioned at the onset, none of these scenarios are base case individually. They weren’t meant to be. But what’s striking is how many are at play in 2018: we managed to come up with more with more than 40 "what ifs" in less than an hour. What you see above is merely a selection. To us, it again illustrates the uncertainty around the prevailing paradigm as we head into 2018. How they play out remains to be seen and there are positive risks too, but overall the exercise has really rammed home how lop-sided risk-reward is at the onset. When spreads are at historical tights, no news is probably the best news one can realistically hope for.

Bitcoin Futures Open Above $20,000... Then Dump

Both CME and CBOE Bitcoin Futures contracts opened above $20,000 this evening (with Bitcoin spot hovering around $19,000). However, as soon as trading started, Bitcoin futures got hammered lower.

 

Those expecting a surge in futs volumes on the CME vs the CBOE will be disappointed:

CME Bitcoin futures volume 150 ????

— Lee Saks (@Lee_Saks) December 17, 2017

In fact, spoting actual trades in the first few minutes of trading is not heavy to say the least. Obviously Jan is seeing all the volume...

And March not so much... (let alone the $1200 bid-offer spread)

The lack of trading will likely be a surprise to those who were expecting a more "vigorous" futures launch on the CME, such as Brooks Dudley, vice president of risk in New York at ED&F Man Capital Markets who told Bloomberg that "CME’s bitcoin contract may not be first, but they are a larger futures clearinghouse and we are looking forward to our clients trading their product on Sunday evening. Not all market participants have been able to short the Cboe bitcoin futures. We have allowed our clients to go long or short to take advantage of dislocations between the futures and the underlying spot market.”

For now, nobody appears to be taking advantage of anything.

Incidentally, here is the (declining) Cboe XBT futs volumes in the first week of trading.

Finally, for those who missed it, here is JPM"s take on CME vs Cboe futs:

• With CME Bitcoin futures set to begin trading on 18th December, there will be competition between the two exchanges to attract volumes. Similar to the CBOE contract, the CME futures are cash settled, and after reviewing the initial margin requirement ahead of launch the CME raised it this week from 35% to 47% for speculative accounts, modestly higher than the CBOE’s
  44% initial margin requirement.


• There are some differences in the contracts worth noting, however. The settlement price of the CME futures will be based on a weighted average of prices from several exchanges (including Bitstamp, GDAX, itBit and Kraken), rather than a single exchange. The settlement dates of the CME futures will also extend further ahead to March, June, September and December. These factors, along with the fact that the CME is a larger exchange, could give it an advantage in terms of attracting trading volumes.

China: Systemic Risk Surges As HNA"s High Coupon Borrowing Binge Accelerates

In early November 2017, we returned to one of our favourite subjects, systemic risk in China related to its big four highly-indebted conglomerates, HNA, Anbang, Evergrande and Dalian Wanda. In particular, we asked whether the extortionately high coupon of 9% on an HNA dollar bond issue, with less than one year to maturity, marked the beginning of China’s Minsky moment? As we noted at the time, HNA has $28 billion of short-term debt maturing before the end of June 2018, much of it accumulated during an acquisition binge over the last two years, which has seen it become a major shareholder in companies such as Deutsche Bank AG and Hilton Worldwide Holdings.

Speaking to Bloomberg at the time, Warut Promboon, managing partner at credit research firm, Bondcritic, noted...

“Nine percent is really high for one year. Basically, it tells you that the worry is real."

In a sign that HNA is under pressure, both from the Chinese government and its creditors, CEO Adam Tan announced last week that the company was reversing its previous strategy. From Reuters.

HNA Group CEO Adam Tan said the acquisitive company is making adjustments to conform with national policies, and has sold some investments and real estate projects to improve its liquidity, domestic media reported on Tuesday.

 

Tan said the company would not invest in those areas not backed by the government, while supporting Beijing’s Belt and Road initiative, the 21st Century Herald reported. “Companies cannot invest chaotically overseas, because chaotic investment creates trouble,” Tan was quoted in a separate article by the media portal Sina.com.

HNA is already in trouble, the question is how much? The group is planning an IPO of Gategroup Holding AG, an airline catering company it only purchased in 2016 for $1.5 billion, next year. However, its interest expenses have been rising rapidly and paying 9% coupons is only going to make it worse.

Meanwhile, it continues to tap bond markets at high rates, this time paying 8.2% for an issue by a subsidiary of Hainan Airlines, the core business from which HNA developed. According to Bloomberg, units of HNA Group Co. are stepping up fundraising in the local bond market even as borrowing costs soar, adding to concerns about the Chinese conglomerate’s debt burden. Yunnan Lucky Air Co., a unit of Hainan Airlines Holding Co. -- HNA’s flag carrier -- sold a 270-day yuan bond to yield 8.2 percent last week, the highest coupon rate ever for the Yunnan airline. Tianjin Airlines Co., another subsidiary of Hainan Airlines, issued similar-maturity notes at the highest coupon rate in five years in November.

As Bloomberg notes, while other Chinese companies have cancelled bond issues, HNA doesn’t have that luxury.

While surging onshore bond yields last month forced Chinese companies to cancel the most bond offerings since April, HNA’s units didn’t slow their pace of financing. They revived debt sales from November, following a lull after news emerged in June about a crackdown by China’s banking regulator. The accelerated fundraising suggests a need for money and may hurt the conglomerate’s credit profile, according to credit research firm Bondcritic Ltd.

“They just keep piling on debt,” said Warut Promboon, managing partner at Bondcritic. “It’s not going to work.”

 

Two calls to Hainan Airlines’ public relations officers weren’t answered. There were no replies to questions sent via text messages.

The flood of issues from constituents of the HNA group is expected to continue, assuming that bond markets are amenable.

Hainan Airlines said last week that it is planning to sell 1 billion yuan of perpetual bonds on Dec. 6. That would be its third note sale in the local Chinese market in a month, according to Bloomberg-compiled data. In the carrier’s most recent sale of onshore securities last month, the company, which has top ratings from local credit assessors, issued local bonds at yields equivalent to junk notes in the nation.

 

Another HNA unit, Sanya Phoenix International Airport Co., is planning its third bond sale in three weeks on Monday, according to a statement on Nov. 29.

During his presentation last week, CEO Adam Tan commented that “Each of our business groups has its own cash flow management”. However, if Hainan Airlines is paying junk rates despite its “top” local ratings, it suggests that creditors are assessing risk from a group perspective…and unfavourably. Last week, Bloomberg noted that S&P cuts the HNA Group’s credit rating to five times below junk, citing its significant debt maturities, rising borrowing costs and proposed acquisition of New Zealand’s UDC Finance (will it ever learn).

S&P said on Wednesday it lowered HNA’s credit profile by one notch to b, or five levels below investment grade, from b+. The change was disclosed in a report by S&P on New Zealand’s UDC Finance Ltd., which HNA is seeking to buy.

 

“HNA Group has significant debt maturities over the next several years and its funding costs are meaningfully higher than that of a year ago," Andrew Mayes and Sharad Jain, analysts at S&P, wrote in their report. "We will closely monitor HNA Group’s access to capital markets and funding costs to determine whether additional actions are necessary.”

 

As to Australia & New Zealand Banking Group Ltd.’s UDC Finance, S&P said it may cut the company’s long-term debt rating by four notches to a junk level of BB- from BBB if its sale to HNA is completed. The deal, announced in January, has yet to be completed pending approval from New Zealand’s overseas investment approvals board.

It’s possible that HNA is approaching the “catastrophic margin call”, from its practice of pledging its own shares and those of its investments, which we first postulated in July 2017 in “A Reverse Rollup From Hell’: China"s ‘Boldest Dealmaker’ Faces Margin Call Disintegration”. From our post.

…while most Chinese companies pledged "only" their own shares to get loans, a handful of companies also used shares of the acquired companies as pledged collateral. This is precisely what HNA Group did, which now faces not only growing regulatory scrutiny from Beijing that threatens to spook bond investors and raise HNA’s financing costs, but also send its shares plunging as holders are forced to liquidate even as most of the shares pledged to fund its buying spree are already declining, accelerating its demise. And, in a scenario that can only be dubbed as a "reverse rollup from hell" - on steroids and margin - one that would make even Valeant blush and snicker, if the value of its collateral, i.e. stock price, falls enough, HNA will soon be forced to sell its holdings to repay debt, thereby resulting in the disintegration of the company.

HNA is a private company, hence a detailed breakdown of its borrowing position and its share pledges is not available. However, the circumstantial evidence remains highly negative and the systemic risk it poses for China is likely rising not falling.

The Man Behind The Oil Price Rally

Authored by Dan Dicker via OilPrice.com,

The OPEC meeting is over and the cartel has extended production cuts throughout 2018. The decision is obviously crucial to supporting oil prices, but perhaps an even bigger story is the relentless strategy from the young Saudi Prince, Mohammed bin Salman, being played out both inside OPEC and in his own country. And oil is the key to it all.

Last Sunday premiered the newly formed Islamic anti-terrorism coalition, putting together leaders from Sunni Arab nations to denounce and combat fundamentalist terrorism throughout the Middle East and the world. It was another bold initiative towards the West of the young and energetic Crown Prince of Saudi Arabia, coming on the heels of other bold moves that have looked to consolidate political and religious power in the Kingdom.

Together, all of these initiatives couldn’t be more transparent. They represent a movement of the most economically powerful nation in OPEC towards social, cultural and economic change, the realization of the Saudi “Vision 2030”. It is a top-down Arab Spring movement that likely has a better chance of success than the populist movements that resulted in more chaos than change in 2010.

However, the ultimate success for Vision 2030 will rely upon achieving the main economic goal of this revolution – the divestiture of Saudi Arabia from the singularity of oil revenues. Because we know that ultimately money – and lots of it – will be needed to drive the engines for change, we get a far better picture of just how important these latest production extensions agreed to in Vienna were for the young Prince.

And here we’re brought back to the upcoming IPO of Saudi Aramco, still on tap for 2018.

Even the planned 5 percent offering of the Saudi state oil assets could yield an instantaneous $100 billion dollars, if the $2 trillion-dollar valuation of Saudi Aramco is accurate. That’s a lot of capital to start the process of rebuilding a Saudi economy from one that is now virtually completely reliant upon the State. 75 percent of the Saudi public is under 35 years old, and they are starving for a new economic infrastructure that will bring job opportunities, cultural diversity, music, education – global access of all kinds – the kind of freedoms that the 2010 Arab Spring uprisings were supposed to deliver. Only this time, the push for change is coming from the top down, not as a populist movement from the people upwards.

It’s hard to overstate the importance of this story for us as energy investors going forward, as it will dominate Middle East geopolitics for decades.

And the bottom line is this – it all comes down to oil.

At a $40-barrel price, the IPO will be a complete bust, and without that economic power from oil diversification, the push forward on all the other social and cultural changes the youth are yearning for in Saudi Arabia, (and in the rest of the Arab world) is guaranteed to fail.

At $75, or better still $100 a barrel – the Prince will wield the economic power to enter the Western capital markets as a player who has executed a brilliant and revolutionary plan on his way to the Saudi throne, where he will sit for decades. He will be able to avoid the likely rebound of angry cousins and conservative clerics an economic failure of a weak IPO will surely bring.

It’s enough to say that the balance of Middle East politics, from Iraq and Iran to Israel, all will be determined by the outcome of the Crown Prince’s grand strategy.

And all of it relies on a very, very high price for oil. That should inform us to a great degree on how we should be investing right now.

Russia Plans First-Ever Sale Of Yuan Bonds

As Russia braces for further sanctions from Washington D.C. over their alleged role in "meddling" in the 2016 U.S. election, they are reportedly prepping a $1 billion yuan-denominated bond issuance in an effort to preemptively diversify financing risks away from the West.  According to Bloomberg, the sale will total 6 billion yuan and could come as early as next week.

Russia hired Bank of China Ltd., Gazprombank and Industrial & Commercial Bank of China Ltd. to arrange investor meetings for the sale of 6 billion yuan ($907 million) in five-year notes, according to people familiar with the plans. The issuance is slated for the end of this year or beginning of 2018, they said, speaking on condition of anonymity because the deal isn’t yet public.

 

The sale has been under discussion since U.S. and European sanctions in 2014 over the takeover of Crimea blocked many state-owned Russian companies’ access to Western capital markets. A report due next quarter from the U.S. Treasury on the potential consequences of extending penalties to include Russian sovereign debt has increased pressure on the Finance Ministry to seek out alternative means of borrowing.

 

“It would be wise of Russia to tap the yuan market now,” said Vladimir Miklashevsky, a senior economist at Danske Bank A/S in Helsinki. “China remains Russia’s biggest trade partner, China’s enormous financial system has lots of buying potential, too.”

While Bank of Russia Governor Elvira Nabiullina has said there will be “no serious consequences” from U.S. sanctions on new domestic government debt, economists in a Bloomberg survey estimated the move could add 50 basis points to 150 basis points to borrowing costs.

The Yuan-denominated bonds, known as dim-sum bonds, would be listed on the Moscow Exchange and available for investors to purchase via the Moscow branch of ICBC.

Of course, in addition to advancing Russian diversification interests, a successful sale of yuan-denominated Russian debt would also advance China"s interests in the internationalization of the yuan. 

If Russia goes through with the sale, it would be the first sovereign issuance of a yuan-denominated bonds outside of China since 2016, according to Dealogic, with prior issuances in Hungary, Mongolia, the U.K. and the Canadian province of British Columbia.

Meredith, Koch Brothers Buy Time Inc In $2.8 Billion Deal

Confirming rumors that had swirled over the past 10 days, on Sunday night Meredith Corp., publisher of Better Homes & Gardens, Martha Stewart Living and Family Circle announced it has agreed to acquire all of Time Inc"s outstanding shares for $18.50/share or $1.85BN; including the assumption of Time"s debt, the deal is valued at a total of $2.8 billion. Meredith has secured $3.55BN in debt financing from RBC Capital Markets, Credit Suisse, Barclays and Citigroup Global Markets, according to the FT.

More importantly, the acquisition is also backed with a $650 million preferred equity commitment from Koch Equity Development, the private equity firm of Charles and David Koch, giving the conservative billionaires a stake in one of America’s best-known publishers. That said, the Kochs will not have a seat on Merediths board and, the company said, “will have no influence on Meredith’s editorial or managerial operations”.

That remains to be seen, especially if Trump now develops aspirations toward Meredith"s Man of the Year award. Needless to say, it is the Koch"s takeover of Time that is giving the left nightmares:

This item about Koch having “no influence” over TIME should give you as much assurance as WSJ’s “editorial independence committee,” which caved to Murdoch just 4 months after the acquisition https://t.co/JUlSLktdih

— Bill Grueskin (@BGrueskin) November 27, 2017

In any case, this is Meredith’s third run at 94-year-old Time according to the FT, which publishes Time, People and Sports Illustrated magazines. The deal has been approved by both companies’ boards and is expected to close in the first quarter of 2018.

As the WSJ reports, "the deal caps the end of an era."

Time, whose namesake Time magazine hit the newsstands in March 1923, emerged as one of the country’s great journalistic enterprises, shaping both the political and cultural landscapes. But in recent years, the magazine publisher lost ground as a shift among readers to digital platforms cut into traditional print revenue and a new generation of online rivals emerged.

Like most other legacy media outlets, Time has been trying to transform itself from a print to a digital media business in the face of successive years of declining revenues but has been shackled with a $1.2bn long-term debt burden. The $2.8bn deal value includes assumption of Time Inc’s debt.  The company has been making sweeping cost cuts, eliminating 300 jobs, cutting back the circulation and frequency of some of its best-known magazines, and attempting to sell its UK magazines division. Time Inc. has also been investing in online video and branded content and even a subscription services for pet owners, yet its print magazine circulation and advertising still account for about two-thirds of total revenue. In the first nine months of the year, magazine revenue dropped 17% to $1.3 billion. Time Inc. claims 30 million print subscribers, although that sounds like the fakest news yet. Time expects to generate about $1 billion this year in nonmagazine revenue.

Time has struggled to find a path to growth since its spinoff from Time Warner in 2014. The publisher’s shares lost more than a third of their value, even as Time has cut traditional jobs while adding digital staffers, reorganized its ad sales and scaled back the circulation and frequency of some titles. As the FT adds:

"Time Inc’s 3½-year run as a standalone publisher has been rocky. It has been hard hit by the erosion of print and has not recorded revenue growth over the past six years. A strategic reorganisation aimed at growing digital revenues and reaching a wider audience has shown some progress, but has been overshadowed by the woes of its traditional magazine business, where revenues have dropped 14 per cent from a year ago."

Time"s new owner, Iowa-based Meredith, publishes monthly magazines aimed at women, including Better Homes & Gardens, Martha Stewart Living and Family Circle, and has long coveted Time titles such as People and InStyle. It has tried and failed to reach a deal twice before. In 2013, talks with Time Warner, which then owned Time Inc, fell apart and the publisher was spun off as an independent company.

Stephen Lacy, Meredith’s chairman and chief executive, said the combined company will be able to reach almost 200 million consumers across all platforms, including digital. “The vision is the absolute premiere media company in the country with premium branded content on every platform,” Mr. Lacy said in an interview. “We’re very excited to bring these businesses together.” Lacy said he has never met with the Koch brothers. “They won’t have a seat on the board of which I chair,” he added.

Meredith’s own magazine revenue has slipped slightly, but it has somewhat of a buffer thanks to its ownership of local television stations. For the fiscal year ended June 30, revenue at its magazine group fell 2% to $1.08 billion, while its TV station group saw revenue rise 15% to $630 million.

Few in the magazine industry have been spared the downturn in print and difficulties of building a sustainable digital business. Condé Nast, the owner of Vanity Fair and Vogue, is slashing budgets and staff; Vanity Fair’s new editor has been tasked with trimming its costs by 30 per cent. Rolling Stone, the iconic rock-and-roll magazine, is being sold by its founder.

As the WSJ concludes, for Time CEO Rich Battista, the sale may be bittersweet. Soon after he took the reins in September 2016, Time found itself the target of several interested buyers, and then a sale process dragged on for months with no deal. While Mr. Battista has emphasized the company’s digital efforts and ramped up the production of TV programming and video, he had relatively little time to shift Time toward a more robust digital future.

“As a publicly traded company, and one operating in such a dynamic industry as media, we know circumstances can change quickly,” Mr. Battista said in a memo to employees. “Meredith presented us with an opportunity to combine companies to create even greater scale and financial flexibility.”

Finally, in light of the animosity between the Koch"s and Trump, the president can forget being Time man of the year for 2017 or as long as the billionaires are de facto in charge.

7 Reasons Why Stocks No Longer Care About Political Shocks, And 2 Why They Should

From Nicholas Colas of DataTrek Research

Why do global equity markets ignore political shocks like Brexit, President Trump’s election or the news that Angela Merkel failed to form a government in Germany? There are plenty of good reasons, actually, which we review below.

News that German Chancellor Angela Merkel failed to form a new government was the big shock of the day. It is unclear if the country will have a minority coalition or call fresh snap elections. The New York Times quoted a Der Spiegel deputy bureau head as saying “This is Germany’s Brexit moment, its Trump moment”.

Capital markets agreed with the Trump/Brexit comparison, sending the DAX up 0.5% on the day. Every other major European bourse closed in the green as well. As did the US.

All of this got us thinking (again) about why stock markets ignore politics and government when it comes to “Crisis moments”. It wasn’t too hard to come up with several explanations.

Reason #1: The Brexit vote and Trump election are fresh in investors’ minds, and they feel they know the “Crisis playbook” well at this point. Buy any notionally negative political headline first, look for the silver linings later. Muscle memory is a powerful behavioral force.

Reason #2: Global equities remain in rally mode, with investors still more afraid of missing out than looking for reasons to sell. Every major global index (S&P, EAFE, Emerging Markets) is either at or near their one-year highs. And with just a few more weeks left in the year, plenty of investors are playing catch up to their ever-rising benchmarks.

Reason #3: US corporate earnings still enjoy positive momentum. With Q3 earnings season almost over, FactSet reports that the most recent quarter showed 6.2% earnings growth. The companies of the S&P 500 even managed to show a little margin expansion (10 bp) in the quarter, and Q4 estimates still show a 10% bottom line growth rate.

Reason #4: Any political crisis is a potential catalyst for central banks (especially the ECB in the case of today’s headlines) to remain accommodative, with Eurozone QE supporting ultra-low long term interest rates and equity valuations. German 10 Year Bunds still yield just 36 basis points, well off their July highs of 60bp. Today’s news was worth all of 0.3 bp to the German yield curve.

Reason #5: Consumer confidence is still good across the US and Europe. Markets rightly feel that any “Crisis” that leaves consumer sentiment untouched is no crisis at all. OECD data on German confidence shows it at one-year highs as of October after drifting lower in prior months.

Reason #6: Energy prices are still moderate. The one sort of crisis that gets investor attention ties headline-worthy events to the price of gasoline. Despite rumblings out of the Middle East, WTI crude prices are still comfortably below $60/barrel.

Reason #7: Tech stocks have driven a lot of the performance in large cap US and EM this year, and this sector enjoys strong secular tailwinds. As we have outlined in prior reports, the Technology sector represents 25% of the S&P 500 by weighting, and 30% of the MSCI Emerging Markets Index. Neither the US President nor the German Chancellor (or any other global leader we can think of) have any impact on how many people stream videos, use social media, shop online, or buy new smart phones.

* * *

Now, does all this mean global markets will remain impervious to political headlines? Of course not. A few thoughts on what might shift the market’s sentiment:

Real Crisis #1: An absence of global leadership on tough geopolitical problems. With Angela Merkel sidelined, Europe has no single political figure to guide the region’s policy on global issues. President Trump, while still popular with his base, is a divisive figure abroad. China’s President Xi is trying to step into the role of a truly global leader, but that’s a tall ask when it comes to American or European democratic sensibilities.

So who is in charge when if/when a geopolitical crisis arises? For the moment, this is not a question investors seem to ponder much. That doesn’t mean it’s not important. It’s just not important right now. Once North Korea/Iran/some other problem gets to a boil, things will be different.

Real Crisis #2: Political fissures can swallow up positive catalysts. As we outlined in yesterday’s note, the Democrats may be able to retake the majority in the House during midterm elections. That makes passage of tax reform in the current Congress an imperative for US equity markets. Past November 2018, Washington may be back in gridlock mode until January 2020.

Summing up, there are plenty of reasons why notional “Crises” have so little effect on global equity prices. Overall economic conditions are still good enough to spur profit growth, and interest rates remain low. Yes, things seem brittle on the political front everywhere from Stuttgart to Seattle. But until a real crisis comes along to break investor confidence, it is hard to see global equities letting any crisis go to waste

Gresham"s Law

Authored by Ted Rivelle via TCW.com,

This year’s Nobel prize in economics was awarded to Richard Thaler, a pioneer of behavioral economics. But there is a tale told by a lesser known Nobel laureate, Kenneth Arrow. As a World War II weather officer, he was tasked with analyzing the reliability of the army’s long-range weather forecasts. His conclusion: statistically speaking, the forecasts weren’t worth the paper they were printed on. Captain Arrow sent along his report only to be told, “Yes, the General is well-aware the forecasts are completely unreliable. But, he needs them for planning his military operations.”

Okay, maybe you don’t actually need a Nobel prize to know that rationality in the decision-making department is often lacking. Case in point: the capital markets. While subtle and ingenious in construction, the capital markets are, nonetheless, driven by the mass action of millions. They are a reflection of ourselves and necessarily express both the summit of our knowledge as well as the pit of our fears, and everything else in-between. And, this brings us to the subject at hand: Gresham’s Law. Sir Thomas Gresham was a financier in the time of King Henry VIII and his name is, of course, attached to the principle that “bad money drives out good money.” Coin collectors of a certain age are familiar with the near immediate disappearance from circulation of all silver American coins once Congress had mandated the use of base metals beginning with the 1965 vintage. While all coins – silver and copper alike – carried identical legal tender value, it was the silver coins that vanished. Perhaps you are wondering what this has to do with bond investing? Everything!

Consider the state of financial markets as witnessed by metrics of implied volatility:

VIX Index

Source: Bloomberg

MOVE Index

Source: Bloomberg

Both indices hover at generational low levels. If markets were “run” today by humanity’s better angels of wisdom and rationality, you would have to conclude that Mr. Market has drawn on his collective insight and pronounced the capital markets to be safer now than at any other time in the past quarter-century. That is a stunning conclusion! But if rationality can’t explain a 25-year trough in expected risk, then we must necessarily conclude that there must be some other, less rational explanation. How about this: investors are, by and large, famished for yield and willing to underwrite most any risk to get some income. In short, the marginal price setter is “irrationally exuberant”, or dare we say it out loud? “Greedy.”

So, the age old tension that presents itself is this: there are those investors, the “value tribe”, that resists the general lowering in underwriting standards that comes with the aging cycle. The value guys believe that their principal is always precious and is best “wagered” when the return/risk profile is asymmetrically biased in favor of the investor.

The “momentum tribe”, in contrast, tends towards a belief that your capital must be kept working, otherwise “yield” is “needlessly” sacrificed.

Does it not stand to reason that, late in the asset price cycle, that the “momentum” money drives out the “value” money? Yes! Capital that lowers its hurdle rate of return and adapts itself to loose underwriting criteria will necessarily bid up asset prices to levels that become inconsistent with the criteria applied by the more discriminating pools of capital. The “clad” underwriting drives out the “silver.”

Now, admittedly, a win is a win, and momentum has been the winning trade. Whether intrepid or fool-hardy, “risk on” has won the year 2017. But do trees ever grow to the skies? Did Minsky not elucidate how extended periods of low volatility have the effect of masking financial pathologies, allowing them to metastasize throughout the system? Indeed! While the central bankers dream of a never-never land where wise scholars can direct the flow of irrational humans, the real world that the rest of us inhabit is decidedly messier.

How so? Long periods of low volatility often mean that some traders and fund managers become less concerned with closely scrutinizing what they own. Credit analysis is hard, and in an environment where prices become inelastic to the “fundamentals,” some conclude that the work involved in analyzing bonds is a case of the juice not being worth the squeeze. Low volatility environments remove incentives to trade, thereby degrading the quality of price information. Meanwhile, the low rate / high asset price environment removes the impetus for corporate frame breaking changes, and so low productivity businesses are “allowed” to just muddle along, restraining the Shumpeterian forces necessary for growth. In short, fundamental problems are systemically ignored by the collective. So, if you happen to see an emperor strolling about, happy and stark naked, you just shrug and move on.

But the worm will turn. It always turns. The collective gets jolted out of its slumber and suddenly realizes that capital is surrounded on all sides by clear and present dangers. The torrent of capital that flooded in under the FOMO banner may well become the most formidable ebb tide!

Before concluding one of our typical (i.e., informative and cheery) discussions, it’s worth a brief reminder that markets “vote” in the short-run and “weigh” over the long-run. Equities, real-estate, and bonds with “hair” have all voted, and we know how that has turned out. Meanwhile, we may not have heard enough from one of the most reliably smart guys in the financial markets. He seems to do a pretty good job of “weighing” and has one of the better (though far from perfect!) track records of forecasting recessions. Never heard of him? Oh, yes you have: he’s the yield curve, of course:

U.S. Treasury Yield Curve

Source: Bloomberg

Stocks roar to new highs. Tax cuts advance in Congress, I think. Consumer confidence revs while unemployment plumbs its lowest levels in decades. Yet, the yield curve just doesn’t seem to be buying it. Perhaps he has lost his mojo. On the other hand, even if he has misplaced his crystal ball, a flattening yield curve does more than just signal that growth and inflation prospects are viewed skeptically.

A flatter curve squeezes the term premium out of the equation for virtually all financial intermediaries. Less term premium means less net interest margin (NIM). Less NIM dis-incentivizes credit formation. Indeed, should term premia continue its vanishing act, we might find that it was the yield curve that helped put the “de” back into “de-leveraging.” Proceed with caution!

Is Financial Argmageddon Bullish For Stocks? One Bank"s Surprising Answer

Everyone knows that after nearly a decade of capital markets central planning by the world"s central banks, "good news is bad news." But did you also know that financial armageddon has become the most bullish catalyst to buy stocks? That"s the understated take-home message from the year ahead preview by Macquarie"s Viktor Shvets published last week. It is also the conclusion that One River Asset Management"s Eric Peters reached in his latest weekend notes.

While we will have much more to comment on Macquarie"s rather macabre 2018 preview, which is arguably one of the most honest, comprehensive, and objective predictions of what to expected from the "central bank/market confidence boosting nexus", we will highlight the one argument that has served to promote countless BTFD algo-driven stock rips, summarized in the following blurb, which is a sublime explanation by Viktor Shvets the worst things are, the more you should buy:

If volatilities jump, CBs would need to reset the ‘background picture’. The challenge is that even with the best of intentions, the process is far from automatic, and hence there could be months of extended volatility (a la Dec’15-Feb’16). If one ignores shorter-term aberrations, we maintain that there is no alternative to policies that have been pursued since 1980s of deliberately suppressing and managing business and capital market cycles. [T]his implies that a relatively pleasant ‘Kondratieff autumn’ (characterized by inability to raise cost of capital against a background of constrained but positive growth and inflation rates) is likely to endure. Indeed, two generations of investors grew up knowing nothing else. They have never experienced either scorching summers or freezing winters, as public sector refused to allow debt repudiation, deleveraging or clearance of excesses. Although this cannot last forever, there is no reason to believe that the end of the road would necessarily occur in 2018 or 2019. It is true that policy risks are more heightened but so is policy recognition of dangers.

 

We therefore remain constructive on financial assets (as we have been for quite some time), not because we believe in a sustainable and private sector-led recovery but rather because we do not believe in one, and thus we do not see any viable alternatives to an ongoing financialization, which needs to be facilitated through excess liquidity, and avoiding proper price and risk discovery, and thus avoiding asset price volatilities.

Translation: central banks remain trapped by the mountain-sized bubble they have blown with years of QE and ZIRP/NIRP, and once volatility returns, and risk assets plunge, CBs will have no choice but to scramble right back and prevent the pyramid from keeling over and undoing a decade of fake "wealth creation" which was pulled from the future to the tune of $15 trillion in central bank asset purchases, which while still rising is about to go into reverse in just over a year"s time.

 

If that"s not enough, here is One River"s Eric Peters, with the exact same conclusion:

Anecdote

 

“The market has an accident, the Fed returns to QE, slashes interest rates, bonds surge, stocks recover,” said the CIO, high atop his prodigious pile, alone. Staring into the distance. Squinting, straining.

 

“The correlation between bonds and equities remains negative, the risk parity equity/bond portfolios are dented but not destroyed. And we descend to the next lower level in real interest rates. US bond yields turn negative. In essence, we prolong the paradigm that has driven markets for a few decades.”

 

Far below, economies hummed in harmony, capitalists collecting their expanding share. “A continuation of this paradigm is what everyone believes. And I just doubt that outcome so sincerely.” Hidden within the distant economic whir, labor strived, struggled. Their wage growth anemic, their children indebted, career prospects uncertain.

 

“It has taken time, but the political context for a regime shift is now established; populism is evident in recent elections. And the academic context for a seismic economic policy shift is in place too.”

 

The extraordinary response to the global financial crisis prevented depression. But the price of salvation is proving to be as profound as it is impossible to precisely measure -- unexpected election outcomes, political paralysis, an isolationist America, de-globalization, fake news, opioid epidemics.

 

And connecting it all, a corrosive, woven thread; injustice, unfairness, inequality, hypocrisy, distrust, endemic, growing. “We are on the cusp of great change, the old paradigm is set to shift,” he said, at altitude, the air crisp, clear.

 

“The market has an accident, monetary policy is seen to be bust, the models have been wrong, we have to change what we do, we can’t go down the same route, we need to move to a different policy mix. Fiscal expansion, infrastructure, labor over capital. We’re moving to something that may be great for the economy, but no good for asset markets. New Regime -- end of story.”

Moody"s Boosts Modi: India Gets First Sovereign Credit Upgrade Since 2004

Moody’s upgrade to India’s credit rating comes as a much-needed boost for India’s Prime Minister, Narendra Modi, who has been criticised for the fallout from the goods and services tax (GST) and demonetisation reforms. Indeed, Moody’s argued that Modi’s reforms will help to stabilize India’s rising debt levels. According to Reuters.

Moody"s Investors Service upgraded its ratings on India"s sovereign bonds for the first time in nearly 14 years on Friday, saying continued progress on economic and institutional reform will boost the country"s growth potential. The agency said it was lifting India"s rating to Baa2 from Baa3 and changed its rating outlook to stable from positive as risks to India"s credit profile were broadly balanced. Moody"s upgrade, its first since January 2004, moves India"s rating to the second lowest level of investment grade. The upgrade is a shot in the arm for Prime Minister Narendra Modi"s government and the reforms it has pushed through, and it comes just weeks after the World Bank moved India up 30 places in its annual ease of doing business rankings.

Moody"s believes that Modi’s reforms have reduced the risk of a sharp increase in India’s debt, even in potential negative scenarios. On the GST reform, which converted India"s 29 states into a single customs union, the rating agency expects it to boost productivity by removing barriers to inter-state trade. In addition, the recent $32 billion recapitalisation of state banks and the reform of the bankruptcy code are beginning to address India’s sovereign credit profile.

"While the capital injection will modestly increase the government"s debt burden in the near term, it should enable banks to move forward with the resolution of NPLs."

Following the upgrade, India’s S&P BSE Sensex Index rose 1.1%, with metals, property and banks the strongest performers. The Sensex has risen 25% so far in 2017, while the banks sector is 42% higher. Retail investors have piled into financial assets and the banking system has been awash with funds since Modi unexpectedly banned high denomination bank notes last November.

As Reuters notes, the Indian government had been unsuccessful at persuading Moody’s to upgrade the rating in 2016.

Last year, India lobbied hard with Moody"s for an upgrade, but failed. The agency raised doubts about the country"s debt levels and fragile banks, and declined to budge despite the government"s criticism of their rating methodology. The government cheered the upgrade on Friday with Economic Affairs Secretary S. Garg telling reporters the rating upgrade was a recognition of economic reforms undertaken over three years.

The Rupee and Indian bonds also rallied on the Moody’s announcement – although some debt traders expressed scepticism that the rally was sustainable.

"It seems like Santa Claus has already opened his bag of goodies," said Lakshmi Iyer, head of fixed income at Kotak Mutual Fund said. "The move is overall positive for bonds which were caught in a negative spiral. This is a structural positive which would lead to easing in yields across tenors," she said. 

 

The benchmark 10-year bond yield was down 10 basis points at 6.96 percent, the rupee was trading stronger at 64.76 per dollar versus the previous close of 65.3250. "We have been expecting it for a long time and this was long overdue and is very positive for the market. Looks like sentiments are going to become positive," said Sunil Sharma, chief investment officer with Sanctum Wealth Management. However, debt traders said the rally was unlikely to last beyond a few days as the coming heavy bond supply and hawkish inflation outlook were unlikely to change soon.

 

"Who has the guts to continue buying in this market?" said a bond trader at a private bank.

India has basked in its status as the world’s fastest growing major economy and Moody’s forecasts suggests that it will continue to outpace China’s roughly 6.5% growth, but only marginally. In the fiscal year to March 2018, Moody’s expects the Indian economy to grow at 6.7% versus last year’s 7.1%. From Reuters.

Moody"s noted that while a number of key reforms remain at the design phase, it believes those already implemented will advance the government"s objective of improving the business climate, enhancing productivity and stimulating investment. “Longer term, India"s growth potential is significantly higher than most other Baa-rated sovereigns," said Moody"s.

Bloomberg published some initial reactions from portfolio managers and analysts.

Luke Spajic (head of portfolio management for emerging Asia at Pacific Asset Management Co. in Singapore)

• “The upgrade came sooner than expected. India has undertaken some tough but necessary reforms like demonetization and the GST, the benefits of which are yet to be fully calculated”


• “India is on the right long-term path with capital markets -- in both debt and equity -- pricing in potential improvements in investment quality”

Lin Jing Leong (investment manager, Asia fixed income, at Aberdeen Standard Investments in Singapore)

• “The upgrade has been long time coming” given Modi’s reform ambitions. “This is not a surprise -- we do believe all the rating agencies have been behind the curve somewhat”


• Initial Indian market reaction is likely to be knee-jerk, but we still expect dollar-India credit spreads, onshore India bonds and the rupee to continue outperforming the broader Asia and emerging-market bloc.

Navneet Munot (chief investment officer at SBI Funds Management Pvt. in Mumbai)

• This will boost global investors’ confidence in India, but factors like world monetary policy shifts and company earnings will also be key to foreign inflows.


• Investors like us who have long positions on India always expected an upgrade.


• The firm has been boosting equity holdings in Indian corporate lenders, industrial and telecommunications companies.

Nischal Maheshwari (head of institutional equities at Edelweiss Securities Ltd. in Mumbai)

• Equity markets have already given a thumbs up to the news”.


• It will lead to a reduction in borrowing costs, which is a major improvement.


• “For foreign investors in equity, it doesn’t change much as their concerns around high stock valuations remain. However, their commitment to the country is in place and the upgrade will only help reiterate their position”.

Shameek Ray (head of debt capital markets at ICICI Securities Primary Dealership in Mumbai)

• Foreign investors won’t be able to take full advantage of the positive sentiment from the upgrade as quotas for them to buy into rupee-denominated government and corporate debt are full, Ray says.


• “Whenever these quotas open up there will be keen interest to take India exposure,” but in the meantime Indian companies will get more access to offshore markets.


• “We could see them pricing dollar or Masala bonds at tighter levels”.

Ken Hu (chief investment officer for Asia-Pacific fixed income at Invesco Hong Kong Ltd.)

• The upgrade confirms Invesco’s positive view on India’s structural economic reforms.


• “With more political capital, Modi and his party are able to launch more difficult but more impactful structural reforms. The positive feedback loop will continue to lead to more credit rating upgrades of India in future”.

Chakri Lokapriya (managing director at TCG Asset Management in Mumbai)

• The upgrade is “very positive for banks, infrastructure and cyclical sectors”.


• “Banks will benefit strongly as their credit costs come down leading to a reduction in interest costs for infrastructure and manufacturing companies”.

Ashley Perrott (head of pan-Asian fixed income at UBS Asset Management in Singapore)

• The upgrade is a bit of a surprise, so the market is likely to see some initial bond-spread tightening.


• “But raising one notch does not make much difference from a fundamental perspective”.

Avinash Thakur (managing director of debt capital markets at Barclays Plc in Hong Kong)

• “The upgrade should help issuers from India as they are no longer on the cusp of investment grade”.


• “It makes a big difference to investors and we will see more dollar bond supply from India”.

What Central Banks Have Done Is What They"re Actually Good At

Authored by Jeffrey Snider via Alhambra Investment Partners,

As a natural progression from the analysis of one historical bond “bubble” to the latest, it’s statements like the one below that ironically help it continue. One primary manifestation of low Treasury rates is the deepening mistrust constantly fomented in markets by the media equivalent of the boy who cries recovery.

That narrative “has ruffled a few feathers,” BMO Capital Markets strategists Ian Lyngen and Aaron Kohli wrote in a note last week.

 

“Growth is moving at a solid clip and the labor market is ostensibly at full employment — so why aren’t we in an environment with a steeper curve and higher yields?”

If solid growth plus full employment equals a steeper yield curve and higher long rates, and they do, then a flatter curve at lower nominal rates must then equal what?

The answer is far easier than the media makes it out to be. In what is pure Aristotelian sophistry, they try very hard to ignore their own logic where the answer to this “conundrum” is clearly choppy, lackluster growth that has left the (global) economy considerable hangover slack.

That’s what the yield curve continues to say, the only thing it has said for many years now.

It’s amazing that after more than a decade now of these markets (UST’s, eurodollar futures, swaps, FX, etc.) declaring that “something” is wrong how easily it is for these people to simply set it all aside because their highly optimistic view on the economy, derived exclusively from central bank forecasts and actions, just has to be right. They are actually saying that markets need to conform to their opinions without evidence, and without recognizing the market prices are evidence, as if theirs is the only correct possibility.

Time plays a significant component of that backwards view because it is extremely hard to believe the global economy could ever be stuck in such an awful place for so long.

It just seems so impossible, completely out of our own experience. Even if by random luck you would think enough would have gone right in just monetary policy by now that what is claimed for the economy in the mainstream might actually have come true. But this set of circumstances is not absent from all experience, just the modern one.

The point of failure is right where it shouldn’t be. That’s what’s making it so difficult. Even the bond market (as eurodollar futures and the rest) is declaring this to be the case. The issue is central banks and central bankers who have done nothing right, failed to achieve any positive offsets, and left the global economy to stand naked against the intermittent forces (three so far) of negative monetary decay.

So the real problem in the mainstream is over who to believe; the central bank technocrats who most people have been thoroughly schooled to trust without question, or these markets where actual discipline is the order of operation?

As hard as it may be to believe, I once gave central bankers the benefit of the doubt, too (though perhaps not as stridently as some still today). I had come to expect in early 2007 that the Fed, though clearly behind the curve, would catch up and fix the problem before it got out hand. Greenspan’s reputation had lost a lot of luster in my eyes as a result of lingering unanswered questions about the dot-com era and “jobless recovery” after that (mild) recession, but surely he wasn’t grossly incompetent. He couldn’t have been, could he?

It was really difficult to accept that it was all smoke and mirrors, one of those viral kind of things where you tend to believe something is true simply (solely) because everyone else does. It becomes such hardened “fact” that to even think about challenging it makes people wonder what’s wrong with you. The wisdom of the crowd is perhaps just as often that sort of mass delusion wrapped in an impenetrable bubble.

Then August 9 happened, and similar days happened afterward in repeating fashion. Then 2008. That should have been more than enough to dispel any notions of competence on any subject related and not; monetary as well as economic. The panic itself and the enormous global economic consequences should have ended Economics.

They really don’t know what they are doing. They never have. The central bank holds only one specialty to which it is any good, a capability that Milton Friedman pointed out in one of the last interviews he ever gave more than a decade ago just prior to the onset of all this trouble.

The difficulty of having people understand monetary theory is very simple - the central banks are good at press relations. The central banks hire people and the central banks employ a large fraction of all economists so there is a bias to tell the case - the story - in a way that is favorable to the central banks.

But the Great Depression was such a major event and such a disaster that there was no way in which you could talk it away, although they tried to do so. If you read the annual reports of the Federal Reserve Board or its testimony before Congress, you will find that as late as 1933, at the very depths of the depression, it’s talking about how much worse things would have been if the Fed hadn’t behaved so well. [emphasis added]

Central bankers simply did it again.

What was Ben Bernanke’s message at the end of 2008? He was no longer talking about prevention, as had been standard up until Lehman, and accounting for what he had done prior.

Bernanke simply began speaking and writing and televising exclusively about “jobs saved”, what the Fed was going to do in the future to cushion the blow that was then some devious, exogenous factor no reasonable person could ever think to blame monetary officials about. No longer would there be much about the past, what they had done prior. All the world’s central banks were suddenly victims, too.

And like the thirties, it was all BS.

But “we” let them off the hook to write their books, revise the official history of the crisis so that somehow they come off the heroes when they were seriously, perhaps criminally, as well as obviously (when you look), derelict. The degree of gross incompetence was absolutely staggering – and it never ceased. You require no special training to easily understand that if as a central banker you “need” a second QE (let alone a third or fourth) the whole thing just doesn’t work (how can it be “quantitative” if you don’t know the right quantity?)

 

Central banks are the epitome of PR and media manipulation. And that’s all they are, certainly no money in monetary policy. They’ve done such a masterful job of it that even today no matter how much market data disagrees, people just refuse to believe it.