The Boock Report

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Bond auctions and what they say

The 3 yr note auction was mediocre with a yield of 2.664%, exactly where the when issued was trading just prior. The bid to cover of 2.83 was below the one year average of 2.93. And, dealers got left with 39.4% of the auction, a touch above the 12 month average of 37% with direct and indirect bidders taking the rest.

The 10 yr auction was better. The yield of 2.962% was a few bps below the when issued. The bid to cover of 2.59, a five month high and was above the one year average of 2.45. Also, direct and indirect bidders took almost 72% of the auction, a touch above the 12 month average of 70%.

Bottom line, if only market participants could talk here. I believe the short end reflects the continued expectations of rate hikes as inflation pressures are moving in the direction the Fed wants it to as the core CPI rate is approaching a 10 yr high. Also, we have some calm in Italy. While the 10 yr yield is heading back to 3% again, the flattening between 2s/10s (44 bps currently) I believe still reflects the belief that this rate hike cycle, as do most, eventually slows growth. Did the better tone in the 10 yr reflect worries about trade tariff induced slower economic growth? I don’t know of course but maybe. The stock market on the other hand certainly doesn’t believe this and is more focused on the current earnings pace and what will likely be a good Q2 economic performance. One side is likely off sides or maybe the reconciliation between the two is just in the differing time horizons.

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An interesting week to come

The Italian markets heard exactly what they wanted to hear from the Italian Finance Minster Giovanni Tria who spoke yesterday. “The position of the government is clear and unanimous. There is no question of leaving the euro…It’s not just that we do not want to leave, we will act in such a way that the conditions do not get anywhere near to a position where they might challenge our presence in the euro.” With respect to the other worry, that of a budget busting fiscal policy, he said “Our goal is growth and employment. But we do not plan on reviving growth through deficit spending…These will be fully coherent with the objective on the path of lowering the debt/GDP ratio.”

The Italian 2yr yield is down by 50 bps to 1.20% and the 10 yr yield is lower by 20 bps to 2.93%. The euro though is little changed. Mario Draghi also will like what was said as we approach his comments on Thursday at the ECB press conference. He though remains the biggest risk to Italian markets, among others in the region. If I were to guess as to what they will do is cut QE again starting October 1st and tapering it thru December. The inflation numbers are shifting up as are wages and therefore his options are shrinking.

The economic data though out of Europe continues to disappoint. Italy reported a 1.2% m/o/m decline in industrial production vs the estimate of a .5% decline. UK IP unexpectedly fell by .8% m/o/m, worse than the estimate of a modest gain of .1%. Manufacturing production was the main reason as it dropped a 1.4% m/o/m vs the forecast of a .3% rise. The pound did not like this data as its lower vs the dollar. If this continues, the BoE will enter the next slowdown with a benchmark rate of just .50%.

Ahead of the Kim/Trump get together, the South Korean Kospi is back in positive territory for the year with its .8% rally overnight. The bottom line seems to be whether North Korea will agree to fully getting rid of its nuclear weapons and will they demand in return the US military leaving South Korea.

With the fate of NAFTA even more uncertain after the war of words after the G7 meeting, the Canadian dollar is little changed but the Mexican peso is lower by .6%. Who knows what happens from here. Trump did propose correctly what would happen in an ideal case, no tariffs anywhere on either side as it’s just a tax after all to protect one’s own.

Japan’s uneven economic path continues but in a good way in April as its machinery orders figure surprised to the upside with a 10.1% m/o/m jump, well better than the estimate of up 2.4%. This is great to see but the number is so volatile each month that I don’t know what to make of it after the weak Japanese GDP pace in Q1.

The BoJ also meets at the end of the week and it’s hard to believe they will tell us anything new.

Ahead of the rate hike announcement from the Fed on Wednesday we’ll see CPI tomorrow and PPI the day after. The headline CPI figure is expected to be up 2.7% y/o/y with a core rate of up 2.2%. Thus, another rate increase of 25 bps to 1.875% will still leave policy with negative real interest rates. With the Fed’s so called objectives currently met, they should be at the END of the rate hike cycle with POSITIVE real rates not barely half way thru it. Catch up is still the story but we know they are also tightening in another fashion via their balance sheet. There is a double form of tightening going on.

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Succinct Summation of the Week’s Events – 6/8

Positives

1) The ISM services index was a better than expected 58.6, up from 56.8 in April and one point better than the estimate after a 2 pt drop in April. Supply constraints though apparent in the jump in new orders, supplier deliveries and prices paid. While the headline services PMI printed up m/o/m, the breadth weakened. Of 18 industries surveyed 14 saw growth vs 18 in April and that matches the smallest since January 2017. The ISM said “The majority of respondents are optimistic about business conditions and the overall economy. There continue to be concerns about the uncertainty surrounding tariffs, trade agreements and the impact on cost of goods sold.”

2) The number of job openings in April rose to a fresh record high at 6.7mm. This compares with the number of unemployed at 6.1mm and the pool of available workers (includes those unemployed and those not looking but would take a job) of 11.5mm.

3) The April trade deficit narrowed to $46.2b from $47.2b in March. That was about $3b less than expected and was partly driven by higher energy exports which took exports to a record high.

4) Thanks to a 9 bps w/o/w decline in the average 30 yr mortgage rate to 4.75%, the lowest since April 20th thanks to the US Treasury rally over the past week, mortgage applications bounced after a month of declines. Purchases grew by 4.2% w/o/w after a 7.5% drop over the previous 5 weeks. They are also up 9% y/o/y. Refi’s were up by 3.8% w/o/w but still down 17% y/o/y.

5) In yuan, Chinese exports in May rose 3.2% y/o/y, double the estimate and imports jumped by 15.6%, nearly twice the forecast. Because of the strength in the dollar, exports were up by almost 13% in dollar terms with the trade surplus with the US rising to $24.6b vs $22.2b in April.

6) The private sector weighted services PMI in China was unchanged in May with April at 52.9 as expected. The internals were somewhat mixed. Caixin said “The employment index continued to rise, while the new business index slipped slightly, indicating a positive change on the supply side and marginally weaker demand across the service sector. The changes led to a softer rise in prices charged, easing the upward pressure on service prices. However, input costs rose at a faster pace after slowing for 3 consecutive months, suggesting that the upward pressure on costs has not completely eased.”

7) In Japan, regular base pay rose 1.2% y/o/y for a 2nd straight month in April and that is the best rate of increase since 1997. Bonus pay did fall almost 10% but after jumping in the two prior months.

8) Singapore’s May PMI improved to 56.8 from 55.6 and that is the best in this survey’s history dating back to 2012. It did though come with rising inflationary pressures. “The strength of the upturn is pulling prices in general upwards. Overall input prices rose at a survey record rate, suggesting that wider inflationary pressures may intensify in coming months” according to Markit.

9) For the sake of some sort of normality, a few members of the ECB said they will give us more details next week on when and how QE will end.

10) The services PMI in the UK improved to 54 from 52.8 and 1 pt better than expected. The comments here were also mixed. “new business volumes continued to rise at a relatively subdued rate, with survey respondents noting that Brexit related uncertainty remained a key factor holding back decision making among clients. At the same time, tight labor market conditions placed upward pressure on staff wages and difficulties recruiting suitably skilled staff in May.”

11) The eurozone April PPI index rose 2% y/o/y, little changed with 2.1% in March but below the estimate of up 2.4%. PPI ex energy was up a more modest 1.3%.

12) Greece’s economy grew by 2.3% y/o/y in Q1 with the q/o/q gain of .8% vs the estimate of up .3%. The 2.3% growth rate from last year is the best since Q1 2008 as the country recovers from its own Great Depression.

 

Negatives

1) Initial jobless claims totaled 222k, 2k more than expected and little changed with the 223k seen last week (revised up by 2k). The 4 week average did tick up to 226k from 223k because a 211k print 5 weeks ago dropped out of calculation. Continuing claims, delayed by a week, rose 21k after falling by 22k last week.

2) Mexico, Canada and the EU are now responding back with their own tariffs on us.

3) For European bonds, a few members of the ECB said they will give us more details next week on when and how QE will end.

4) Somewhat dated because we are 2/3 of the way done with Q2, Q1 productivity was revised down to a .4% q/o/q annualized gain from .6% initially. This lead to higher unit labor costs of 2.9% q/o/q annualized, the most since Q1 2017. Looking y/o/y, productivity was still up 1.3% y/o/y. Unit labor costs were also up 1.3% y/o/y.

5) In Germany in April IP fell 1% m/o/m vs the estimate of down .3%. This was though mostly offset by a 7 tenths revision higher to the March figure. Exports in April (probably the most important number to come out of Germany with 40% of its GDP being exports) fell .3% m/o/m as expected after a 1.8% rise in March. Notable is the 2% y/o/y rise which is the slowest since March 2017.

6) German factory orders in April disappointed again with a 2.5% m/o/m decline vs the estimated gain of .8%. The weakness was all within Europe and Germany itself as non eurozone orders were up. Orders have now fallen for the 4th straight month.

7) France reported a miss in its IP figure with the manufacturing component below expectations.

8) The Eurozone services PMI in May was 53.8 vs the initial print of 53.9, estimate of 53.9 and is the lowest level since January 2017. The high number of holidays in May was cited as a reason “but many other companies reported that demand has softened compared to earlier in the year.” Markit also said “Crisis torn Italy has meanwhile reported the weakest expansion of the four largest euro member states for the 4th month running.”

9) Worries about Italy had a sharp impact on the Sentix economic confidence index for June which surveys investors. It fell to 9.3 from 19.2 and that is the lowest read since October 2016. The expectations component fell to the weakest since August 2012 soon after “Whatever it takes” was said by Draghi. Sentix said “The new government in Italy is giving investors fears for the eurozone.” They also blamed the tariff fears. The component for Germany specifically fell to the lowest since July 2016.

10) Hong Kong’s PMI softened to 47.8 from 49.1 and that’s the weakest since July 2016. The report did not read well. “The weaker headline reading reflected a faster decline in inflows of new business. New work not only fell for a 2nd month running in May, but at the steepest rate since August 2016. Anecdotal evidence suggested that weak demand conditions, high competition and client losses were reasons for decreased sales. Furthermore, export orders from mainland China fell sharply in May after a 6 month period of growth.” Employment also fell. While input prices eased, “A range of reasons were cited for inflation, including higher prices of raw materials, suppliers’ price hikes, and salary adjustments.”

11) The services PMI in Japan weakened by 1.5 pts m/o/m to 51 and dropped below 50 in India. In Japan, Markit said “There were worrying signs of deteriorating demand conditions, with new sales increasing at the softest rate in 20 months.”

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China/Europe

The trade data out of China in May was better than expected. In yuan, exports rose 3.2% y/o/y, double the estimate and imports jumped by 15.6%, nearly twice the forecast. Because of the strength in the dollar, exports were up by almost 13% in dollar terms with the trade surplus with the US rising to $24.6b vs $22.2b in April. We of course wait for some deal or resolution to the trade spat with China. I can’t separate from the data what activity took place as companies scrambled to get things done before tariffs become real and what was organic growth. The biggest influence for China’s economy though will be the trend from here in credit growth.

On the heels of Brazil’s selloff yesterday, EM in Asia was red across the board. The Shanghai comp closed down 1.4%, the H share index was lower by 2%, the Kospi ahead of the Un-Trump coffee talk was weaker by .8% to name a few.

After seeing the weaker than expected German factory orders number yesterday, they reported a disappointing industrial production figure today. In April IP fell 1% m/o/m vs the estimate of down .3%. This was though mostly offset by a 7 tenths revision higher to the March figure. Exports in April (probably the most important number to come out of Germany with 40% of its GDP being exports) fell .3% m/o/m as expected after a 1.8% rise in March. Notable is the 2% y/o/y rise which is the slowest since March 2017.

France also reported a miss in its IP figure with the manufacturing component below expectations.

Bottom line, Q2 in the two biggest economies in Europe has gotten off on a more modest pace and continues the slew of economic moderation that we’ve seen. Not including today’s data, the Citi Eurozone Economic Surprise index is a touch above a 6 year low. The euro is weaker after these numbers.

After a sharp selloff over the past 4 days in Italian bonds, they are little changed today and German, French and UK bonds are seeing a flight to safety. The stage is now set for Mario Draghi next Thursday to update us on his thinking and the fate of QE. His scorched earth monetary policy over the past 4 years all for his desire for 2% inflation has put him in quite the box considering how much he compressed interest rates so far below they ever would have been otherwise. When the ECB steps away (although they will still be reinvesting), who will buy this paper at these yields?

By the way, the Fed will also raise rates as we know next week and we’re just a few weeks from QT going to $120b per quarter from $90b. The BoJ also meets but I don’t expect any change there not surprisingly.

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Brazil/Italy

The Brazilian stock market is getting blasted today, now down almost 6% and the Real is lower by 2.7%. This is also dragging down some other EM currencies like the South African Rand, and Mexican Peso (worries about NAFTA). Brazil is coming off a brutal week of strikes which hurt their economy at the same time political worries ahead of their fall election are picking up.

Italian yields after being down in the morning ended up closing higher with the 2 yr yield up 28 bps after a jump of 36 bps yesterday. I believe both Italy and Brazil are the reason for the bid to Treasuries after Europe closed as European bond weakness pressured US Treasuries during their session. After touching 2.99% this morning, the 10 yr yield is down to 2.92-.93%. I’m only surmising that it is also the reason why stocks are mostly lower but they were due for a rest anyway after the impressive rally seen as RSI’s (relative strength index) have gotten stretched.

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Tattoos & piercings are fine and same if you’re a felon

Initial jobless claims totaled 222k, 2k more than expected and little changed with the 223k seen last week (revised up by 2k). The 4 week average did tick up to 226k from 223k because a 211k print 5 weeks ago dropped out of calculation. Continuing claims, delayed by a week, rose 21k after falling by 22k last week.

The bottom line is still the same and we all know how drum tight the labor market is with the demand for labor strong while the supply of it continuing to shrink. Here are two recent quotes I’ve seen last week and this week and highlights the state of the labor market:

In last week’s Beige Book: “Some firms have begun relaxing drug-testing standards and restrictions on hiring felons to alleviate labor shortages.”

In yesterday’s WSJ: “To attract workers, the Saladworks restaurant chain has raised its starting wages about 5%. It also has relaxed standards on tattoos and piercings, allowed employees to wear jeans and bandannas and become more flexible about schedules.”