Carney Steps Back, Rate Fears On Hold

Mint – Blain’s Morning Porridge – August 14 2014

To be up the crow’s nest, singing my say. Shiver me Timbers, cause I’m a-sailing away..

Mark Carney steps back and puts UK rate fears on hold – until next time or the time after that. I suspect he is as worried about increasingly apparent weakness in housing as he is about wages. (RICS shows decline is coming!)

But the other question is what is holding back UK wages? I read everything from falling productivity to the rise in the self-employed sector discussed yesterday. I think there is another factor. I’m convinced “minimum wage” legislation has been corrupted into a massive distortion on the UK economy – de facto it’s become the maximum wage ceiling for large swathes of service jobs from serving staff, manual labour and outsourced jobs. Equally pernicious are zero hours contracts.

As more and more workers find themselves caught in that trap what’s the alternative? Self-employment has become the choice of many on the basis of dignity – good on them! Long-term, the minimum wage could have profound damaging effects on the productivity of the UK work force by further constraining work and earnings mobility, and any motivation among workers. I know there are a good few economists and university types on the readership, and I’d challenge someone to examine the distortion effects of wage ceilings on the economy.

As I read about banker salaries going through the roof again, it strikes me social inequality will be sharpening its axe! 

Back on planet market, I’m greatly indebted to my old chum Larry Mcdonald – his book: “A Colossal Failure of Common Sense” about the end of Lehman is the best book on financial stupidity I’ve read. He saw me getting beaten up on CNBC for my “boring” “treasuries still have upside” trade earlier this week. So Larry gave me 12 good reasons why Treasuries continue strong – and I’ve added a 13th:

1)    Geopolitical risk – continues apace in Crimea, Ukraine, Libya, Syria, Gaza, Iraq, etc.

2)    Foreign demand – China, Japan, OPEC etc still buyers of treasuries, $2.7 trillion and rising.. “If you need a safe place to park $20bn, its easier to use liquid US markets… the only game in town..”

3)    US elections look to deliver the Senate to the Republicans. They will cut spending.

4)    US demographics – ageing population will buy more bonds.

5)    Global growth – looks to be stalling. 4% in US looks possible, but y-o-y it's low. IMF has cut global growth outlook.

6)    Oil prices are back to 2008 prices – not indicative of global growth.

7)    Low inflation expectations – flatter curves.

8)    Regulations - Dodd Frank and Basel 3, require banks to hold more treasuries.

9)    Fannie and Freddie are putting money back into government and paid off their debts further reducing the deficit.

10) The rise in employment is matched by dropouts from the workforce – don’t be fazed by strong numbers.

11) Convexity hedging – large numbers of MBS holders are hedged vs prepayment risk.

12) Global yield arbitrage – when US yields 130 basis points more than Germany and Europe is undergoing Japanification (German GDP down 0.2% and France flatlining this morning).. What’s not to like about treasuries?

And, 13) So many asset classes in bond markets (high-yield, banks, IG, etc) look overly tight. Folk expect correction. Bond tourists are exiting these liquidity-dangerous sectors and the only place to put “fear” money is the liquidity-rich treasury market. (That’s my own one!)

So this morning we also find out who is long the battered high-yield sector. According to a story on Bloomberg: Barclays, Wells and Citi are all telling investors the recent sell-off in high-yield means the sector is now a buying “opportunity”. Citi “would rather be long than short”, while Barclays thinks “high-yield is attractive on a relative basis..”

You won’t be surprised I disagree. The high-yield market remains frothy and is not properly valuing the critical factors like mean reversion on default rates (they are currently way way low) and low recoveries. Bond tourists looking for yield remain a major distortion on the market – and comments from banks that it's back to fair value are bunkum.

Same thing is true across number of markets where we’ve recently seen small corrections – they are not fundamental corrections back to real value, but trading moves that look more likely to entice and trap another coachload of bond tourists before a proper sell-off. They have further to fall before they reflect proper fundamental market revaluations and risk/reward.. Sound complex? It is. But, on that basis I still think CoCos, Hi-yield and others are too tight.

This will be the last porridge for a couple of weeks. She-who-wishes-to-be-Mrs-Blain and I are going sailing on our yacht Batfish V.. Not sure where yet – it depends where the wind and tides take us. I’m worried about the chill in the air this morning (Winter is Coming ). Look out points South to West. Anyone down on the Channel Islands who is around, drop me a line on [email protected] and we can try to meet up if we end up headed that way..

Have fun, be good..

Bill Blain

0207 786 3877

07770 881033

[email protected]

[email protected]