FIG Topics of Interest



The European Union faces another existential crisis, and the European Central Bank will need to do whatever it takes to staunch it again. So far, it's showed little inclination. By letting the turmoil continue, it risks creating a full-blown conflagration.
Investors are taking fright at the threat that Italy could leave the euro. Yields on the country' two-year bonds have surged to more than 2.5 percent from minus 0.3 percent less than three weeks ago. The extra premium investors demand to hold Italian bonds over their German counterparts has jumped to the highest since 2013.

The contagion is starting to spread to Portuguese, Spanish and Greek governments bonds. Yields on the latter’s 10-year securities have surged 75 basis points this month — a move that, if continued, could put at risk Greece's smooth exit from its latest bailout in August.

If all this eerily resembles the sovereign debt crisis of 2011-2, that's because it does. Only the stakes are higher, given the size of Italy's debt. Mario Draghi was able to stem the first crisis by promising -- with the implicit support of Germany -- to do "whatever it takes" to save the euro. Since then, the ECB has amassed almost 2 trillion euros ($2.3 trillion) of European government bonds on its balance sheet.

Contrast that action with outgoing ECB Vice President Vitor Constancio's comments on Tuesday that "we will see what happens." Bank of Italy Governor and ECB governing council member Ignazio Visco has added fuel to the fire by saying Italy is always a "few short steps away" from losing trust. We are on that precipice now.

The best place to start may be those short-dated Italian bonds. The balance of supply and demand tilts should help. The country only has about 8 billion euros of two-to-three-year bonds to sell in 2018. More than 20 billion euros of redemptions and coupons will be paid back this week, more than outweighing the 6 billion euros of medium- and long-dated securities that will be sold on Wednesday. It's a similar picture for the rest of the year. 96 billion euros of issuance will be outweighed by a further 135 billion euros of maturities. With that cashflow, Italy could well buy back its own bonds.

The ECB has committed to reinvest its maturing government bonds. Until September at least, it is also committed to buying 4 billion euros of Italian bonds a month. And it can overbuy -- as it often has in the past two years.

It's highly likely the ECB will have to delay any debate about how it will end quantitative easing. The bond-buying program, due to end in September, will surely have to be extended and the prospect of QE continuing into 2019 now looks a real possibility.

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Iran expects oil exports to remain at current levels, continued access to international finance and the completion of contracts signed with European companies, according to the person, who asked not to be named in line with diplomatic protocol. The official spoke Friday in Vienna ahead of talks with Chinese, French, German, Russian and U.K. diplomats about the fate of the Joint Comprehensive Plan of Action, as the 2015 accord is formally known.
President Donald Trump’s May 8 order to exit the JCPOA, and reimpose U.S. sanctions, has cast doubt over whether the deal can survive, even as International Atomic Energy Agency inspectors continue to verify Iran is sticking to its part of the bargain. Friday’s meeting in the Austrian capital is the first step in the dispute resolution mechanismproscribed by the JCPOA that may lead to a meeting of foreign ministers in June.

The finance ministers from France, Germany and the U.K. are also scheduled to talk about Iranian measures on the sidelines of a European Union meeting in Brussels, according to participants. The EU pledged May 18 it would find ways to maintain the sanctions relief promised to Iran under the JCPOA.
While Iran is willing to allow Europe time to fill the vacuum left by the U.S., the official said his country is skeptical that the 28-nation bloc can exert its independence from Washington. French President Emmanuel Macron and German Chancellor Angela Merkel should have focused on building alternatives to the accord without the U.S. rather than appeasing Trump with potential compromises, the official said. Both leaders visited the White House in the days before Trump announced his decision in attempts to sway him.

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“It seems like they couldn’t agree on anything beyond the next meeting,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC in New York. “They’re really, truly going to be taking this one meeting at a time.”
Inflation rose at the committee’s targeted pace of a 2 percent annual rate in March, yet officials were cautious on whether that was sustainable given that prices had been mostly below that goal for the past six years.

“It was noted that it was premature to conclude that inflation would remain at levels around 2 percent, especially after several years in which inflation had persistently run below the committee’s 2 percent objective,” the minutes said.

The commentary was somewhat unusual given the data in hand: unemployment at the lowest level in 17 years, wages gradually moving higher and the economic expansion apparently on a firm footing.

“There was very little concern about overheating and inflation overshooting too much,” said Julia Coronado, president of Macropolicy Perspectives LLC in New York. “There was more concern that the recent progress cannot be sustained.”

“They could have sounded a lot more optimistic about the economy, and confirmed expectations for four increases this year, but they didn’t do that,” said Michael Hanson, chief U.S. macro strategist at TD Securities in New York. “This is a committee that feels like it has been head-faked one too many times on inflation.”

“The closer you get to a normal monetary policy, the less agreement you’re going to have about continuing to slog along,” Stanley said. “I’m a little bit surprised that that discussion seems to be drawing so much disagreement already.”

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China will cut the import duty on passenger cars to 15 percent, further opening up a market that’s been a chief target of the U.S. in its trade fight with the world’s second-largest economy.

The Finance Ministry said Tuesday the levy will be lowered effective July 1 from the current 25 percent that has been in place for more than a decade, boosting shares of automakers from India to Europe. Bloomberg News reported last month that China was weighing proposals to reduce the car import levy to 10 percent or 15 percent.
“This is, without a doubt, positive news,” said Juergen Pieper, Frankfurt-based head of automobiles research at Bankhaus Metzler. “You can’t completely disregard the fact that there are certain imbalances in China’s favor. This could be a signal that if one side is making concessions, it could lead to the Americans easing some of their pressure as well.”

Beijing has also pledged to cut ownership limits in the auto sector as well as in banking, and last November reduced import tariffs on almost 200 categories of consumer products.
For his part, President Trump has retreated from imposing tariffs on billions of dollars worth of Chinese goods because of White House discord over trade strategy and concern about harming negotiations with North Korea, according to people briefed on the administration’s deliberations. In further evidence of an easing in tensions, China and the U.S. agreed on the “broad outline” of a settlement to the ban on China’s ZTE Corp. buying American technology after alleged sanctions infringements, the Wall Street Journal reported.

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“We’re putting the trade war on hold,” Treasury Secretary Steven Mnuchin said Sunday after the two sides released a joint statement a day earlier. “Right now, we have agreed to put the tariffs on hold while we execute the framework.”
The truce is “little more than a brief de-escalation of tensions,” said Eswar Prasad, a trade policy professor at Cornell University and former head of the IMF’s China unit. “The fundamental differences on trade and other economic issues remain unresolved.”
During the talks, China and the U.S. agreed to “substantially” reduce the U.S. trade deficit in goods with China. Beijing promised to “significantly” increase purchases of U.S. goods and services, but there was no dollar figure attached, despite White House assurances that China would cave to its demand for a $200 billion annual reduction in the trade gap.
“As this process continues, the United States may use all of its legal tools to protect our technology through tariffs, investment restrictions and export regulations,” U.S. Trade Representative Robert Lighthizer said in a statement Sunday. “Real structural change is necessary. Nothing less than the future of tens of millions of American jobs is at stake.”
It’s “difficult to contemplate” how the two countries could cut their trade imbalance by $200 billion, said Victor Shih, a professor at the University of California in San Diego who studies China’s politics and finance.

“Even with a drastic reallocation of Chinese imports of energy, raw materials and airplanes in favor of the U.S., the bilateral trade deficit may reduce by $100 billion,” said Shih. “A $200 billion reduction would mean a drastic reduction in Chinese exports to the U.S. and a dramatic restructuring of the supply chain.”

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Why is there so little noise about the emerging oligopoly in one of the hottest elements on the periodic table, lithium?
Tianqi Lithium Corp. will pay $4.1 billion to buy Nutrien Ltd.’s 24 percent stake in Soc. Quimica & Minera de Chile SA, or SQM, in a deal that will entangle the biggest and fourth-biggest producers of the battery metal. The transaction could theoretically give Tianqi half of the board seats, though other major shareholders who’ve historically guarded their interests have opposed such a path.
Here’s how the lithium carbonate market is structured at present: North Carolina-based Albemarle Corp. is the market leader, with an 18 percent share, followed by Jiangxi Ganfeng Lithium Co. on 17 percent; SQM on 14 percent; and Tianqi on 12 percent. Other players have the 39 percent or so that remains – the largest among them being FMC Corp., which is soon to offer its shares to whoever wants them in a planned initial public offering.
That in some ways understates how connected these players are. The single biggest mine deposit is a joint venture between Albemarle and Tianqi, the Greenbushes mine in Australia, which alone accounted for about 35 percent of global lithium carbonate-equivalent supply last year. 1   Albemarle’s other major deposit is the Atacama brine lake, adjacent to SQM’s deposits in Chile.
On top of that, Ganfeng and Tianqi, while both technically independent private companies, are strategically important businesses operating in the China of 2018. Tianqi Chairman Jiang Weiping is a delegate to China’s National People’s Congress, according to the company’s latest annual report. Ganfeng Chairman Li Liangbin has been a member of the standing committee to the People’s Congress in Xinyu city, where the company is based, according to its IPO prospectus.

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For the first 19 weeks of 2018, U.S. railroads reported cumulative volume of 4,879,984 carloads, up 1.1 percent from the same point last year; and 5,158,588 intermodal units, up 5.9 percent from last year. Total combined U.S. traffic for the first 19 weeks of 2018 was 10,038,572 carloads and intermodal units, an increase of 3.5 percent compared to last year.

For this week, total U.S. weekly rail traffic was 550,029 carloads and intermodal units, up 5.8 percent compared with the same week last year.

Total carloads for the week ending May 12 were 267,196 carloads, up 5.3 percent compared with the same week in 2017, while U.S. weekly intermodal volume was 282,833 containers and trailers, up 6.3 percent compared to 2017.

Seven of the 10 carload commodity groups posted an increase compared with the same week in 2017. They included coal, up 7,347 carloads, to 81,523; nonmetallic minerals, up 5,714 carloads, to 42,383; and chemicals, up 1,128 carloads, to 32,431. Commodity groups that posted decreases compared with the same week in 2017 were motor vehicles and parts, down 1,440 carloads, to 16,915; miscellaneous carloads, down 657 carloads, to 9,189; and metallic ores and metals, down 326 carloads, to 23,875.

North American rail volume for the week ending May 12, 2018, on 12 reporting U.S., Canadian and Mexican railroads totaled 372,423 carloads, up 5.3 percent compared with the same week last year, and 371,131 intermodal units, up 5.2 percent compared with last year. Total combined weekly rail traffic in North America was 743,554 carloads and intermodal units, up 5.2 percent. North American rail volume for the first 19 weeks of 2018 was 13,535,733 carloads and intermodal units, up 3.2 percent compared with 2017.

Canadian railroads reported 84,175 carloads for the week, up 7.9 percent, and 70,827 intermodal units, up 4.2 percent compared with the same week in 2017. For the first 19 weeks of 2018, Canadian railroads reported cumulative rail traffic volume of 2,777,892 carloads, containers and trailers, up 3.1 percent.

Mexican railroads reported 21,052 carloads for the week and 17,471 intermodal units. Cumulative volume on Mexican railroads for the first 19 weeks of 2018 was 719,269 carloads and intermodal containers and trailers.

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“We do think this hiking cycle is quite well advanced,” Sydney-based Mead said at the Bloomberg Invest summit in Sydney. “We also know that the backdrop of the U.S. economy has been pretty strong and going for a long time. At some point we will find these high yields will become an impediment for growth.”
The yield on 10-year Treasuries has topped 3 percent and reached the highest since 2011 on Tuesday as concerns about inflation and the pace of Fed rate hikes increased. While there has been a growing consensus for higher rates this year, debate has shifted to the extent of the advance with JPMorgan Chase & Co.’s Jamie Dimon and Franklin Templeton suggesting yields are headed toward 4 percent.
“Nothing is pound-the-table cheap,” but rising yields mean investors can gradually reduce their underweight bond positions, Mead said.

Mark Delaney, the chief investment officer of AustralianSuper Pty, the nation’s largest superannuation fund, said he was thinking about buying bonds again after selling almost all holdings last year.
“We sold almost all our bonds in 2017, but now they’re a percent higher -- a percent plus, a bit higher -- we’re starting to think about whether or not we should start closing those short positions,” Delaney said at the summit.

Jeffrey Johnson, head of Asia-Pacific fixed income at Vanguard Investments Australia, said inflation was still seen as anchored. Powerful forces such as demographics, globalization and technology should keep a cap on yields, Johnson told the summit.
Fair value for U.S. 10-year yields would be 3 percent to 3.25 percent, Johnson said. Vanguard has seen evidence of investors getting back into fixed income to take advantage of the higher yields, he added.

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With the spread between 5- year and 30-year Treasuries narrowing last week to the lowest levels in more than a decade, here are some of the Fed's recent comments...

A Fed study released April 3 found that an inverted yield curve remains a powerful signal of a looming recession and that is still the case even if the current ultra-low level of U.S. interest rates are taken into account.

America's budget deficit and unemployment rate are heading in opposite directions — something that's never happened during post-World War II peacetime and could cause a significant jump in interest rates.

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The idea of bringing down U.S. drug prices is universally popular. The hard choices, trade-offs and political fortitude needed to actually do it, however, are a harder sell. So here we are, with a drug-pricing plan so toothless that biotech shares soared as it was unveiled by President Donald Trump on Friday afternoon.
Some of Trump’s initiatives will be only mildly impactful, like changes to the Medicare Part D drug benefit that might slightly lower costs to the government and seniors. Other proposals are vague and may never be pursued, like changes to the drug-rebate system. Still others are nonsensical political theater, like the notion that other countries can be compelled to raise drug prices, and that this will somehow lower U.S. prices.
The few immediate  actions outlined in the plan — like ending a rule that makes it hard for pharmacists to steer patients to lower-priced options and forcing drugmakers to include the list price of drugs in advertisements — will be visible in a campaign year and allow the administration to claim it is taking action. But they won’t actually stop soaring drug spending.
Trump’s plan could have had more teeth if he followed through on a policy he once endorsed, and has been criticized for not pursuing: allowing Medicare to directly negotiate drug prices. But here again is another example where trade-offs would be required. Nine out of 10 Americans are in favor of giving the government the power to negotiate, according to a Kaiser poll. But that number would drop precipitously if they knew what the government would have to do in order to make the policy effective.
To gain any leverage with drugmakers, the government would need to be able to refuse Medicare coverage of certain medications because they are too expensive, and firmly steer patients to cheaper treatments. That is, the more restrictive the government is allowed to be, the bigger the potential impact on prices. But enacting such restrictions would be enormously unpopular. It’s one thing when it’s a private company making you jump through hoops, it’s another entirely when Uncle Sam is telling your grandmother she can’t have a potentially lifesaving medicine.

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