Taking away the punchbowl one way or another, Chinese version

The Chinese sense of humor was evident as they raised short term interest rates on Christmas Day by 25 basis points. (Bloomberg) What is interesting about this Saturday surprise is what happened a few days before with their failed treasury bill auction.

The ministry sold 16.76 billion yuan ($2.53 billion) of 91- day securities, falling short of the planned 20 billion yuan target, according to traders at the lead underwriters of government debt, who asked not to be identified. The average winning yield was 3.6769 percent, according to the traders. That compared with 3.22 percent on the debt of similar maturity in the secondary market yesterday.

Since the Chinese central bank was not able to drain enough cash out of the markets via Tbill sales, they raised interest rates instead.   One possible reason why the Tbill auction was not well received is there appears to be other demands on short term money in the Chinese banking system.  Short term bank repo rates are spiking higher as the year comes to a close. Why buy 3 month Tbills at 3.7% when you can lend out at 5.60% in the 3 month repo market?

As you can see there were spikes in the repo rates just before the end of previous quarter ends and I wonder how much of this current rise is due to squaring the books before year end.  We'll know soon. . .

Something to watch in the new year

The year is wrapping up and the US stock market continues to grind higher in a Christmas rally. While the US is in a much calmer state as compared to a year ago, not all is well across the pond in Europe.

The fiscal crisis in the PIIGS of Europe (Portugal, Ireland, Italy, Greece, Spain) has not been 'fixed' in my opinion and will most likely move up to the headlines in America very shortly.

Here you can see a chart of the PIIGS bond yields  (Bloomberg) and they are not going in the right direction. The spike and fall in May 2010 was due to Greek financial difficulties and the spike in November was from Ireland. Note how much faster the fall in yields after the Ireland event has been retraced as compared to the Greek event.

As this chart shows the absolute yields and not the relative 'risk' of the PIIGS regions looking at the combined CDS for the PIIGS (Bloomberg) provides a clearer view of perceived risk.  It too is almost at new highs and could very well exceed previous peaks before the new year.    I suggest you keep an eye on both of these indicators and if you see them shooting higher you will most likely see weakness in the equity markets as well.

Hugh Hendry December Commentary

Mr. Hugh Hendry's December commentary has been floating around the internet for a few days and I thought I'd share it with my loyal readers.  As always his letters are an interesting read, seamlessly combining the literary and financial.

Hugh Hendry / Ecletica Fund December 2010 commentary





His main thrust is the monetary stimulus by central bankers is not enough to outweigh the massive consumer deleveraging going on right now.  It is an epic tug of war and Hugh Hendry is on the side of further deleveraging and deflation (for now)  Please read.

ht: ZeroHedge

Inflation update

With the recent rise in interest rates I thought revisiting inflation rates would be helpful.

3 data series on this graph [click to enlarge]:
Blue for total Consumer Price Index (CPI) aka 'inflation'
Red for inflation minus (food and energy)
Green for housing subset

Notice how overall inflation tends to peak at the onset of a recession.
Headline inflation is still very low overall at near 1%
Housing inflation is still negative.
Inflation less food and energy is at a low for this timeline and is trending down.  Yes, we all need to eat and consume energy but both of those items are extremely volatile and stripping them out of the data series can provide additional useful information.

China comes to mind when people speak about energy and food inflation and like almost every other basic commodity the Middle Kingdom overshadows other negative factors such as Europe's continuing austerity drive and our own tepid domestic growth.  To me it appears whichever way China goes the energy, food, metals, etc. complex will follow.

Consumer credit update

Consumer credit data was recently released and the deleveraging continues.  This time I've shown the change in consumer credit over the entire data series so one can see how infrequently consumer credit declines.

The rate of decline is turning around, or so it seems.

This next graph shows a slightly different story (Thanks to @dafowc of declineandfallofwesterncivilization.blogspot.com)

Remove lending by Sallie Mae and the Federal government and the rate of decline has not been arrested.  Furthermore you can see this is a new phenomenon.

Very curious . . .  

More thoughts on the muni market

My previous post on the muni market needed some more information.  (Ready, Fire, Aim)
Bond Girl over at self-evident.org highlights some recent events which most likely were the catalyst for the most recent downdraft in the muni market.

The pending expiration of the Build America Bond (BAB) program has pulled supply forward, and this is going to seesaw over the next several weeks.  Since the BAB program was initiated, most issuers have structured their new issues with the sense that they will go to either the tax-exempt or taxable market, whichever is more advantageous at the time. . . 

What is going on now is that muni issuers are scrambling to get deals done to take advantage of the program before it expires, and this is pulling the number of new issues that would ordinarily be coming to market forward.  So the looming expiration of the BAB program is creating the very conditions it was created to alleviate.

I suggest reading the entire article for some additional info on the current situation. As I mentioned in my previous post  it is unusual for muni bonds to trade at a higher yield to treasuries as the muni's have a tax benefit.  The current situation is unusual and bears further attention.

Some perspective on the muni bond market

There's been some recent news regarding how municipal bond prices are dropping and California is having some problems selling new muni debt.  Looking back one can see the relative drop in municipal bond prices is not new and its been going on since May.

Observing the ratio of the etf's MUB (nationwide muni bond fund) to IEF (7-10 year US Treasury bond fund) can be instructive as it shows the relative value of two bond funds with almost the same duration (7.58 vs 7.26)

The relative decline in MUB is more dramatic when observed in this fashion versus an absolute basis. Furthermore looking at each etf's yield is interesting:
MUB 12 month yield: 3.71%
IEF 12 month yield: 3.00%
In other words a tax free bond fund is yielding 71 basis points more than a treasury fund with the same interest rate risk.  This 'shouldn't be' as muni bonds are tax free and a safe investment, right?  The markets are telling you something here; the perceived credit risk of muni bonds is increasing.

Source:
Stockcharts MUB:IEF
etf MUB home page
etf IEF home page

edit:  I have a followup post to this entry which you should read as well.