The Daily Prophet: Banks Gorge on Bonds in Ominous Sign

Connecting the dots in global markets.

With all the talk about the first synchronized upswing in the global economy since 2007, it would be easy to dismiss the rally in super-safe U.S. Treasuries as just a knee-jerk reaction to the latest geopolitical risk. That is, until you realize that the nation's biggest financial institutions, which supposedly have their fingers on the pulse of the economy, are loading up on the securities again in a rather ominous sign.

The latest weekly data from the Federal Reserve shows that U.S. banks have boosted their holdings of government and related debt to a record $2.486 trillion. The most recent increase of $12.2 billion was the second-biggest this year. There's plenty more to worry about than just North Korea testing a hydrogen bomb. Congress must raise the debt ceiling this month or risk a government shutdown that could throw markets into turmoil, all while passing authorization of key government programs such as the National Flood Insurance Program and debating how much aid to provide Texas in the wake of Hurricane Harvey, which Texas Governor Greg Abbott said should be in the range of $150 billion to $180 billion. And now there's the possibility that Hurricane Irma, which has morphed into a Category 5 storm, could hit Florida.  

It's no wonder that yields on benchmark 10-year Treasuries fell the most since May on Tuesday, reaching 2.07 percent, their lowest level of the year. The implied odds of another interest-rate increase by the Fed this year has fallen below 30 percent, according to Bloomberg News' Brian Chappatta. Lael Brainard, a member of the Fed’s board of governors, said Tuesday that the central bank should be cautious about raising rates until inflation is back on track. "With vacation season winding down and the market returning to reassess the policy/economic outlook, the rally points to a degree of pessimism toward the near-term balance of risks that was also apparently on holiday until this week," the strategists at BMO Capital Markets wrote in a research note.

There's a lot of focus these days on the lack of breadth in the U.S. equities market, whether it be the fact that just a handful of tech stocks have led major indexes higher this year or the diminishing number of shares hitting new 52-week highs or any other metric that shows cracks in the foundations. Big down days like the one Tuesday only seems to increase the focus. Here's a new one to consider: At one point in August about 43 percent of stocks in the S&P 500 Index were selling for more than their 50-day moving average prices. That’s near the smallest proportion since before the U.S. presidential election, and down from about 62 percent when the benchmark peaked on Aug. 7, according to Bloomberg News' Oliver Renick and Elena Popina. By the way, September is historically a rough month for U.S. stocks, with equities on average losing about 1 percent, data compiled by S&P Global show. Traders are taking precautions. Put contracts on the largest exchange-traded fund tied to the S&P 500 outnumber calls by 2-to-1, according to Popina.

These days, what's good for Treasuries is bad for the dollar, which seems to have lost its position as a haven currency along with the Japanese yen, the Swiss franc or even gold. That's because lower bonds yields tend to lessen the appeal of the greenback relative to other currencies, especially those in emerging markets. The Bloomberg Dollar Spot Index tumbled as much as 0.5 percent Tuesday, bringing its year-to-date slide to 9.44 percent as the prospect for more rate increases from the Fed diminishes. At the same time, the MSCI Emerging Markets Currency Index is up 9.21 percent for the year. It's notable that the greenback even fell against the likes of Brazil's real, Chile's peso and Israel's shekel on a day when investors couldn't get enough of assets considered havens.


It seems that not even the threat of nuclear war is enough to shake investors' faith in emerging markets. Both the MSCI emerging market stock and currency indexes rose in late trading Tuesday even as major market gauges such as the S&P 500, Stoxx Europe 600 and Japan's Topix fell. Emerging market bonds were also buoyant, with news that Indonesia is mulling the issuance of the nation’s first global sovereign bonds denominated in rupiah given that foreign investors on course to pump in a record amount into government securities. Investor anxiety, as measured by one-month implied currency volatility, has dropped to multi-month lows in Russia, South Africa and Brazil -- countries with some of the most generous yields on their local government debt, according to Bloomberg News' Ben Bartenstein. This is not just a grab for yield. Credit quality is improving. S&P Global Ratings analyst Elena Anankina says Russia has one of the biggest groups of so-called rising stars -- companies on the cusp of investment grade with a BB+ rating and a positive outlook, according to Bloomberg News' Dina Khrennikova and Yelena Timonina.

Last week it was gasoline, this week it's orange juice's turn to be roiled by a hurricane. Hurricane Irma strengthened to become a Category 5 storm and remained on track to reach the U.S. later this week, threatening crops in southern states. Orange juice for November delivery climbed as much as 7.3 percent to $1.464 a pound on ICE Futures U.S. Tuesday, the biggest intraday gain for the contract since June 26. Cotton was also affected, prices for December delivery jumped by the 3-cent exchange limit, or 4.2 percent, to 74.88 cents a pound. Trading volumes for both commodities were above their respective 100-day averages, according to Bloomberg News' Marvin G. Perez and Jeff Wilson. All of Florida’s orange crop is at risk of moderate to severe damage, with trees already full of fruit, said Donald Keeney, meteorologist with MDA Weather Services in Gaithersburg, Maryland. The Sunshine State is also the biggest U.S. sugar producer. Cotton's risk comes with areas around the Gulf Coast already struggling to recover from flooded fields caused by Hurricane Harvey. Cotton surged 5.5 percent last week.

The Bank of Canada on Wednesday kicks off a particular busy time for central banks. The consensus is that policy makers will leave their benchmark interest rate unchanged at 0.75 percent, but the decision became a lot tougher after Statistics Canada said last week that the economy unexpectedly accelerated at a 4.5 percent pace in the second quarter -- tops among Group of Seven countries and the fastest in six years. Even so, the Bank of Canada will likely want to see how the red hot housing market and the Nafta talks evolve as well as what happens with the trade, jobs and inflation data before hiking rates at the October 25th meeting, according to the strategists at RBC Capital Markets. A dovish Bank of Canada could be a disappointment to currency traders, as Canada's dollar has been the best performing major currency over the past three months on the prospect of higher rates, with the Bloomberg Correlation-Weighted Index for the so-called loonie rising 4.68 percent.

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