Prophets

The Daily Prophet: Trump's Tough Talk Makes T-Bills Very Kinky

Connecting the dots in global markets.

The bond market is getting very worried that President Donald Trump’s threats to shut down the government in October over border wall funding are more than just political bluster. Just take a look at what’s happening in U.S. Treasury bills, where a “kink” in the yield curve is becoming more pronounced.

In normal times, rates on fixed-income instruments get progressively higher the longer the maturity. That’s because the longer you lend money to someone or something, the greater the risk that things could go wrong, and you want to be compensated for that risk. But something unusual is happening in T-bills, with investors demanding higher rates on those securities maturing Oct. 5 -- which is around the time when the Treasury has estimated it won’t be able to pay its debts -- than on those coming due just a few weeks later. To be sure, this has been going on for a few weeks as the deadline to raise the nation’s debt limit approaches, but for some reason Trump’s comments at a rally in Phoenix on Tuesday night caused traders to become extra jittery. This issue isn’t just a Wall Street problem. Fitch Ratings said Wednesday that Congress needs to raise the U.S. debt limit in a timely manner or the firm will review the nation’s sovereign rating, “with potentially negative implications.” That could raise borrowing costs for the government, companies and individuals.

Fitch said in a report that if the “x-date” -- when the Treasury exhausts the extraordinary measures it’s using to fund itself -- is breached without an increase and the Treasury resorts to a plan that prioritizes debt service over other obligations, that may jeopardize the country’s AAA rating, according to Bloomberg News’s Liz McCormick and Alexandra Harris. “The issue is that prioritizing debt-service payments has never been done, so we’d be in uncharted territory,” said Charles Seville, a Fitch senior director. “There are operational risks, and our broader concern would be if not meeting other commitments would be compatible with AAA status. It’s not that we’d see default as inevitable after the x-date.”

DÉJÀ VU ALL OVER AGAIN
The more things change, the more they stay the same. In 1999, then-Federal Reserve Chairman Alan Greenspan kicked off the central bank’s annual Jackson Hole symposium by highlighting the impact of rising stock prices on an economy that was then enjoying low inflation and low unemployment. Now, Bloomberg News’s Rich Miller reports, Janet Yellen faces a similar confluence of economic forces as she prepares for what might be her last speech at the Wyoming conference as Fed chair on Friday. And, like Greenspan before her, she has to decide how much weight to give to each as she tries to keep the economic expansion on track. Buoyant asset prices and low unemployment argue for Yellen to press ahead with interest-rate increases -- or even accelerate them, according to Miller. Weak inflation suggests she might even want to consider providing more stimulus, not less. “Tightening wins by a vote of two to one,” Ethan Harris, head of global economic research at Bank of America Corp. in New York, said. He sees the Fed raising rates again in December and further next year.

EMERGING MARKETS RAPIDLY BUILD RAINY DAY FUNDS
Even though there’s still four months left in 2017, this is already the best year for the currencies of developing economies since 2009, with the MSCI EM Currency Index up about 8 percent. The story so far has been that emerging markets have benefited from a rare synchronized global economic recovery. Now, there’s evidence that these economies didn’t squander the opportunity. Foreign-exchange reserves for the 12 largest EM economies, excluding China, have risen to $3.05 trillion from $2.89 trillion at the end of last year. The $157 billion increase is already the most since 2012. Morgan Stanley says it sees no reason to get out of emerging market assets. The firm’s strategists said in a report that emerging markets continue to benefit from a strong alignment in fundamentals, valuations and technicals. Specifically, the firm says it prefers local markets, aided by firmer currencies, over external debt. 

THE KIWI IS SINKING FAST
One currency that isn’t doing so well of late is the kiwi. Named after a flightless bird, the currency is trading at some of its weakest levels of the year against its developed-market peers as measured by Bloomberg Correlation-Weighted Indexes. Based on that gauge, it has underperformed every major peer over the past week, one month and six months. The currency was the biggest loser Wednesday in foreign-exchange markets after the New Zealand Treasury cut its economic growth forecast for 2017 to 3.5 percent from 3.7 percent. “Despite our bullish risk attitude, we have turned NZD bearish arguing that New Zealand’s overleveraged economy is now rolling over,’’ Morgan Stanley strategist wrote in a research note. The weakness should be a welcome development for the Reserve Bank of New Zealand, which in recent months has complained that the currency was too strong while hinting that it may need to intervene in markets to weaken it. Kiwi strength is a problem for the RBNZ because it damps import prices and suppresses inflation. The central bank, which has cut its benchmark rate to a record-low 1.75 percent, forecast earlier this month that inflation will slow to 0.7 percent by the first quarter of next year.

SUGAR OUTLOOK TURNS SOUR
Raw sugar futures traded in New York have fallen by almost 30 percent this year, the worst performer in the Bloomberg Commodity Index. So, the logical thing would be for producers to cut back on supply, but the commodities market isn't always logical. The global sugar surplus is expanding as Brazil, Thailand and the European Union drive world production to record, according to Green Pool Commodity Specialists. Supplies will outpace demand by 7.1 million metric tons in the 2017-18 season that starts in October in most countries, a 29 percent increase from a May forecast, the Brisbane, Australia-based researcher said in a report Wednesday. That would reverse shortages in the previous two seasons and represent the biggest surplus in five years, according to Bloomberg News’s Isis Almeida. Consumption growth has also slowed compared with historical averages due to health concerns and alternative sweeteners. "We are now reasonably confident, given the monsoon is two -thirds to three-quarters over, that Thailand, in particular, had excellent rainfall," said Tom McNeill, a director at Green Pool. "Europe has had plenty of catch-up rainfall and the beet tests are good."

TEA LEAVES
Britain’s currency has been under extreme pressure in recent weeks, with the Bloomberg Pound Index falling to its lowest level since January. A flagging economy is a big reason for the weakness. That’s why investors and economists will be paying close attention to Thursday’s report on second-quarter gross domestic product. This second estimate is likely to confirm that the economy expanded 0.3 percent over the first quarter, according to the median estimate of economists surveyed by Bloomberg. That’s not to say there won’t be new information to parse, as this report will provide details on all-important consumer spending. If there is any weakness there, markets are likely to price in a delay in interest-rate increases by the Bank of England, further weighing on the pound.

If you’d like to get The Daily Prophet in e-mail form, right in your inbox, please subscribe to this link. Thanks!

DON’T MISS
Central Banks Need to Exit QE for Markets' Sake: Alberto Gallo

The Shape of the Phillips Curve Should Worry Markets: Ben Emons

EU, U.S. Are Changing the Rules of the Bond Market: Mark Grant

The Lowflation Demon Vexing Central Banks: Mohamed A. El-Erian

Bad Market News From Junk Forecasting Models: Barry Ritholtz

Bloomberg Prophets Professionals offering actionable insights on markets, the economy and monetary policy. Contributors may have a stake in the areas they write about.

    To contact the author of this story:
    Robert Burgess at bburgess@bloomberg.net

    To contact the editor responsible for this story:
    Max Berley at mberley@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE
    Comments