7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
1/47
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
2/47
Barclays | Market Strategy Americas
10 May 2012 2
FORECASTS
2011 2012 2013 Calendar year average
% change q/q saar Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2011 2012 2013
Real GDP 0.4 1.3 1.8 3.0 2.2 2.5 3.0 3.0 2.0 2.5 2.5 3.0 1.7 2.4 2.5
Private consumption 2.1 0.7 1.7 2.1 2.9 2.5 3.0 3.0 2.0 2.5 2.5 3.0 2.2 2.4 2.6
Public consump and invest. -5.9 -0.9 -0.1 -4.2 -3.0 -3.0 -3.0 -3.0 -2.0 -2.0 -1.5 -1.5 -2.1 -2.7 -2.3
Residential investment -2.4 4.2 1.3 11.6 19.1 8.0 10.0 10.0 8.0 10.0 12.0 12.0 -1.3 10.6 9.8
Equip. & software investment 8.7 6.2 16.2 7.5 1.7 10.0 12.0 12.0 9.0 12.0 12.0 12.0 10.4 8.3 11.1
Structures investment -14.3 22.6 14.4 -0.9 -12.0 10.0 10.0 10.0 8.0 10.0 10.0 10.0 4.6 3.2 9.5
Net exports ($ bn, real) -424 -416 -403 -411 -410 -407 -408 -409 -408 -414 -424 -434 -414 -408 -420
Net exports (contr to GDP, pp) -0.3 0.2 0.4 -0.3 0.0 0.1 -0.1 -0.1 0.0 -0.3 -0.4 -0.4 0.0 0.0 -0.1
Final sales 0.0 1.6 3.2 1.1 1.6 2.5 2.9 2.9 2.1 2.6 2.7 3.0 1.9 2.2 2.5
Ch. inventories ($ bn, real) 49.1 39.1 -2.0 52.2 69.5 69.5 71.5 73.5 77.5 82.5 86.5 90.5 34.6 71.0 84.3
Ch. inventories (contr to GDP, pp) 0.3 -0.3 -1.4 1.8 0.6 0.0 0.1 0.1 0.1 0.2 0.1 0.1 -0.2 0.3 0.2
GDP price index 2.5 2.5 2.6 0.9 1.5 2.6 2.7 2.7 2.7 2.7 2.8 2.9 2.1 2.0 2.7
Nominal GDP 3.1 4.0 4.4 3.8 3.8 5.1 5.7 5.8 4.7 5.2 5.3 6.0 3.9 4.5 5.3
Industrial output 4.4 1.2 5.6 5.0 5.4 4.0 5.0 5.0 4.0 4.5 4.5 5.0 4.1 4.7 4.5
Employment (avg mthly chg, K) 192 130 128 164 229 172 200 230 170 200 220 230 153 208 205
Unemployment rate (%) 9.0 9.1 9.1 8.7 8.2 8.1 7.9 7.7 7.6 7.4 7.2 7.0 8.9 8.0 7.3
CPI inflation (% y/y) 2.1 3.4 3.8 3.3 2.8 1.9 1.8 2.1 2.1 2.2 2.6 2.7 3.2 2.2 2.4
Core CPI (% y/y) 1.1 1.5 1.9 2.2 2.2 2.2 2.2 2.4 2.6 2.6 2.7 2.8 1.7 2.3 2.7
Core PCE price index (% y/y) 1.1 1.3 1.6 1.8 1.9 1.9 2.0 2.2 2.3 2.3 2.4 2.5 1.4 2.0 2.3
Current account (% GDP) -3.2 -3.3 -2.8 -3.2 -2.9 -2.9 -2.9 -2.8 -2.8 -2.8 -2.8 -2.8 -3.1 -2.9 -2.8
Federal budget bal. (% GDP) -8.7 -7.1 -5.5
Federal funds rate (%) 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25
Note: All numbers expressed in q/q saar % unless otherwise specified. The budget balance is fiscal year.Source: BEA, BLS, Federal Reserve, US Treasury, Barclays ResearchSUMMARY OF VIEWS
Direction Fiscal and European uncertainty likely to keep yields at current levels. Remain neutral on duration.
Curve/
Curvature
Term premium in the front end is low, given the uncertainty about the economic outlook. Maintain vol-weighted 2s3ssteepeners.
Maintain 10s30s Treasury curve steepeners. Recommend hedging the mark-to-market risk by being short 10y TIPS. Remain neutral on the long 5s10s30s fly. Short the 5s7s10s fly, as the 7y sector look rich ahead of intermediate supply.
Swap spreads Mar 13 FRA-OIS spread as a protection trade. 30y spread tighteners for asymmetric tightening risk. TY invoice spread tighteners hedged with 1y1y Libor-OIS for swapped issuance.
Other spreadsectors
Front-end agencies have continued to outperform Treasuries; we recommend moving out to the 5-7y sector or owningfront-end MTNs. Short-dated Bermudan callables offer an opportunity to fade the sell-off in rates and spike in vol.
We remain constructive on Canadian covered bonds, given their relative isolation from Europe and continuedsignificant spread pickup to agencies.
Inflation Neutral on breakevens outside the very front end; overweight on 30y breakevens versus 10s. Long Apr13s covered BE hedged with energy. Long 10y relative TIPS ASWs, as the sector looks cheap. Long Apr17s versus Jan17s, as the floor premium on new 5s could rise with risk aversion.
Volatility Neutral 3m*10y, as there is little catalyst to push rates higher, but levels are already low. Short 2y*10y as low rate expectations push further out. 2y*10y is at 20%+ premium to 3m*10y.
Source: Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
3/47
Barclays | Market Strategy Americas
10 May 2012 3
OUTLOOK
The ins and outs of the labor market
Flows out of employment into unemployment have fallen sharply since the end of therecession; jobless claims and layoffs are close to pre-recession levels.
However, flows out of unemployment into employment have not risen materially,despite a pickup in job openings.
We expect job growth to average about 200k per month, weak compared with previousrecoveries from deep recessions but sufficient to push the unemployment rate lower.
Go with the flow
Data on labor market flows (ie, the movement of workers between employment and
unemployment and in and out of the labor force) can help illuminate shifts in payroll growth
and the unemployment rate. For example, flows out of employment into unemployment have
fallen consistently since the end of the recession, in line with the decline in initial jobless claims,
which have reversed most of the increase during the recession (Figure 1). An alternativemeasure of job losses layoffs and discharges as measured in the JOLTS report paint a similar
picture. Indeed, layoffs fell below pre-recession levels during 2011. In other words, the job loss
side of the ledger looks much like one would expect for an economy three years into a recovery.
However, the hiring side of the ledger remains very weak. In particular, the flow of workers from
unemployment to employment, having stabilized in mid-2009, has barely risen since. Strikingly,
this remains the case despite a significant pickup in job openings. The JOLTS measure of hiring
tells a similar story (Figure 2). As we have written previously (see US Outlook: A not so
refreshing Beveridge, 30 March 2012), we believe this in part reflects a mismatch between the
supply of available labor (the unemployed) and the demand for labor (job openings).
It also helps explain why long-term unemployment (defined as those out of work for six
months or longer) has persisted at unprecedented high levels. This is particularly striking
compared with the expansions that followed the deep recessions in the 1970s and 1980s
(Figure 3) and is likely explained by the relatively weak pace of hiring in the current cycle.
Taken together, the mismatch of available jobs and available workers and the persistence of
Peter Newland
+1 212 526 [email protected]
Job losses have eased
considerably
Figure 1: Flow from employment to unemployment falling Figure 2: Flow into employment yet to pick up significantly
1.0
1.2
1.4
1.6
1.8
2.0
2.2
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
250
300
350
400
450
500
550
600
650
700Inflow rate, employed to
unemployed (lhs)
Initial j obless claims (rhs)
000sratio, 3mma
14
18
22
26
30
34
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
0.55
0.65
0.75
0.85
0.95
Outflow rate, unemployed to
employed (lhs)
Ratio of openings to hires (rhs)
ratio, 3mmaratio, 3mma
Source: BLS, Labor dept, Barclays Research Source: BLS, Barclays Research
but hiring remains weak
and long-term
unemployment very high
https://live.barcap.com/go/publications/content?contentPubID=FC1806655https://live.barcap.com/go/publications/content?contentPubID=FC1806655https://live.barcap.com/go/publications/content?contentPubID=FC1806655https://live.barcap.com/go/publications/content?contentPubID=FC18066557/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
4/47
Barclays | Market Strategy Americas
10 May 2012 4
long-term unemployment suggest that the increase in unemployment during the downturn
will prove partly structural, in our view.
Job flow data can also shed light on movements in and out of the labor force. The outward
flow, reflected in the decline in the labor force participation rate, has been notable in recent
years. As we detailed in Dispelling an urban legend: US labor force participation will not stop
the unemployment rate decline, 1 March 2012, we believe the majority of the decline can beexplained by demographic factors, particularly the increasing retirement rates of the baby
boom generation, and that a sharp rebound in participation (which would stall the
downward trend in the unemployment rate) is very unlikely.
The job flow data provide some supporting evidence: since the end of the recession, those
leaving the labor force have increasingly been from employment (rather than
unemployment). This is also reflected in the JOLTS data on separations, which show that
layoffs and discharges have fallen sharply, while quits and other separations (including
retirement) are now trending higher. On the flip side, those entering the labor market are
increasingly doing so into employment, rather than into unemployment (Figure 4).
Where next for employment and the unemployment rate?
Payroll growth reflects the net of new hires (those entering employment from unemployment
or from outside the labor force) and job losses (either those entering unemployment due to
layoffs or leaving the labor force due to retirement or for other reasons). With job losses
having subsided, payroll growth will likely be driven by the hiring side of the equation. Hiring
is picking up but has not kept pace with job openings. To the extent that this reflects
structural factors, including the troubles of the long-term unemployed finding work, job
growth is likely to remain modest compared with recoveries from previous deep recessions.
We expect payroll growth of about 200k per month, in line with the recent trend (absent the
likely boost from weather effects in the winter and subsequent payback in March and April).
Meanwhile, flows into unemployment are, absent a shock to the broader economy, likely to
continue to ease job losses have slowed, and we do not believe that a surge into
unemployment from outside of the labor force is very likely. Combining these factors
suggests that a modest pace of employment growth will be sufficient to push the
unemployment rate lower.
Figure 3: Long-term unemployment has barely declined Figure 4: Flows in and out of the labor force
0
10
20
30
40
50
Jan-70 Jan-80 Jan-90 Jan-00 Jan-10
2
4
6
8
10
12Long-term unemployed (lhs)
Unemployment rate (rhs)
% unemployed %
3200
3400
3600
3800
4000
4200
4400
4600
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
Flow from not in the labor force to employed
Flow from employed to not in the labor force
000s, 3mma
Source: BLS, Barclays Research Source: BLS, Barclays Research
Flow out of the labor force
unlikely to be reversed in full
Layoffs have fallen as
a share of separations
Employment growth likely
to remain modest
but sufficient to push the
unemployment rate lower
https://live.barcap.com/go/publications/content?contentPubID=FC1798216https://live.barcap.com/go/publications/content?contentPubID=FC1798216https://live.barcap.com/go/publications/content?contentPubID=FC1798216https://live.barcap.com/go/publications/content?contentPubID=FC17982167/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
5/47
Barclays | Market Strategy Americas
10 May 2012 5
GDP TRACKING
Q1 GDP tracking 1.9%, Q2 tracking 2.5%
A deterioration in the trade balance in March was largely offset by an upward revision to
February. Meanwhile, growth in wholesale inventories was weaker than expected inMarch. The net result was a one-tenth reduction in our Q1 GDP tracking estimate.
The real trade in goods deficit widened more than the BEA had assumed at the time of thefirst Q1 GDP estimate. However, this was largely offset by an upward revision in February,
suggesting that net trade will remain broadly neutral for Q1 GDP growth (Figures 2 and 3).
Wholesale inventories outside of the auto sector rose a softer-than-expected 0.3% inMarch. This subtracted 0.1pp from our tracking estimate (Figure 1), although inventory
accumulation is still likely to have added to growth in Q1.
The April vehicle sales report remains the only hard data released for April. Sales roseto 14.4mn, broadly in line with the average in Q1. Our Q2 GDP tracking estimate
stands at 2.5%.
Peter Newland
+1 212 526 [email protected]
Figure 1: GDP tracking*
Release date Indicator Period
Q1
tracking
Q2
tracking
27-Apr GDP Q1-1st 2.2
30-Apr Personal spending March 2.2
1-May Construction spending March 2.2
1-May Vehicle sales April 2.2 2.5
2-May Factory orders March 2.0 2.5
9-May Wholesale inventories March 1.9 2.510-May Trade March 1.9 2.515-May Retail sales April
15-May Business inventories March
16-May Housing starts April
Source: Barclays Research
Figure 2: GDP growth contributions Figure 3: Net trade
Q4 3rd estimate Q1 1st estimate
% q/q
(saar)
Cont.
(pp)
% q/q
(saar)
Cont.
(pp)
Real GDP 3.0 2.2
Consumption 2.1 1.5 2.9 2.0
Govt. spending -4.1 -0.8 -3.0 -0.6Res. investment 11.7 0.3 19.0 0.4
E&S investment 7.5 0.6 1.7 0.1
Structures -1.0 0.0 -12.0 -0.3
Net exports, $bn -411 -0.2 -410 0.0
Ch inventories, $bn 52.2 1.7 69.5 0.4 -750
-700
-650
-600
-550
-500
-450
-400
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
Customs values, monthly
NIPA basis, quarterly
$bn (saar)
Source: BEA, Barclays Research Source: BEA, Census Bureau, Barclays Research
Note: *Our GDP tracking estimate is distinct from our published GDP forecast. It reflects the mechanical aggregation of monthly activity data that directly feed into theBEAs GDP calculation.
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
6/47
Barclays | Market Strategy Americas
10 May 2012 6
DATA REVIEW & PREVIEW
Dean Maki, Michael Gapen, Peter Newland, Cooper Howes
Review of last weeks data releases
Main indicators Period Previous Barclays Actual Comments
Consumer credit, chg, $ bn Mar 9.3 R 8.5 21.4 Continues to be driven by growth in student loansWholesale inventories, % m/m Mar 0.9 0.5 0.3 Small negative for our Q1 GDP tracking estimate
Trade balance, $ bn Mar -45.4 R -49.0 -51.8 Strong rise in non-petroleum goods imports
Import prices, % m/m (y/y) Apr 1.5 (3.6) R 0.0 -0.5 (0.5) Largely reflected drop in petroleum prices
Nonpetroleum import prices, % m/m (y/y) Apr 0.3 (0.7) R 0.1 0.0 (0.3) Sharp decline in prices of industrial supplies
Treasury budget balance, $ bn Apr -40.4 ('11) 60.0 59.1 First monthly budget surplus since 2008
Preview of the next week
Monday 14 May Period Prev 2 Prev 1 Latest Forecast Consensus
Tuesday 15 May Period Prev 2 Prev 1 Latest Forecast Consensus
8:30 Retail sales, % m/m Apr 0.6 1.1 0.8 0.2 0.2
8:30 Retail sales ex autos, % m/m Apr 1.1 1 0.8 0.2 0.2
8:30 Core retail sales, % m/m Apr 1.0 0.5 0.4 0.4 -
8:30 CPI, % m/m (y/y) Apr 0.2 (2.9) 0.4 (2.9) 0.3 (2.7) 0.0 (2.2) 0.1 (2.4)
8:30 Core CPI, % m/m (y/y) Apr 0.2 (2.3) 0.1 (2.2) 0.2 (2.3) 0.2 (2.3) 0.2 (2.3)
8:30 CPI, NSA index Apr 226.665 227.663 229.392 229.9 230.0
8:30 Empire State mfg, index May 19.5 20.2 6.6 11.0 9.0
9:00 Net long-term TIC flows, $ bn Mar 19.1 102.4 10.1 - -
10:00 Business inventories, % m/m Mar 0.6 0.8 0.6 0.4 0.5
10:00 NAHB housing market, index May 28 28 25 27 26
No significant events or releases
Retail sales:We expect retail sales to increase 0.2% m/m in April. Within non-core components, we are looking for a small gainin auto sales (in line with the rise in unit sales reported by the main suppliers) to be largely offset by a decline in gasoline, in line
with the decrease in prices relative to March on a seasonally adjusted basis. Elsewhere, we are also looking for a solid 0.4% gain
in core sales, in line with the increase in March.
CPI: We are looking for a flat m/m reading on the CPI in April, consistent with an NSA CPI index print of 229.9, up from 229.392
in March. Within this, we expect a negative contribution from energy (notably gasoline) prices and a small increase in food prices,
alongside a 0.2% rise in the core CPI. We continue to believe that core price gains will be underpinned by persistent gains in the
heavily weighted core services components, particularly shelter. Core goods prices are likely to be more volatile but we expect
them to, on net, add to the core CPI over the coming months as well.
Empire state mfg: While the Empire State manufacturing index declined in April, the new orders component was little changed
and the employment index experienced a solid increase. Given that, we look for a rebound in the headline index to 11.0 in May.
NAHB housing market: We look for the NAHB housing index to increase to 27 in May from a print of 25 in April. This would keep
the index in line with levels that, until the boost likely caused by warm weather in the first few months of 2012, have not been
seen since 2007.
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
7/47
Barclays | Market Strategy Americas
10 May 2012 7
Wednesday 16 May Period Prev 2 Prev 1 Latest Forecast Consensus
8:30 Housing starts, thous saar Apr 714 694 654 685 678
8:30 Building permits, thous saar Apr 682 715 764 - 735
9:15 Industrial production, % m/m Apr 0.7 0.0 0.0 0.4 0.5
9:15 Capacity utilization, % Apr 78.7 78.7 78.6 79.0 79.0
12:30 St. Louis Fed President Bullard (FOMC non-voter) speaks in Kentucky14:00 Minutes of FOMC meeting released 24-Apr
Thursday 17 May Period Prev 2 Prev 1 Latest Forecast Consensus
8:30 Initial jobless claims, thous (4wma) May-12 392 (383) 368 (384) 367 (379) 365 (373) -
10:00 Philadelphia Fed mfg, index May 10.2 12.5 8.5 10.5 10.0
10:00 Leading indicators index, % m/m Apr 0.2 0.7 0.3 0.2 0.2
12:35 St. Louis Fed President Bullard (FOMC non-voter) speaks in Kentucky
Philadelphia Fed mfg: We expect the Philadelphia Fed manufacturing index to rise to 10.5 in May, partially offsetting the decline
last month. Like the Empire State, the April Philadelphia Fed manufacturing index experienced only a small decline in the new
orders index and a strong improvement in the employment index despite a headline decrease.
Leading indicators: We look for the Conference Board's index of leading indicators to rise 0.2% in April. We expect interest rate
spreads and building permits to provide solid positive contributions, but these will be largely offset by negative contributions
from initial claims and consumer confidence.
Friday 18 May Period Prev 2 Prev 1 Latest Forecast Consensus
No significant events or releases
Housing starts: We expect housing starts to rise 4.7% m/m in April to 685,000 units. While single-family starts were flat last
month, multi-family starts fell 17% on the month. The strong 26% m/m increase in multi-family permits suggests that this will
be reversed in the coming months, and we look for some of that to be reflected in the April report. A rise to 685,000 units would
return starts to the Q1 average of 687,000 units and well above 2011 levels. It would also provide confirmation that
improvements in homebuilder sentiment, falling inventory, and a robust rental market are translating into better start activity. We
continue to expect residential construction to add to GDP growth in the coming quarters.
IP: We are looking for a 0.4% m/m increase in industrial production and manufacturing output in April. Headline industrial
production growth has been volatile in recent months, largely reflecting swings in the mining and utilities components, likely
partly related to the warmer-than-usual weather over the winter. Excluding these, manufacturing output posted a small decline in
March (-0.2%), following very strong gains in December, January, and February. Our forecast for a rebound in April reflects theincrease in the production component of the ISM survey, as well as small gains in manufacturing employment and hours worked
during the month. We also expect a small positive contribution from auto output, consistent with production schedule data.
FOMC minutes: We read the tone of the April FOMC statement as indicating that the Fed does not expect to conduct further
asset purchases or continue its maturity extension program beyond June. In addition, several participants brought forward the
expected timing of the first rate increase. Therefore, we look for the minutes of the April FOMC meeting to provide additional
insight into why Chairman Bernanke characterized monetary policy as being in the right place and how the committee came to
adjust its forecast in favor of stronger growth (in 2012), higher inflation, and a lower unemployment rate. We also look for the
minutes to provide further context about how the committee views the decline in the unemployment rate and what conditions
would be necessary to begin further purchases of securities. One other aspect to watch will be whether a couple of members
still judged that, in April, additional asset purchases may be warranted, as was the case in March.
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
8/47
Barclays | Market Strategy Americas
10 May 2012 8
TREASURIES
Another reason to worry
We remain wary of fading the rally, given a modest growth outlook and strengthening
linkages between sovereigns and banks in Europe. We instead recommend shorting 7sversus the wings for normalization of QE expectations and intermediate supply ahead.
Treasury yields gradually drifted lower as economic data weakened somewhat; our
economists tracking estimate of Q1 GDP fell to 1.9% from 2.2% at the beginning of the
month due to lower inventory accumulation, but mainly in response to higher uncertainty in
Europe following the elections in France and Greece. The spread of French government
yields to German yields has remained elevated and that of Italy and Spain has widened over
the week (Figure 1). The latter was likely due to increased concerns about public finances
being used to shore up the banking system.
Given the political uncertainty and even stronger linkages between European banks and
sovereigns following the LTRO led bank demand for government securities, we remain wary
of fading the rally. Figure 2 shows that since the beginning of the year, banks in Italy and
Spain have increased their holdings of government securities by ~30%. In the recent flare
up, spreads of European financials have caught up with sovereign spreads (Figure 3).
Liquidity injected via the LTROs only helped financials outperform temporarily as the
underlying sovereign concerns were not really addressed; CDS spreads on Spanish
government debt are now trading at wider levels than late last year, and those of Italy and
France have reversed 50% and 60% of the move, respectively.
Another reason we are cautious in fading the rally is that expectations of USD L-OIS basis
have more room to widen before they catch up with European financial spreads. Figure 4
shows that over the past few months, 1y fwd L-OIS expectations have been driven mainly
by European bank credit risk. Even though the latter has reversed more than half of the
move tighter, L-OIS expectations have not risen much; they could easily be 10bp higher. Insuch a scenario, US yields are unlikely to be higher (see the swaps piece for a discussion on
how to best position for a flare up).
Anshul Pradhan
+1 212 412 [email protected]
European financial spreads have
caught up with sovereign
spreads given strengthening
linkages between sovereigns and
banks
Figure 1: Recent political changes in Europe have done littleto alleviate uncertainty
Figure 2: Linkage between European banks and sovereignare even stronger now
2.5
3.0
3.5
4.0
4.5
5.0
5.5
Jan-1 Jan-22 Feb-12 Mar-4 Mar-25 Apr-15 May-6
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
Spain Italy France, rhs
Spreads of 10y Govt bonds vs Germany, %
150
175
200
225
250
275
300
325
350
Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12
$bn
Italian Banks Spanish Banks
A 28% in holdings of
general government
securities
A 28% increase in
holdings of general
government securit ies
Source: Bloomberg Source: EUDATA, Haver Analytics
USD Libor-OIS expectations have
room to widen, given the level of
European financial spreads
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
9/47
Barclays | Market Strategy Americas
10 May 2012 9
Finally, recent trends in US economic data do not justify much higher yields. Our
economists Q1 real GDP growth tracking estimate is now 1.9% and real final sales over the
last year have also grown at ~1.9%. While growth is indeed expected to pick up, consensus
forecast is for 2.3% growth in 2012 and 2.5% in 2013; our models suggests that 2-2.5%
growth is consistent with about spot 10y yields of 2%. In addition to the European
sovereign risk, the downside potential from fiscal tightening next year should prevent
investors from extrapolating upside surprises this year (please read Will the bond marketselloff be sustained?March 22, 2012, for a detailed discussion).
Such an outcome should keep the Fed in wait-and-see mode, with the outlook neither weak
nor strong enough to announce any policy changes. Given that the markets expectations of
further stimulus have risen substantially, as evident in the richness of the belly of the curve
and the low level of real yields, we believe investors should position in the near term for a
normalization of such expectations instead of position for much higher yields. At similar
level of yields, the belly was much cheaper earlier this year. We recommend shorting the
5s7s10s fly, which should also benefit from intermediate sector supply.
We also maintain our 10s30s steepener view as fundamentally the curve looks too flat given
current expectations of monetary policy and the levels of long term inflation expectations,
though investors should consider hedging it by shorting real yields to benefit from an
unwind of QE expectations. While long-end supply being behind us argues for a near-term
flattening as the concession is unwound, the setup that happened mainly in the morning
heading into the auction has already been unwound, in our view. 30y yields rose 7bp until
1pm on Thursday but ended the day almost unchanged as the auction came through by
2.5bp. Similarly, the 10s30s curve steepened ~2bp until 1pm but ended the day slightly
flatter. Hence, the risk of a flattening from a further unwind of the concession seems low.
RV opportunity in shorter maturity HC securities
With ongoing Fed sales in the front end but stable short-term yields, relative value
opportunities in the high coupon space have gone unnoticed. We recommend switching
from the rich high coupon issues, 9.875% Nov 15s, to the cheaper ones , 11.25% Feb 15s,
as the latter have unduly cheapened after becoming eligible for Fed sales under Twist.
Modest economic data in US do
not argue for much higher yields
We recommend shorting the
5s7s10s fly, as excessive
expectations of further stimulus
should normalize and the
auction concession
should build in the belly
We maintain our 10s30s
steepener view, as the setup
ahead of the bond auction
already seems to have been
unwound
Figure 3: European bank spreads are now catching up withEuropean sovereign spreads
Figure 4: Risk aversion, USD Libor-OIS spread, has room torise
0
50
100
150200
250
300
350
400
Jan-10 May-10 Oct-10 Feb-11 Jul-11 Dec-11 Apr-12
Average Sovereign 5y CDS Spreads, bp
European Senior Financial 5y CDS Spreads, bp
125
175
225
275
325
375
May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12
10
20
30
40
50
60
70
80
European financials,5y CDS spreads, LHS, bp
1y fwd 3M LOIS Expectations, bp, RHS
Source: Bloomberg Source: Bloomberg
https://live.barcap.com/go/publications/content?contentPubID=FC1804425https://live.barcap.com/go/publications/content?contentPubID=FC1804425https://live.barcap.com/go/publications/content?contentPubID=FC1804425https://live.barcap.com/go/publications/content?contentPubID=FC18044257/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
10/47
Barclays | Market Strategy Americas
10 May 2012 10
One way to judge the relative cheapness is to compare the discount at which P STRIPS from
the high coupon (old 30y) series are trading versus their lower coupon (10y series)
counterparts (Figure 5). There does not seem to be a consistent trend, and there is a fair bit of
variation in how the high coupon issues are asset swapping versus the low coupon issues; Feb
15s/May 16s are ~2bp cheaper, whereas Nov 15s are 6bp richer. This was not always the
case: Figure 6 shows that Feb 15s cheapened quite dramatically in February, when they first
became eligible for sale, and May 16s also cheapened later, even though they are well beyondthe 3y maturity. Nov 15s, on the other hand, have drifted steadily richer.
While some of this variation can be explained by the difference in the available float, Feb 15s
and Nov 15s are still outliers. Figure 7 plots the relative cheapness of high coupon issues
against the available float (outstanding minus the amount held by the Fed). The higher the
float, the cheaper the issue is. For instance, the cheapness of May 16s can be attributed to
the almost $13.2bn available float as compared with a median float of $5.6bn. Still, Feb 15s
look 2bp cheap and Nov 15s are 2bp rich. Even though Aug 15s float is $1bn lower and Feb
16s is only $0.2bn higher, they are ~3bp cheaper to Nov 15s.
The cheapening of Feb 15s since the beginning of the year is only partly justified by sales
under Operation Twist. The Fed has sold ~$2.2bn since February, increasing the float
outstanding to $8bn. The Fed currently holds $2.5bn but with the recent declining trend of
the amount sold and only two operations left, it is unlikely that the float will increase
materially (Figure 8). It therefore seems odd that Feb 15s are trading at similarly cheap
levels of May 16s.
We therefore recommend investors switch from 9.875% Nov 15s to 11.25% Feb 15s (in
whole bond or STRIPS space); we expect the yield spread of P STRIPS to compress by 4bp.
High coupon Feb 15s and May
16s are trading cheap and HC
Nov 15s are trading rich
Figure 5: No consistent trend in the relative pricing of highcoupon Issues
Figure 6: HC Feb 15s cheapened recently as they becameeligible for Fed sales; spread versus LC counterpart
-38
-36
-34
-32
-30-28
-26
-24
-22
-20
Feb-15 Nov-15 May-16 May-17 May-18
Ps ASW - 30y series Ps ASW - 10y series
-8
-6
-4
-2
0
2
4
Jan-12 Feb-12 Mar-12 Apr-12 May-12
Feb 15s Nov 15s May 16s
Source: Barclays Research Source: Barclays Research
Feb 15s appear cheap and Nov
15s rich, even after controlling
for the level of available float
We recommend switching from
HC Nov 15s to HC Feb 15s
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
11/47
Barclays | Market Strategy Americas
10 May 2012 11
Figure 7: Feb 15s look cheap and Nov 15s rich, even afteraccounting for the differences in available float
Figure 8: Fed sales of HC Feb 15s have declined quitesharply; not much of a risk to a long view
y = 0.55x - 4.95
R2
= 0.64-6
-5
-4
-3
-2
-1
0
1
2
3
0 2 4 6 8 10 12 14
Feb 15s
May 16s
Nov 15s
Available Float, $bn
Discount of 30y P STRIPS to 10y P STRIPS
y = 0.55x - 4.95
R2
= 0.64-6
-5
-4
-3
-2
-1
0
1
2
3
0 2 4 6 8 10 12 14
Feb 15s
May 16s
Nov 15s
Available Float, $bn
Discount of 30y P STRIPS to 10y P STRIPS
1.444
0.661
0.11
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
2/23/12 3/29/12 4/27/12 5/29/12 June
Amount Sold of 11.25% Feb 15s
$bn
Source: Barclays Research Source: New York Fed, Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
12/47
Barclays | Market Strategy Americas
10 May 2012 12
INFLATION-LINKED MARKETS
A glance at foreign holdings
Foreign investors have become an important demand base in the TIPS market. The
update to the annual TIC holdings report has finally provided some detail. These datashow that foreign accounts owned $206bn TIPS as of June 2011, a figure we expect to
continue to grow.
Finally, some outside data
In early 2009, when the 10y breakeven got near zero, foreign investors came in to buy. This
in itself was not an oddity because there had been tactical trading from that demand base
before and we also viewed breakevens as cheap to fundamentals. The surprise was that
even once breakevens recovered, not only did those positions not get unwound, but buying
continued. Whereas before 2009 there were few foreign official institutions with structural
allocations to the TIPS market, they seemed to have been drawn in by relative value, but
became structural buyers because of diversification and concerns about the potential for a
declining USD. Others also realized that a neutral weight to TIPS was at least some levelabove zero, given that TIPS make up about 7.5% of outstanding Treasuries.
While we have discussed this changing demand base, there has been little official data as
evidence to which we could point. Finally, the Treasury has included a breakout of TIPS in its
update of its annual TIC holdings survey of foreign investors, and it shows some interesting
results. As of June 30, 2011, the data show that foreign accounts owned $206bn in TIPS, of
which $136bn was held by foreign official institutions. This means that whereas foreign
accounts own about 50% of all US Treasuries, they owned only about 27% of the TIPS
market. Foreign official accounts, which owned about 18% of the TIPS market, had a lower
relative holding: they accounted for about 75% of total foreign-owned Treasuries, whereas
they only accounted for about 66% of foreign-owned TIPS holdings.
Figure 1: Foreign holdings of Treasuries as of June 30, 2011 Top 10 holders of TIPS
Treasury long-term debt (1)
Countries and Regions Total Total
of which:
Nominal
of which:
TIPS
Treasury
short-term
debt
TIPS as %
of Total
TIPS as a
% of LT
China, mainland 1,307 1,302 1,266 37 5 2.8% 2.8%
Middle East oil-exporters 189 117 97 20 72 10.6% 17.2%
Taiwan 147 144 125 20 2 13.3% 13.6%
Singapore 64 58 40 18 7 28.3% 31.5%
Japan 882 818 805 13 64 1.5% 1.6%
Cayman Islands 111 47 36 11 64 9.9% 23.5%
Brazil 216 212 201 11 4 4.9% 5.0%
United Kingdom 130 118 108 10 13 7.5% 8.3%
Switzerland 118 106 97 10 12 8.2% 9.1%
Luxembourg 124 88 81 7 36 5.3% 7.5%
Australia 21 17 11 6 5 27.2% 35.0%
Note: (1) Long Term (LT) denotes original maturity of over one year. Source: US Treasury
Michael Pond
+1 212 412 [email protected]
Chirag Mirani
+1 212 412 6819
As of June 30, 2011, the TIC data
show that foreign accounts
owned $206bn in TIPS
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
13/47
Barclays | Market Strategy Americas
10 May 2012 13
A few data highlights stick out. China is reported to have owned the most TIPS among
foreign accounts at $37bn, though this is only 2.8% of Treasury holdings, whereas TIPS
accounted for about 4% of total foreign ownership of Treasuries (Figure 1). Middle East oil
exporters, Taiwan, and Singapore come in a close second, third and fourth with about
$20bn each in TIPS holdings. Singapore, Australia and Malaysia have over 30% of long-term
Treasury holdings in TIPS, and Denmark is not far behind with a 26% allocation. Of its
$151bn in Treasury holdings, Russia owns just $21mn in TIPS.
The regional breakout (Figure 2) shows that Asia owned the most TIPS at $117bn; we
believe this largely represents foreign official holdings. Europe and the Caribbean owned
$44bn and $15bn, and we believe this is held mostly by money managers and hedge funds.
If foreign accounts were to move to a market neutral weight, which would be about 7.5% of
total Treasuries, this would mean holding about $350bn, or about $147bn more than June
2011 levels. We would argue that foreign accounts should actually hold greater than a
market weight allocation to TIPS because they offer a de facto currency hedge relative to
nominal Treasuries. Therefore, while structural buying has been strong and the Treasury
has responded to additional demand through increased issuance, we believe structural
foreign demand will continue to grow with the market. We hope more detail will follow on
the history on foreign ownership of TIPS, but are happy to have gotten some hard data.
Figure 2: Foreign holdings of Treasuries as of June 30, 2011 regional breakdown
Treasury long-term debt (1)
Countries and Regions Total Total
of which:
Nominal
of which:
TIPS
Treasury short-
term debt
TIPS as %
of Total
TIPS as a
% of LT
Total 4,708 4,049 3,843 206 658 4% 5%
of which: Holdings of foreign officialinstitutions 3,518 3,103 2,968 136 414 4% 4%
Total Africa 36 24 24 0 12 0% 0%
Total Asia 2,962 2,658 2,540 117 304 4% 4%
Total Caribbean 212 111 96 15 101 7% 14%
Total Europe 1,041 851 807 44 190 4% 5%
Total Latin America 318 288 273 15 30 5% 5%
Canada 45 36 31 4 9 9% 12%
Total Other Countries 25 19 13 6 6 24% 32%
Country Unknown 0 0 0 0 0 16% 19%
International and Regional Organizations 68 63 59 4 6 6% 7%
Note: (1) Long Term (LT) denotes original maturity of over one year. Source: US Treasury
Buying at auction accounts for less than half of holdings
Also providing evidence of increased foreign involvement in the TIPS market are the
Treasurys auction allotment data. Since 2009, foreign accounts have bought an average of
$1.27bn at 5y TIPS offerings, compared with about $730mn before 2009 (Figure 3).
Similarly, the average 10y auction takedown by foreign and international accounts has been
$1.5bn, whereas before 2009 it had been $668mn (Figure 4). However, the sum of all TIPS
bought by foreign and international accounts since 2000 is about $70bn. The total holdings
data of $206bn as of June 2011 indicate that this was only a small part of the demand
coming from abroad.
The regional breakout (Figure 2)
shows that Asia owned the most
TIPS, at $117bn
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
14/47
Barclays | Market Strategy Americas
10 May 2012 14
Figure 3: 5y TIPS auction allotment to foreign accounts($mn)
Figure 4: 10y TIPS auction allotment to foreign accounts($mn)
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
Oct-05 Apr-07 Oct-08 Apr-10 Aug-11
Foreign and international
0
500
1,000
1,500
2,000
2,500
3,000
Apr-06 Jul-07 Oct-08 Jan-10 Jan-11 Nov-11
Foreign and international
Source: US Treasury Source: US Treasury
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
15/47
Barclays | Market Strategy Americas
10 May 2012 15
AGENCIES
Back in black
With foreign interest in agency bellwethers returning, we examine the first Fannie Mae
quarterly profit to taxpayers since conservatorship. While both GSEs could stay roughlyprofitable near term, a dividend-rate redefinition would remove significant uncertainty.
Foreign participation remains robust; opportunities remain
Well above average foreign participation in recent 5y bellwether issuance, in our view,
reflects market participants comfort with GSE credit, which Fannie Maes (FNM) 1Q12
results should boost. At +27bp to matched-date Treasuries, we believe the 5y sector still has
tightening potential, as does the 7y point at T+33bp (Figure 1).
We concur in our base-case view that the remaining $125bn/$150bn in post-2012 capital
support will more than suffice to support the GSEs over the next few years, as the high
credit quality, post-conservatorship vintages have become a 55%-and-growing share of the
guarantee books (Figure 2). This should allow enough time for Congress to hammer out
housing finance reform. Furthermore, the Treasury can unilaterally increase the margin of
safety, and time, by modifying the senior preferred dividend rate.
Fannie Mae 1Q12 financials: The beginning of the end (of provisions)
Fannie Mae posted net income of $2.7bn in 1Q12 after a $2.4bn loss in 4Q11, the first
positive quarter since 4Q10, before paying $2.8bn in senior preferred dividends to the
Treasury. Owing to a mark-up in AOCI, FNM did not make a request for more capital during
the period, the first such quarter since the conservatorship. Factors in the improvement
occurred across the board: a reduction in credit loss provisions, increase in net interest
income, and modest MTM gains on derivatives all contributed.
Credit provisioning reduces sharply; reserves expected to sufficeFNM provisioned just $2.0bn for credit losses in 1Q12 after $5.5bn in 4Q10, as single-family
loss severities decreased to 33% after reaching 37% in late 2011. In our view, this seems in
line with the sharp recent reduction in serious delinquency rates at FNM. Notably, FNM
James Ma
+1 212 412 [email protected]
Rajiv Setia
+1 212 412 5507
We expect remaining PSPA
capacity post-YE12 to more than
suffice
Figure 1: Agency-Treasury spread curve stays steep Figure 2: Guarantee book quality varies sharply by vintage
0
10
20
30
40
50
0 2 4 6 8 10
Maturity, y
A-T Spd, bp
FNM FRE FHLB
660
680
700
720
740
760
780
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
16/47
Barclays | Market Strategy Americas
10 May 2012 16
estimates that with the $2.0bn in credit provisioning it recognized this quarter, its balance of
loan loss reserves would be sufficient to cover future losses on the legacy guarantee book.
With this balance at $75bn, the $85bn in cumulative charge-offs since 2008 imply total legacy
guarantee losses of $160bn; this is roughly in line with our own estimates. 1 This dovetails with
FNMs expectation that credit-related expenses will be less in 2012 than 2011 (which were
$26bn). The same calculation at FRE gives $83bn in guarantee losses from $38bn in reserve
balances and $45bn in charge-offs (also close to our estimates, Figure 3).
Recall that our estimates were based on cumulative NPA reaching $550bn at both GSEs with a
45% severity rate, for combined credit losses of $250bn. Our view was partly predicated on
lower recovery from the MIs, to which FNM/FRE have $90bn and $40bn of exposure,
respectively. As of Q1, the GSEs have recognized $464bn (Figure 4). If housing rebounds
strongly, it is possible our default and severity estimates may prove high. The fact that the
GSEs provisioning has been in line with our more punitive estimates indicates that FNM/FREhave been conservative in provisioning for losses on their legacy book of business.
Net interest income stays stable; MTM items swing to gains
Net interest income improved in 1Q12 at FNM to $5.2bn, after totalling $4.5bn the previous
quarter, as funding costs fell. Along with slow prepayments, this has made the portfolios a
profitable revenue stream for the GSEs (Figure 5), a pattern likely to continue over the next
few years. However, in the medium term, mandatory portfolio shrinkage (at least 10% per
year), increasing NPA, and rising funding costs could all erode net interest income.
Derivatives positions led to a MTM $280mn gain at FNM in Q1, up from the $800mn loss in
4Q11 (note that FRE booked a $1bn loss in Q1). The level of rates should remain a large
source of volatility in GSE earnings: for instance, the 5y swap rate has rallied 20bp quarter-to-date, a move that would likely lead to a FAS 133-related charge in Q2.
OTTI has remained minimal at $60mn recognized in income. Also, AOCI in owners equity was
marked up $400mn, leading to the zero draw in Q1. We are less sanguine about such mark-
ups to offset taxpayer lossesat currently high dollar prices/low durations, the retained
portfolios higher-coupon MBS have more limited scope for price appreciation.
1 US Agencies Outlook 2012 Achtung baby, 13 December 2011
Figure 3: Provisions approach our estimated total needs Figure 4: NPA balances increase, but more slowly
79
160
0
20
40
60
80100
120
140
160
180
FHLMC FNMA
$bn
Loss provision Barclays' estimated credit loss
85
165
in 000 loans FNM FRE Total
90d+ Delinquencies, as of 1Q12 651 401 1,052
REO on Balance Sheet, 1Q12 114 59 173
Cum REO Liquidations, 3Q08-1Q12 629 314 943
Cum Short Sales/DIL, 3Q08-112 219 123 342
Total NPA Loans, as of 1Q12 1,613 897 2,510
Total Loans Serviced 17,738 11,425 29,163
As a % of Guarantees 9.10% 7.90% 8.60%
Total NPA Loans, in $bn 298 166 464
As a % of Guarantees in $bn 10.70% 9.50% 10.30%
Source: Barclays Research Source: Barclays Research
Balance of loss reserves and
cumulative charge-offs in line
with our projections
Net interest income improves,
but we see reasons for portfolio
revenues to erode
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
17/47
Barclays | Market Strategy Americas
10 May 2012 17
A pause in draws bolsters our views on GSE credit
By making no draw this period, FNM has kept its balance of senior preferreds outstanding at
$117bn through 1Q12 (FRE has also stayed stable at $72bn). We would not be surprised to
see FNM stay just at the cusp of profitability for the balance of 2012, but would anticipate
sustainable profits once loss provisioning for legacy guarantee losses ceases in 2013.
Consider the below stylized GSE income statement (Figure 5):
We assume the guarantee books stay stable at $4.7trn combined (ie, the GSEs maintainmarket share) and fee rates stay at 25bp the Treasury has diverted revenues from the
last fee hike (10bp) to fund the payroll tax cut extension, and we expect any future fee
hikes to be similarly siphoned. This leaves $11.75bn/year in revenues, assuming
minimal prospective credit losses.
At a 180bp NIM and $1.3trn size, the retained portfolio throws off $23bn in net interestincome in 2012; however, as the portfolio is mandated to shrink 10%/year, this revenue
stream decreases, for instance to $20.7bn in 2013.
With credit provisioning finished in 2012, the main source of expenses will be the seniorpreferred dividend payments, which at 10%/year is near $20bn combined.
This simplistic exercise implies that the GSEs could become profitable for a period in the
medium term in our base case, even assuming a 10% preferred dividend. However, draws
would continue if: a) NIM compresses, b) the portfolios shrink, or c) both occur. Thus, to
increase the margin of safety in case of a double dip in the economy, we recommend the
Treasury redefine the senior preferred dividend to the lesser of 10% or all the net income in
a period. Note that no congressional approval would be needed for this; pending the
outcome of the elections, this may occur as early as December.
Stress case scenario and implications for the future of housing finance
In this vein, we have received increasing inquiries on how long the remaining capital
($125bn at the larger FNM) would last after YE12 in a stress case. Using a stylized example:
The $125bn in capital remaining post-YE12 supports a mortgage portfolio of about$2.8trnthis would be exhausted with roughly 5% losses on the post-conservatorship
book. Assuming severity rates near the current 40%, the implied default rate is 12.5%.
We expect GSE profitability to be
ultimately temporary, requiring
Treasury action
Figure 5: Stylized GSE income statement Figure 6: GSEs continue to short fund
Projections, $mn 2012 2013
Guarantee income (25bp on $4.7trn) 11,750 11,750
Net interest income (1.8% on $1.3->$1.15trn) 23,400 20,700
Expenses ($0.5bn/quarter each) -4,000 -4,000
Credit provisioning (est) -14,000 0
Net income before senior pfd dividend 17,150 28,450
Senior preferred dividend -19,400 -19,625
Net income to the taxpayer -2,250 8,825 0%
10%
20%
30%
40%
50%
60%
70%
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
Short-term Bullet Callable
Source: Barclays Research Source: Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
18/47
Barclays | Market Strategy Americas
10 May 2012 18
Per our colleagues in residential credit strategy, this is consistent with another 20% HPIdecline and/or a spike in unemployment to 13-14%; as the underlying mortgages are
higher-quality origination, the latter would be more significant.
We think a stress scenario such as the one above is not particularly useful. The fact remains
that in the event that market shocks tighten financial conditions and lead investors to
conclude that another double-dip in housing is likely, a lack of capital support at the GSEswill trigger market instability even before credit losses materialize. The simple fact is that the
GSEs funding is still extremely reliant on continued market access. Consider that about
40% of the GSEs funding is either discount notes or callable debt (Figure 6); FNM/FRE
would face refunding difficulties well in advance of their capital being drawn down.
We also believe the entrenched interests in FNM/FRE, including Fed ownership of $950bn in
their debt and MBS, are too great for the government not to act to prevent any adverse
outcome such as the above. Further, in the near term, given that there are no viable
alternatives to the GSEs for housing finance, any market shock would have severe ripple
effects on global capital markets.
For instance, foreign capital would likely flee the mortgage market. By our measures,
foreigners hold about $1trn in agency MBS and debt combined. Moreover, in this macro
environment, banking sector losses would also be substantial and require government
support. Given the numerous steps taken by policymakers to support housing thus far, the
scenario above is far-fetched.
Despite our base case view that the GSEs will become profitable before preferred dividends
by next year, we continue to recommend that the Treasury adjust the preferred coupon,
preferably to the lower of 10% or all net income in any given quarter. In our view, this would
increase the margin of safety available to debt/MBS investors, and ensure that:
Future dividends are not paid with still more draws, a problem in past quarters. The credit and capital situation at FNM/FRE cannot become a cause of financial
instability and investor concern.
Windfall gains are not given to junior preferred and common equity holders.In our view, such a course of action would buy sufficient time for true housing finance
reform, both for Congress to agree on replacements and for household and bank balance
sheets to heal enough to accommodate a new system.
While the 1Q12 FNM result is a positive and squares well with our loss estimates, the GSE
business model is not sustainable in the long run. Therefore, we expect the government to
act sooner rather than later to address some of these concerns and prevent undue
turbulence in global markets. We believe it would be prudent to do so before YE12, when
the PSPA limits return.
A stress case scenario may not
need to occur for GSE funding to
be disrupted
We continue believe the simplest
way to increase the margin of
safety is a dividend redefinition
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
19/47
Barclays | Market Strategy Americas
10 May 2012 19
SWAPS
May 2010 all over again?
Given the return of European concerns, we believe that near-dated FRA-OIS wideners
have attractive risk-reward profiles. They should benefit even if Libor rises for a few daysin a row, and the downside is limited, in our view, given Libors recent stability.
Greek and French election results last week sparked renewed concerns about a crisis in
Europe, sparking a flight to quality and a widening of front-end swap spreads. Libor registered
its first increase in two weeks, even though it was a tenth of a basis point and driven by the
Libor setting of only one bank. Given the extreme degree of uncertainty until the middle of
June, when Greece has payments due, we still recommend buying protection in the form of
Libor-OIS spread wideners.
The optimal point for buying protection is now at the very front end
In Simmers of Discontent, published on April 12, we introduced two metrics to determine
the optimal forward starting point for buying Libor protection:
The ratio of the upside to the 1y range in putting on a widener, assuming a move inFRA-OIS comparable with that of September last year over the next three months, after
accounting for roll-down. A higher ratio means that the point is further away from the
high of last year and closer to the lower end of the range.
The risk in the trade, represented by the volatility of the particular forward Libor-OISspread over the past year.
Based on these metrics, we recommended Libor-OIS wideners with 2y forward starting dates.
However, over the past four weeks, there has been a widening of this spread, and from a roll-
down point of view, the trade is no longer as attractive (Figure 1). In fact, long-dated forward
Libor-OIS spreads are now wider than at the peak of last year.
Figure 1 suggests that the risk reward of buying FRA-OIS protection at the very front end,
has improved significantly. The market is pricing in only a 1bp widening in spot Libor-OIS
Amrut Nashikkar
+1 212 412 [email protected]
The resurgence of European
sovereign risk has led protection
trades to perform well
Figure 1: 3m3m Libor-OIS wideners now offer a better riskreward profile than spreads further out
Figure 2: The average European bank has higher Libor setsthan the average non-European bank
40%
45%
50%
55%
60%
65%
70%
75%
1m3m 3m3m 6m3m 1y3m 2y3m
Upside/1y
range
9-May-12
40
42
44
46
48
50
52
54
56
58
60
Feb-12 Mar-12 Apr-12 May-12
Avg US bank setting Avg UK bank setting
Avg EUR bank setting
Source: Barclays Research Source: Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
20/47
Barclays | Market Strategy Americas
10 May 2012 20
spreads over the next month. A short-term widener would benefit from any risk flare but
should not lose too much otherwise, considering that Libor has been stable at its current
levels and the European crisis is likely to continue. Furthermore, given the momentum the
market prices in the forward spread curve once Libor begins to widen, a 1m or a 3m
forward starting widener should do well even if Libor merely rises for three or four days in a
row. We believe that the chances of that happening are high, and the trade can be re-
evaluated at that stage. The question is whether a near-term increase in Libor that wouldmake these trades perform is possible.
The link between Libor-OIS and sovereign risk
Since the beginning of the financial crisis in 2007, the Libor settings of European banks have
generally been higher than those of US banks. This can be seen in Figure 2 while the Libor
sets of US and UK banks declined significantly over the past three months, those of
European banks have lagged. This is because of a dollar asset-liability mismatch in Europe
and because Europe has experienced the sovereign and the associated banking crisis.
This can be seen in Figure 3, which shows that the average USD Libor setting of banks
belonging to a particular country is higher if the sovereign CDS of the country trades at a
higher level. This relationship is as true today as it was three months ago. For instance, whileFrench sovereign CDS has deteriorated, the average French bank 3m Libor setting has not
risen. This, in itself, suggests that a rise in Libor is possible.
Furthermore, the recent increase in European banks CDS has yet to be reflected in their
Libor settings. This can be seen from Figure 4, which shows a plot of spot 3m Libor-OIS
spreads against European financial CDS spreads. Since 2009, an increase in CDS spreads has
usually preceded a rise in Libor, and a decrease in CDS has preceded a fall in Libor. When
viewed in this light, a rise in Libor back to the levels of January 2012 does not appear far-
fetched. With a one-month lag, a monthly increase of 40bp in European bank CDS spreads
should lead to a 1m rise in Libor of 5bp. Considering that this is comparable with the
increase in bank CDS spreads over the past month, it would be consistent with the historical
pattern if Libor rose by 5bp.
However, it might now
make sense to initiate near-
dated FRA-OIS wideners rather
than long-dated ones
The increase in sovereign and
bank CDS spreads over the past
month suggests that a near-
term rise in Libor is possible
Figure 3: Libor settings of banks are strongly related to thehealth of their sovereigns
Figure 4: Changes in the European financial CDS indexprecede changes in 3m Libor-OIS by about a month
Swiss
US
UK
Germany
Japan
France
35
40
45
5055
60
65
25 75 125 175 225
Sov. CDS (bp)
Avg Libor
set (bp)
Current
3 months ago
-30
-20
-10
0
10
20
30
-100 -50 0 50 100
Itraxx- SNRFIN 5y (MoM 1m lagged)
3mLOIS
MoM
Source: Barclays Research Source: Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
21/47
Barclays | Market Strategy Americas
10 May 2012 21
FUTURES
TU too rich
The front TU contract appears rich, driven by positioning; we recommend purchasing
the two potential CTD securities basis heading into the roll month. In tandem, sellingATM straddles can be used to establish a position that performs well across scenarios.
As the front TU front contract enters the M2-U2 roll month, it appears rich, as evidenced by
a negative net CTD basis (Figure 1) and high implied repo rates. One possible reason is the
recent increase in long positions by asset managers and other reportable investors, because
these tend to be less price sensitive categories. The two classes of investors have increased
their net long positions, as a percentage of open interest, by 30pp and 5pp, respectively,
since the end of March (Figure 2).
Trade outline and rationale
Given the richness of the TU contract, we think going long the basis of either of TUM2s
close CTDs. The risk-return profile is even better if we combine basis positions in the twoclose CTDs. Assuming a notional of $10mn, we recommend buying $10mn par of 1.75%
Mar14s, buying 10mn par of 1.25% Mar14s and selling 93 TUM2 ($200k notional)
contracts against the cash securities. Since basis positions are effectively options on the
yield curve and slope, the combined position is effectively a long straddle position, while
taking advantage of the current richness of the contract. The position benefits from the net
basis increasing to zero at expiration. Further, considering the recent long build-up by asset
managers and other traders, there could be cheapening pressure on TUM2 during the roll,
so this is a good time to establish the position, in our view.
Since the combined basis position has a payoff at expiry similar to that of an option straddle,
we can monetise it by selling straddles with an offsetting payoff. Specifically, against the
basis positions highlighted earlier, we recommend selling five TUN2 call options struck at110.25 (ATM) and five TUN2 put options struck at 110.25 (ATM).
Amrut Nashikkar
+1 212 412 [email protected]
Vivek Shukla
+1 212 412 2532
Figure 1: TUM2 net basis for the two potential CTDs appearsrich (32nd)
Figure 2: CFTC reports shows that asset managers and otherreportables have increased their net longs in the TU contract
-1.4
(2.5)
(2.0)
(1.5)
(1.0)
(0.5)
-
0.5
1.0
1.5
2.0
05-Apr 12-Apr 19-Apr 26-Apr 03-May
1.75% Mar14s Net Basis 1.25% Mar14s Net Basis
-30%
-20%
-10%
0%
10%
20%
13-Mar 22-Mar 31-Mar 09-Apr 18-Apr 27-Apr
Dealer Net Long
Asset Manager Net Long
Leveraged Money Net Long
Other Reportables Net Long
As % of open interest
Source: Barclays Research Source: CFTC, Barclays Research
Implied repo rates and the net
bases of the two CTD contenders
suggest that TUM2 is rich
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
22/47
Barclays | Market Strategy Americas
10 May 2012 22
CTD switch under different yield curve and slope scenarios
Two securities can be the CTD at the time of last delivery date for the TUM2 contract:
1.75% Mar14s (current implied repo of 40bp) and 1.25% Mar14s (current implied repo of
41bp). Under scenarios of an increase in 2y rates or a 2s3s curve steepening, the former is
more likely to be the CTD, given that it has slightly higher modified duration, while the
opposite is true for the latter.
Based on the historical relationship between 2y yields and the 2s3s curve, where the curve
steepens 0.7bp for every 1bp sell-off, and vice versa, we have considered scenarios of 2y
yields declining 25bp or increasing to 55bp in increments of 5bp, and 2s3s curve steepening
8-30bp correspondingly. We use these scenarios to judge the performance of the proposed
trade in Trade Details below.
Before we proceed with the analysis of the trade, it is reasonable to ask what range of
changes in the level of 2s and the slope of 2s3s we can expect over the next 50 days (ie,
until the futures delivery date). Over the past year, with the Fed firmly indicating that it
expects to keep target rates at exceptionally low levels, 2y rates have been range-bound
between 55bp and 15bp. Thus, the ranges considered above are reasonable. No other
security, apart from 1.75% Mar14s and 1.25% Mar14s, comes close to being the CTD in anyof the scenarios.
Trade details
Instead of putting on a vanilla long CTD basis position, combining the 1.25% Mar14 and
1.75% Mar14 basis positions makes more sense, in our view. Under scenarios where one of
the two securities happens to be CTD, its net basis is zero. However, the other security will
have a positive net basis, as it is not the CTD. Thus, these two basis positions can be
combined using appropriate weights to produce the desired risk-return profiles.
Simplistically, combining these two basis positions in a 1:1 ratio produces the net basis at
expiration profile outlined in Figure 3. Intuitively, when futures prices are below 110.2 (ie, in
sell-offs and curve steepenings), 1.75% Mar14 becomes the CTD; hence, its net basis at
expiration is 0. In these scenarios, the overall P&L is driven by the richening of the basis of
1.25% Mar14s (in addition to benefiting from the basis of the CTD increasing from the
current -1.3 ticks to zero). The opposite is true for rates rallies or curve flattenings. The
In our view, a combined basis
position in the two CTDs is
attractive across rate scenarios
Figure 3: Net basis at expiration of recommended trade ineach of the considered rate scenarios
Figure 4: Combined payoff of options + futures position
-
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
109.4 109.6 109.8 110.0 110.1 110.3
Basis, 32nd
Futures Price
(2.00)
(1.50)
(1.00)
(0.50)-
0.50
1.00
1.50
2.00
109.4 109.6 109.8 110.0 110.1 110.3
Options position payoff Basis payoff Net
32nd
Futures Price
Source: Barclays Research Source: Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
23/47
Barclays | Market Strategy Americas
10 May 2012 23
trade also earns carry on the long cash note position in both legs. We have assumed that
the positions can be financed at overnight repo rates until expiration at 13bp.
Further, this payoff profile can be monetized using options on TUM2 contracts; hence, the
premium can be collected upfront. For the scenarios considered, Figure 4 outlines the payoff
from selling five ATM (strike 110.25) TUN2 straddles for every 100 long futures positions,
collecting an upfront premium of 0.21 ticks. It also shows the combined payoff at expirationfrom the overall strategy (ie, long two basis positions, short two options). The net payoff
line is close to zero at expiration. In other words, this position does not depend on which of
the assumed scenarios is realized. The total payoff will be the option premium collected,
plus the profits from the net basis increasing to 0 from negative levels.
Given the straddle-like payoff of
the combined basis position, one
can also sell TUM2 straddles to
monetise its positive convexity,in addition to benefiting from the
richness of the futures
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
24/47
Barclays | Market Strategy Americas
10 May 2012 24
VOLATILITY
Skew blues
The payer skew is higher than can be justified by rates or the delivered rate-vol
relationship. We suggest knock-out payers to those looking for higher rate protection.
The payer skew on 10y tails has richened lately, reflecting market worries about higher rates
(Figure 1). We think some of this is justified, given low rate levels; nonetheless, it may have
gone a bit too far and warrants monetization.
Fundamentally, payer skew is an argument about "lognormal rates." If rates are low, the
possibility of a 10bp decline is not the same as a 10bp rise, so rates are lognormal. This
holds true for front-end rates or for those in Japan. But 10y rates in US, especially in forward
space, while historically low, are not low enough to justify such lognormal expectations.
For example, the 3y forward 10y swap rate is 2.92%, clearly not low enough to suggest a
10bp decline is not as possible as a 10bp rise, or even a +/- 50bp change.
The fair comparison, from a purely rates perspective, is with the EUR market, where 10yrates are quite similar. For example, the 3y10y EUR swap rate is roughly 2.7%, which is
actually lower than the USD rate. Even so, the EUR skew is not as high as the US skew
(Figure 1). To be fair, EUR skew has been richening rapidly, but even so, the USD skew is
now almost as high as it was in H2 09, when there was significant demand for high-rate
positioning. That demand was also manifested as higher vol: 3y*10y was roughly 30bp/y
higher than current levels.
This brings us to the questions whether there should be any skew, and how much. The answer
to the first is easier: the current level for US rates is unambiguously low, and the risk of a large
sell-off (say, 200bp) is more than a large rate rally. So there should be some skew.
To quantify the size of the skew, we looked at delivered skew over the past few years. Figure
2 plots the daily change in 3y*10y normal vol, along with 3y10y swap rate since the
beginning of 2009. We use early 2009 as the start date because the Fed eased to near zero
on fed funds, and even longer rates fell to historical lows. The period since then shares the
generally low rate environment to which skew has been subjected.
Piyush Goyal
+1 212 412 [email protected]
Figure 1: USD payer skew has richened, is much higher than EUR where rates are similar
-15
-10
-5
0
5
10
15
20
25
30
Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11
US EUR
3y*10y 100bp HS - 100bp LS skew (bp/y)
Source: Barclays Research
US skew is high
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
25/47
Barclays | Market Strategy Americas
10 May 2012 25
There are two key takeaways.
There is a conspicuous relationship between rate and vol: higher vol has generallyescorted a rise in rates.
Two, even during the past few months (starting September 2011), when a sell-off haseluded rates, there has seen a visible relationship.
So as already argued, some skew is justified. But the regression since September 2011
suggests a 100bp change in rates leads to only a 3bp/y change in vol. So the fair value of a
200bp wide skew is perhaps 6bp/y, much lower than the 19bp/y that it is priced. Even with
the longer history since January 2009, the value for the 200bp wide skew is not justifiable
beyond 14bp/y.
However, the markets pricing in much higher payer skew reflects the presence of flows.
Most likely, there continues to be demand for higher rate protection, with investors
positioning for/hedging the specter of higher rates via out-of-the-money payer swaptions.
Also, 1x2 receiver ladders are in vogue. For example, a 3y*10y 1x2 receiver ladder (2.5 vs.
1.95) costs nothing and does not incur a loss unless the 10y swap rate is lower than 1.4%
three years out. With the Fed fighting deflation, it is not unreasonable to expect 10y swaps toend higher than 1.4%. These ladders also carry well. As investors buy high-strike payers or
sell low-strike receivers via the 1x2 receiver ladders, the skew ends richer than can be
fundamentally justified.
Overall, skew is higher than can be justified by the rate backdrop or the rate/vol correlation.
Therefore, we recommend monetizing the same.
Skewering the skew
Investors looking for higher rate protection should consider knock-out payers. A 3y*10y 3%
payer that knocks out at 5% (so no pay-off if rates are higher than 5% three years later) is
40%+ cheaper than a comparable 3y*10y 3%-5% payer spread (Figure 4). The lower cost
improves the pay-off from the structure. The payer spread has a risk-reward of ~1:4.5, while
the knock-out payer has a risk-reward of more than 1:8.
Figure 2: 100bp rise in rates means ~7bp/y rise in 3y*10y vol Figure 3: More recently, 100bp corresponds to 6.4bp/y
y = 0.070x - 0.008
R2
= 0.178
-8
-6
-4
-20
2
4
6
8
10
-60 -40 -20 0 20 40 60
Daily change in 3y10y rate (bp)
Daily change 3y*10y (bp/y)
y = 0.032x - 0.059
R2
= 0.093
-4
-3
-2
-1
0
1
2
3
4
-40 -30 -20 -10 0 10 20 30
Daily change in 3y10y rate (bp)
Dai ly change 3y*10y (bp/y)
Note: Data period: January 1, 2009-May 10, 2012. The chart shows that dailychanges in normal 3y*10y vol is noticeably correlated with rates. Source:Barclays Research
Data period: September 1, 2011-May 10, 2012. Source: Barclays Research
While some skew should exist,
current levels are higher than
can be justified by the delivered
rate/vol relationship
Investors looking for higher
rate protection should
exploit the skew valuations
with knock-out payers
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
26/47
Barclays | Market Strategy Americas
10 May 2012 26
Figure 4: Knock-out payer has attractive risk-reward due to high payer skew
3y10y 3% vs. 5% payer spread 3y10y 3% payer KO = 5% 3y10y 3% payer KO = 5%, if payer skew = 0
Spot 10y rate 2.02% 2.02% 2.02%
3y fwd 10y swap rate 2.90% 2.90% 2.90%
Cost (cts) 386 211 343
Cost (bp swap01) 45 25 40Max pay-off 200 200 200
Risk-reward 1:4.5 1:8.1 1:5
Note: Pricing as of May 10, 2012. Source: Barclays Research
Further, this pay-off is attractive only because the payer skew is high. To quantify this effect,
consider this: if the payer skew were flat, ie, high-strike options were priced at the same vol
as low-strike ones, the same knock-out payer would have required 60% more premium
outlay, meaning a much smaller risk-reward of 1:5 (Figure 4).
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
27/47
Barclays | Market Strategy Americas
10 May 2012 27
BMA
Sell 3y ratios
SIFMA is setting lower than Libor than is priced by front-end ratios. Sell 3y ratios to earn
carry and benefit from a drift higher in Libor. Long-end ratios could come off as municipalyields catch up with sentiment in Treasuries. Sell 15y15y outright or as a 15y-30y flattener.
Across the curve, BMA ratios have been stuck in a range for many weeks. 2y and 5y ratios
have traded within 60-62bp and 76-78bp, respectively, for the past two months. At the
same time, 30y ratios have drifted marginally higher from 90 to 92 ratios. Clearly, the level
of rates matters, and as rates have been range-bound for multiple months, ratios have failed
to deliver a large change.
Long-end ratios, we believe, could catch up with the shorter-end ratios, leading to a lower
and flatter BMA ratio curve. Therefore, we like a 15y-30y ratio flattener, which also happens
to be at attractive entry levels. Separately, Libor has started drifting higher, and may cause
front-end ratios to take another leg lower. So, we like selling 2y-5y ratios, with 3y ratios
offering the best carry/realized vol ratios. We begin by focusing on the front-end.
Low for long
Selling the front-end BMA ratio has been a clear trade for the past few months. 1y ratios
nosedived in the second half of last year from roughly 90bp to 40bp, before inching higher
and stabilizing at c.50 ratios in the past couple of months. Alongside, 2y and 5y ratios have
been pulled lower (Figure 1). This has been the result of a spike in Libor relative to SIFMA
last year (Figure 2). Essentially, Libor represents the credit risk of the 18 banks in the Libor
panel, more than half of which are European. Whereas, SIFMA is a combination of a pristine
municipal issuer and (mostly American) bank credit risk. Given that the Euro zone is the
epicenter of the sovereign crisis, a low SIFMA set alongside Libor shooting higher is
fathomable, in our view.
Piyush Goyal
+1 212 412 [email protected]
James Ma
+1 212 412 2563
Front-end BMA ratios are low in
a historical context as SIFMA is
low relative to libor
Figure 1: Front-end ratios plummeted, then stabilized Figure 2: SIFMA did not participate in the rise of Libor
51
61
77
40
50
60
70
80
90
100
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12
1y 2y 5y
0.0
0.1
0.2
0.3
0.4
0.5
0.6
Dec-09 Jun-10 Dec-10 Jun-11 Dec-11
SIFMA 3m Libor 3m OIS
Note: Last data point as of May 9, 2012. Source: Bloomberg Note: Last data point as of May 9, 2012. Source: Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
28/47
Barclays | Market Strategy Americas
10 May 2012 28
Even if SIFMA continues to set within 20-25bp for many months, at current 50 ratio levels, a
short position in 1y BMA would generate gains, as long as 3m Libor sets higher than 45bp2.
That Libor has already started inching higher suggests to us that even 50 ratios may prove
high for 1y. It is noteworthy the Eurodollar futures market is pricing 49bp on 3m Libor by
mid-June and 53bp+ by September this year. Higher-than-expected Libor sets will only bring
the ratio further lower.
Admittedly, for 1y, levels are already low. Therefore, we like selling 2y-5y ratios. To pick the
best point, we look for the highest 3m carry to realized vol ratio along the curve. The one
with the highest ratio is the most attractive, as it has the highest carry along with the best
probability of making that carry (ie, lowest realized vol). Figure 3 shows the results: 3y ratios
offer the best carry adjusted for realized vol. So we like selling 3y ratios to earn carry as well
as benefit from higher Libor set.
The tide is turning
The long-end ratios, we think, may be peaking out too. Fundamentally, long-end ratios are
driven by the level of rates higher rates imply lower ratios and vice versa. Figure 4 plots the
level of 30y BMA versus 30y Treasuries for the past seven years. There are two key
takeaways from this chart. One, higher rates mean lower ratios and vice versa. Two,recently, for the same level of Treasury yields, ratios have been somewhat lower.
The latter can be explained by the outperformance of municipal yields relative to Treasury
yields in the first quarter of the year. Figure 5 plots the 30y Treasury yield and 30y MMA
yield alongside the ratio of the two. Around mid-2011, municipal yields lagged the decline in
Treasury yields, which is a typical price action in a flight-to-quality-related rally in
Treasuries. However, Treasury yields have stayed range-bound since, and municipal yields
have declined more, reflected as a lower ratio.
2 receive 50% of 45bp vs. pay an average 22.5bp on SIFMA , assuming SIFMA sets within 20-25bp
Front-end ratios could decline
further due to higher Libor sets;
sell 3y
Long-end ratios could come off
too
Figure 3: 3y ratios offer the best carry/realized vol ratio Figure 4: Higher rates mean lower ratios and vice versa
2y 3y 4y 5y
Spot 61.0 67.9 73.6 76.8
3m Fwd 64.5 70.7 75.3 77.9
3m Carry 3.5 2.8 1.7 1.1
60 Realized vol (%/day) 0.44 0.28 0.25 0.24
3m Carry/ realized vol ratio 8.0 9.9 6.8 4.5
y = -12.463x + 138.71
60
70
80
90
100
110
120
2 3 4 5 630y Treasury
30y BMAJan '05 - Dec '12
2012 YTD
Regression
Note: As of May 9, 2012. 3y ratios offer the best carry/realized vol ratio. 3mforward 3y ratio = 70.7, implying 2.8 ratios as three-month carry (= 70.7 67.9).The 60-day realized vol is 0.28 ratios/day, implying that the three-month carry is9.9 times the realized vol. Source: Barclays Research
Note: Data period: January 1, 2005 to May 8, 2012. Source: Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
29/47
Barclays | Market Strategy Americas
10 May 2012 29
The Treasury yields would likely stay low for a very long time, maybe for all of 2012 and
possibly further out. The collapse in short-dated vol is reflective of such market
expectations. 3m*10y has fallen from 120bpy+ in mid-November last year to about 75bp/y
now, which also happens to be its lowest level since the Lehman crisis in 2008. Incidentally,
very recently, 3m*10y pierced through 85bp/y, a level it had previously bounced off five
times since the crisis. Such low levels of short-dated vol point to the low-for-long
expectations for Treasury/ swap yields.
With such sentiment in Treasuries, we think it is only a matter of time that the municipal
yields catch up with the Treasury yields. We would have thought otherwise, but the supply-
demand dynamic in municipals is positive too as the issuance is quite low and inflows into
the municipal bond funds are still positive (Figure 6). Accordingly, as the ratio of municipal
to Treasury yields come off, a lower BMA ratio is in the offing. Those who are wary of a blow
up in the Eurozone and therefore are not convinced of a short in long-end BMA, can hedge
the short in 30y with a short in 3y ratios, or consider a 15-30y ratio curve flattener, which
also happens to be at good entry levels.
.as the supply-demand
dynamic in municipal bonds is
positive; implying municipal
yields could catch up with the
low-for-long sentiment in
Treasuries
Figure 5: Municipal yields are set to catch up with Treasuries Figure 6: Municpal bonds funds are seeing inflows
2.5
3.0
3.5
4.0
4.5
5.0
5.5
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12
80
95
110
125
140
155
170
30y tsy 30y mma 30y mma / tsy ratio
-6
-5
-4
-3
-2
-1
0
1
2
3
May-09 Nov-09 May-10 Nov-10 May-11 Nov-11
Muni fund flows ($bn)
Source: Bloomberg. Barclays Research Source: Haver Analytics
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
30/47
Barclays | Market Strategy Americas
10 May 2012 30
MONEY MARKETS
Regulatory flanking maneuver
Money funds are at risk of being outflanked by regulators. Unhappy about the progress
of the SECs reform efforts, press reports hint at an alternative regulatory tack thatwould declare money funds to be systemically important financial institutions (SIFIs).3
Section 165 of Dodd-Frank would give the Federal Reserve Board broad anddiscretionary authority to set prudential standards covering capital, liquidity, and
counterparty exposure limits.
A SIFI designation might require significantly higher money fund capital buffers than the1-3% the SEC has advocated.
Money funds would be subject to tighter counterparty credit exposure limits. Unlikecurrent SEC mandates, these limits are insensitive to counterparty credit rating or
collateral type.
It is unclear if an expanded regulatory role for the Federal Reserve might also includeredemption gates or floating NAVs.
We suspect that talk of SIFI designation and Dodd-Frank Sec 165 is primarily meant to bring
the SEC and the industry back to the negotiating table.
Getting nowhere
The SEC was expected to release a follow-up to its May 2010 money market reforms
sometime in the first quarter of 2012. But so far, the SEC has yet to put any official proposal
on the table for addressing destabilizing flight risk from (largely) institutional investors in
money funds. Regulators are interested in requiring money funds to shift to a floating NAV
structure or mandating that stable NAV funds maintain capital buffers (of 1-3%) and
redemptions gates (of perhaps, 3% for 30 days).4
3 See, Regulators Seek Plan B on Money Funds, A. Ackerman and V. McGrane, Wall Street Journal, May 8, 20124 See, Money Market Fund Reform: State of Play, Market Strategy Americas, April 5, 2012
Joseph Abate
+1 212 412 [email protected]
Figure 1: Top 10 borrowing banks (% taxable fund balances)
Figure 2: Top 10 complexes (% total industry assets)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
A B C D E F G H I J
0
2
4
6
8
10
12
14
16
18
A B C D E F G H I J
Source: Cranes Data, Barclays Research Source: Federal Reserve, Barclays Research
7/31/2019 Market Strategy Americas the Ins and Outs of the Labor Market
31/47
Barclays | Market Strategy Americas
10 May 2012 31
Unsurprisingly the industry has consistently expressed its unhappiness with these proposals
for a number of reasons including the prohibitive cost and the potential for investors to
leave the industry all together. At the same time, Congress has entered the fray with two
members of the House Committee on Financial Services expressing concern that the SEC
h