Taking it to the streets in Caracas

Conditions in Venezuela are reaching boiling point. Venezuelans - particularly students - are taking it to the streets, as protests sparked by worsening living conditions have turned violent (see story). Inadequate supplies of food and medicine are becoming a serious issue. Suppression of free speech by jailing students is adding to protesters' fury. The Maduro administration of course is blaming all this on what they call the "rebirth of neo-Nazi movement" that is trying to orchestrate a coup d'é·tat.

The markets have responded as expected. In the "unofficial" currency markets, which Maduro will be shutting down, the dollar is now trading at record premium - 87 bolivars per dollar or some 1,300% above the official exchange rate. The government bond market is having trouble finding bids, as the longer dated bonds now trade above 15.5% in yield - the highest since the financial crisis.

Source: Barclays Research

Foreign reserves are now at a 10-year low as the government desperately tries to find dollars to keep the government running.

Bloomberg: - At least three airlines have grounded flights to and from Venezuela so far this year, in part because the nation's government owed the carriers $3.3 billion in foreign exchange they need to pay operating costs. The government suggested it could pay them with government bonds and cheap fuel, but precious little cash. This should do wonders for getting planes flying again.

Credit default swaps spreads are moving into "distressed" territory, with the markets increasingly betting on some form of debt restructuring. Years of economic mismanagement and populist/socialist policies (see discussion) are about to come home to roost.

Source: DB

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The shrinking MBS market

As discussed earlier, the supply of mortgage-backed securities (MBS) continues to fall behind the potential demand - even with the Fed's taper in place. New issuance has steadily declined over the past year, with the Fed becoming an increasingly larger proportion of that market.

Source: SIFMA

Mortgage Daily: - For nine straight months, agency issuance of mortgage-backed securities has moved lower -- though there was an uptick at the Government National Mortgage Association. Securitization volume now stands at its lowest level in more than two-and-a-half years.

Combined issuance of fixed-rate MBS at the Federal National Mortgage Association, the Federal Home Loan Mortgage Corp. and Ginnie Mae totaled 7 percent less in January than in December.

Securitizations have been lower each month since April 2013, has fallen by more than half compared to January 2013 and was the lowest since July 2011.

At the same time the Fed is to continue purchasing large amounts of this paper through the end of the year, albeit at a slower pace.

Some of the decline in new issuance has been due to the drop in mortgage refinancing - old securities don't amortize as quickly and fewer new securities are issued. But part of the reason for the lower volume of these securities remains the supply of mortgage loans. The total mortgage debt outstanding is barely growing - with a great deal of that growth coming from multi-family residence (apartment) financing.

Source: FRB

As a consequence, MBS paper outstanding has been shrinking since the peak reached back in 2007.

Source: SIFMA (includes CMBS)

Some of that of course is due to the collapse in private label MBS market, including sub-prime. But the amount of agency (government-backed) MBS has not grown much either.

While some would say that $9 trillion of MBS paper should be sufficient, one has to keep in mind that the US and the global economy is now substantially larger than it was in 2007. MBS, particularly agency bonds, are becoming a smaller portion of the overall capital markets, worsening the shortage of higher quality bonds (see story). Liquidity in that market has also suffered, with average daily trading volumes at the lowest levels in nearly a decade (see chart). These are some of the reasons the Fed should return the MBS market to the private sector by exiting its purchases as soon as possible.

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Ukraine on the brink

Ukraine's sovereign CDS spread is approaching the high reached right before the Russian bailout was announced. The currency is nearing the pre-bail-out lows.

Source: DB

The market is all but discounting the nation's ability to obtain the next batch of bailout funds - wherever it comes from - before defaulting.

Euronews: - Financial experts have warned Ukraine is on the brink of default with some saying currency reserves are enough for only two months. Russia has provided the first three billion dollar tranche of a loan. With the political stand off the rest has been frozen.

There are no easy answers here, as the nation faces a daunting challenge of obtaining cash to run its government for the next few months. Many view the country as a victim of tensions between the West - who prefers to see a certain type of government there - and Russia, who is not too interested in Ukrainian sovereignty. Some analysts warn that Russia could escalate its pressure on the former Soviet republic.

WSJ (Stephen Blank): - Behind its coercive diplomacy in Ukraine is the threat of force, either incited by Russia or carried out by it. Recent reports of pro-government militant groups forming in eastern Ukraine, calls in the Crimean legislature for Russia to "rescue" them from Ukraine's anti-government uprising, and repeated discussions in the Russian media about partitioning Ukraine, all point to a pattern of escalating pressure from Moscow—a pattern that paves the way for the use of force.

In the mean time, the tensions on the streets are rising, as both sides - the protesters and the authorities - harden their stance (see story). Time is running out for Ukraine.

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Assessing the health of US labor markets remains a challenge

We continue to see debate around the trajectory of US labor markets. Measures such as the employment-population ratio have completely diverged from the "headline" unemployment rate.

The explanation of course is reduced labor "activity", as individuals exit the labor force (see discussion). However, various studies indicate that the answer is not as clear-cut - due among other things to changing demographics. Historically older workers who are still of working age are far more likely to leave the workforce. As the US workforce gets older, there is some natural attrition that would have taken place even without the massive shock to the system from the financial crisis. Some researchers at the NY Fed did a good job in attempting to quantify that effect (see chart/link).

These same dynamics are responsible for a portion of the decline in labor participation rate. BMO has done some good work in the area, which we try to summarize here. The historical trend looks quite unsettling, as the chart below shows.

Source: BMO

But there is an enormous difference in the "natural" labor force participation rate of a 55-year-old vs. say a 35-year-old - that is unrelated to the Great Recession.

And as we get more 55-year-olds in the workforce, the participation rate "naturally" declines.

BMO: - An aging population will continue to press down on the part rate, as persons 55 and over participate at only half the rate of prime-age workers (25 to 54), while persons 65 and over participate at just one-quarter the rate. If the downward pull from aging overwhelms the expected upward push from discouraged workers and college students returning to the labor force, then the part rate will decline further.

BMO lists other reasons for declining participation that are unrelated to demographics. Instead these effects seem to be the result of government policy.

1. Since the onset of the Great Recession many more Americans have started collecting disability (from the Social Security Disability Insurance program) than in the past (see discussion).

BMO: - In addition to the downward pull from demographics, disability rolls could continue to climb. Macroeconomic Advisers estimates that the Social Security Disability Insurance program, by discouraging participation, could have reduced the part ["part" is short for participation] rate by about 0.1 ppts on average from 2006 to 2013 [notice that this represents some hefty numbers on an absolute basis]. 

2. Now that the extended unemployment benefits ended, more people are counted as having exited the labor force altogether because they are not officially "unemployed". See this chart (from WSJ) on what happened in North Carolina after it cut benefits.

BMO: - The expiration of the extended UI benefits program will also depress the part rate this year. Assuming one quarter of the 1.3 million people who lost emergency benefits on December 28 find work and another quarter leave the labor force, the part rate could fall 0.2% in 2014. This accords with the additional decline in North Carolina’s participation rate, relative to the national average, after the state decided to end extended benefits five months earlier. 

3. Many analysts are suggesting that Obamacare will detract from labor force participation as well by making health insurance cheaper for those who have minimal income and incentivizing some to leave the workforce.

BMO: - According to the CBO, the Affordable Care Act will likely also reduce the part rate, as new federally-subsidized private health insurance plans will reduce the incentive to seek employer-sponsored plans. Quantifying this impact, however, is virtually impossible. 

The hope is that the expected economic improvements over time will counteract some of these trends. The challenge for the FOMC of course is which employment measures to use for policy decisions and guidence. Clearly the traditional unemployment rate benchmarks are inadequate. The "activity" measures such as participation are driven by multiple factors, some of which are not directly related to the health of the economy. When is the employment situation in good enough shape to start raising rates for example and which measures do we rely on to make that call? This assessment challenge makes the Fed's "dual mandate" a particularly daunting task. 

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Japan's current account firmly in the red

Japan's current account continues to deteriorate, with the December number coming in below expectations - hitting a new low. For the whole of 2013 Japan showed the lowest surplus on record.

Source: Investing.com

Energy imports and weaker yen continue to be the key culprits. Should oil prices rise further, the nation's deficit could worsen.

Bloomberg: - The yen’s slide and increased demand for foreign energy due to nuclear plants closures are causing imports to outstrip exports. A surplus in overseas investment income is staving off the risk of a sustained deficit that could undermine investor confidence in a nation with the world’s largest debt burden.

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Auto loan competition heating up

The Fed's banking survey seems to indicate that senior bankers on the whole see slower demand for auto loans in the US - see chart. The real issue here however is less with auto borrowers' demand and more about increasing competition. Even the largest lender in the space, the TARP-funded Ally Financial (formerly GMAC) is facing competitive headwinds as it loses its cozy relationship with Chrysler (while its GM contract is about to expire). And more banks are jumping into auto financing recently - particularly now that the mortgage refi gravy train has ended.

WSJ: - An exclusive contract with Chrysler to provide so-called subvented, or promotional rate loans, to car buyers ended last April after the auto maker struck a new financing partnership with lender Santander Consumer USA Holdings Inc.

A similar agreement with GM was set to expire at the end of 2013, but Ally President William Muir said during the call Thursday that the companies have extended their existing agreement and are working on completing a new agreement.

Competition in the auto-lending business has intensified during the last two years as more banks have increased their focus on the business amid a rise in loan demand.

Competition is especially heating up in the sub-prime auto lending - with companies such as Santander expanding into the business.

Reuters: - Santander Consumer offers loans through 14,000 car dealers across the United States and has about $25.6 billion of loans outstanding. A majority of the company's loans are subprime, which have higher yields but also higher default rates.

The demand for yield combined with ample liquidity has created a bid from shadow banking in the form of sub-prime auto ABS (asset-backed securities). The sub-prime ABS outstanding has increased significantly since the end of the recession.

Source: SIFMA

Of course all this competition means lower rates, riskier loans, and higher delinquencies.

Automotive News: - Subprime financing -- and delinquencies -- are likely to grow in 2014, says Melinda Zabritski, senior director of automotive credit for Experian Automotive.

Vehicle loan terms, which hit an average of 65 months for new cars during the first 10 months of 2013, also will continue to stretch out.

With more aggressive lenders in the market, many bankers are indeed experiencing less demand - particularly if they want to maintain their margins. The question is - at what point does this market become overheated?

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Why JPMorgan is back in the CLO market

JPMorgan is once again hunting for primary CLO bonds. The bank made enormous profits since 2009 buying the higher rated tranches that provided great spreads above the bank's funding costs. After the "London Whale" fiasco the bank pulled back on its CLO buying, but now JPMorgan appears to be back.

Asset-Backed Alert: - J.P. Morgan is again showing interest in the senior pieces of newly issued collateralized loan obligations. The bank, which had been among the world’s largest buyer of those securities, retreated from the market early last year. But in the past two weeks, it has resumed discussions with managers that have deals in the works.

Why is this renewed interest in CLO paper? Here are some possible explanations:

1. New CLO bonds are still coming to market with attractive pricing. According to LCD, a recent CLO deal from ING (see press release from Fitch) priced the AAA (the largest tranche) at LIBOR + 150bp. A regular AAA corporate bond would typically price at (equivalent of)  L+20 to L+40bp. While there is clearly more risk with structured paper, the discount is attractive on a relative basis. CLOs also look attractive relative to other structured credit bonds (see post).

2. There is speculation that when it comes to CLOs, the US regulators may provide some Volcker Rule relief (see discussion - Item # 6). Below is the video from the latest congressional hearing on Voclker Rule implementation below.

Asset-Backed Alert: - ... some industry players believe J.P. Morgan now is part of a contingent that expects the Commodity Futures Trading Commission, Comptroller of the Currency, FDIC, Federal Reserve and SEC to ease Volker Rule restrictions for CLOs in the coming weeks.

3. JPMorgan is in effect hedged on its CLO holdings. If the new regulatory framework ends up being damaging to the CLO market by restricting banks' participation, the CLO bond issuance would decline materially.

BW: - Morgan Stanley cut its collateralized loan obligation [2014] forecast by as much as 27 percent to $55 billion as issuance slowed last month because of questions about the Volcker Rule’s impact on the funds that finance buyouts.

This reduction in supply would over time result in strong secondary demand for the highest-rated tranches. And banks will be given ample time to reduce their holdings. Either way, JPMorgan comes out ahead on this.

Hearing:  “The Impact of the Volcker Rule on Job Creators, Part II” 

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Consumer credit and deleveraging

US consumer credit showed an impressive increase at the end of last year as Americans went shopping. Consumer credit outstanding, excluding real-estate debt, stood above $3.1 trillion in December, rising in a nearly linear fashion since 2011.

Reuters: - U.S. consumer credit in December grew by the most in nearly a year due to a sharp increase in credit card usage, a potentially positive sign for the economy.

Total consumer credit rose by $18.8 billion to $3.1 trillion, the Federal Reserve said on Friday. That was the biggest gain since February.

But let's put this number in perspective by making a couple of adjustments. First let's look at consumer credit trend without the government-held student loans. As discussed before, student loans are not market-based and do not represent private sector credit expansion. A very different trend emerges - with non-student-loan consumer credit barely rising until mid 2013. One could argue that student debt is in effect "crowding out" private credit.

Not seasonally adjusted (source: FRB)

Even the ex-student loan measure does not tell the whole story. The overall US economy (and the population) has grown since the financial crisis and in order to make a fair comparison one needs look at the trend relative to the nation's GDP. A very different picture emerges - one of significant consumer deleveraging that is only now beginning to stabilize.

Not seasonally adjusted (source: FRB)

While the absolute level of consumer credit indeed had a nice pop in December, one needs to look beyond the headline numbers to see the full picture.

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