10 Things You Need To Know Before The Opening Bell, Monday, March 17, 2014

10 Things Before Opening Bell

March 17, 2014

Good morning. Here's what you need to know.

Crimea votes for independence.On Sunday, the Ukrainian region of Crimea — an area home to many ethnic Russians — voted in a referendum to announce its independence from the Ukrainian state. Western powers have said they do not recognize the action, and the big question is whether Russia will stage additional military provocations, as well as what potential sanctions against Russia the West will bring. "Following recent risk-off price sessions and the fact that the referendum did not lead to any notable immediate violence, there may be space for an immediate relief in bond markets, and some short-covering in FX (in Central and Eastern Europe) early this week," says a team of analysts at Nordea Markets led by Aurelija Augulyte. "Our baseline is that the conflict will not evolve to the level where tough trade/investment sanctions are imposed, or even to the level where energy supplies are cut off from Russia to Europe. Therefore, we also believe that markets will revert to look at fundamentals within weeks."

China widens renminbi trading band. On Saturday, the People's Bank of China announced a widening the daily trading band around which the value of the Chinese yuan is allowed to deviate from the daily reference rate to 2% from 1%. The move will allow for greater volatility in the U.S. dollar-Chinese yuan exchange rate, and many wonder what the announcement means for its near-term direction. The PBoC has engineered a weakening of the yuan by setting lower reference rates over the past several weeks — largely designed to shake out carry-trading speculators following an extended, multi-year period of sustained appreciation against the U.S. dollar. On Monday, the PBoC set the reference rate at 6.1321 yuan per dollar — down from Friday's 6.1346 fix and 6.1502 close — but the yuan is trading lower, at 6.1790 per dollar.

Markets up. Global financial markets are taking a sanguine view of developments over the weekend. S&P 500 futures are solidly in positive territory, while U.S. Treasury note futures are trading lower and gold has erased overnight gains. The U.S. dollar is stronger against the Japanese yen and lower against the euro. Copper futures are up nicely as well following a big drop last week on fears related to China's fragile shadow banking system. The Russian ruble is losing a bit of ground against the dollar, but Russia's MICEX equity index is up more than 3%. European indices are all rising to begin the week, as did most Asian indices (with the exception of Japan, Australia, and Indonesia). "Risk-correlated currencies consolidated and safe haven currencies lost some ground at the start of the week after the Crimean referendum to join Russia passed and the China doubled the trading band of CNY. Investors’ take could be that the events could point at lower EM volatility ahead," says Valentin Marinov, a currency strategist at Citi. "We think that there are risks to the above view. We think that market risk aversion could still escalate on the back of more tensions between Russia and Ukraine as well as more uncertainty about the Chinese growth outlook."

Euro zone inflation. Eurostat's final estimate of February HICP inflation data indicated that euro zone consumer prices rose only 0.3% in February from the month before — below its initial 0.4% estimate — bringing the year-over-year growth rate to 0.7% from the previous 0.8% estimate and marking a decline from January's 0.8% year-over-year change. The year-over-year rate of change of core consumer prices was unchanged from January and the initial February estimate of 1.0%. Many expect this month to mark the bottom in euro zone consumer prices, which may restrain the European Central Bank from announcing additional easing measures going forward.

Empire manufacturing. Out at 8:30 AM ET are the results of the New York Fed's monthly Empire State Manufacturing Survey. The report's headline index is expected to rise to 7.00 from the February survey's 4.48 reading, indicative of an improvement in business conditions for manufacturing firms in the state of New York over the last month.

Industrial production. The big economic data release in the United States today is the monthly industrial production report, due out at 9:15 AM. Economists predict total output rose 0.2% in February after falling 0.3% in January. Manufacturing production is expected to have risen 0.3% in February after staging a 0.8% decline in January. Weakness in the January report was largely attributed to weather disruptions.

NAHB housing. The final U.S. economic data release today is the National Association of Home Builders/Wells Fargo Housing Market Index, due out at 10 AM ET. Economists predict the index moved back up to 50 in March after falling to 46 in February from 56 in January — the largest one-month drop ever.

FOMC. The big event on the calendar this week is the March FOMC meeting, which will be held on Tuesday and Wednesday, along with the subsequent monetary policy announcement and Janet Yellen's first FOMC press conference as chairman of the Federal Reserve. The consensus view is that the Fed will reduce the pace of monthly bond purchases it makes under its quantitative easing program to $55 billion from $65 billion. Opinions are more split on what the Committee will choose to do with its forward guidance on the likely future path of short-term interest rates.

The hunt for MH370 continues. The disappearance of Malaysian Airlines flight MH370 continues to captivate onlookers around the world as the search for the missing plane drags on. According to reports, U.S. investigators are growing more convinced that the plane is somewhere west of Australia in the Indian Ocean.

Beer companies withdraw parade sponsorship. Guinness USA, Heineken USA, and the Boston Beer Company (the brewer of Sam Adams beer) have withdrawn sponsorships of St. Patrick's Day parades in New York City and Boston in protest of a ban on gay groups expressing their sexuality during the parades. That leaves Ford Motor Company as the last major sponsor of the NYC event.

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Below is a Q&A with Steve Feiss, an interest rate strategist at Government Perspectives.

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BUSINESS INSIDER: What is the most exciting trade out there right now, in your opinion?

STEVE FEISS: I would suggest watching the 5s30s spread as we start off the week thinking about the geopolitical landscape, which is code for risk on/off relating TO U.S. (lack of) response to Crimea vote. Then, mid-week we'll get our first Yellen-led FOMC meeting and press conference. While I had been thinking some sort of steepening (concession) might have helped place last week’s durational supply, that turned out NOT to be the case and, along with some other factors (positions, economics – more on both in a min), combined to keep curve’s flattening momentum in place. It seems that risk-off fixed income rallies benefit the longer end, while any perceived FOMC hawkishness has hit the front end and created what’s been a one-way trade since the end of November. When this changes, or more importantly, WHAT changes this dynamic, will be something exciting. Not sure at this point what that is going to be.

BI: Of the divergences between normally-correlated assets that exist in the marketplace right now, which do you find most puzzling or inexplicable?

SF: The bid for peripheral debt in the euro zone driving yields down and spreads in continues to boggle my mind. While I fully understand the reach for yield created by a global zero interest rate policy, it seems to me that euro zone fixed income market dynamics were healed by ECB's Draghi offering those three famous words, "Whatever it takes," back in July 2012. The way in which U.S. Treasuries continue to grind lower in yield and flatter in curvature (5s30s) even as lower-rated peripheral debt does — like nothing’s ever happened AND as if they are a good alternative to generate SAFE, government bond yield — is a perfect example of how risk on and off CAN peacefully coexist if you look hard enough?

BI: Which developments in global financial markets, if any, would you flag as most concerning for risk appetite?

SF: While central bank balance sheet normalization here in the U.S. is of great concern, I’ll also continue to watch how the political economy shapes up into the midterms and then 2016. The current administration has very good reason for concern and while I may NOT agree with solutions currently being offered, as I look at bigger-picture trends, it seems that big central bank balance sheets aren’t all we thought they were cracked up to be. At least not economically speaking. Coincidence that just six years ago, Bear Stearns was given TO JPMorgan for $2, then $10/share? In that I don’t have THE answers and it’s much easier to be critical, I’ll refrain from politicizing a market view and again, would note great concern IF trends like that in retail sales persist, unaffected by central bank balance sheets and fiscal policies.

BI: What do you perceive to be the most misunderstood trend or event in or characteristic of today's markets?

SF: Low rates meaning bonds are in a bubble. I'm biased as a bond guy but offended almost daily at the flagrant misunderstanding that is "sold" to/through mainstream media regarding the association of low rates with an asset class that is in a bubble. U.S. Treasury rates are as much a "future" discounting mechanism as are the equity markets. What were stock prices thinking back in 1999? Exactly WHAT multiple were they OK with, again? How’d that work out? While I get that low rates hurt savers and retirees, simply selling low rates as a bubble like tech stocks were in 1999 seems to leave out the discussion/distinction between components OF the fixed income markets as well as the fact that as a country, we generally speaking like buying cheap stuff at Target and Wal-Mart. And as long as that continues, China will continue to have an abundance of U.S. dollars, and so will continue to be natural buyers OF our U.S. Treasuries. Low rates are likely here to stay for quite a while. Still. Like it or not...

BI: What pieces of new information (e.g. economic data releases, FOMC, price action in a given market over the next few days/weeks, etc.) do you think have the biggest potential to alter your outlook?

SF: If/when fixed income (and U.S. Treasuries, specifically) positions change, we’ll want to know. We learned that as of the end of February, PIMCO had decreased the number of govies held in the total return fund (tweeting about NOT buying what the Fed will buy less of). Lost in the headlines is that it seems they did so in a curve-steepening fashion. They’ve allocated "-3%" towards the longer end of the curve (so a SHORT) while having "47%" in the 3-5yr sector, a.k.a. the belly. Carry and roll down the curve is powerful, to be sure. We ALSO follow weekly input from JPMorgan clients (reported with a week lag) and similar input from Stone & McCarthy (SMR) who, by and large, continue to indicate a short base in the fixed income arena and very little U.S. Treasuries allocation. Finally, we continue to follow Great (un)Rotation proclamations by the bulge bracket firms and covering pension systems over the years, know there are lots of moving parts TO the liability-driven investing (LDI) game. Matching of one’s assets TO their liabilities matters. Eventually. I’ll keep wondering IF the last bout of curve-flattening has been just that ... a partial unwind of the "pain" trade that has seen steepeners stopped out and under-allocations remedied to some degree. See any number of Great (un)ROTATION notes from BofAML regarding pension funds taking equity profits and plowing them back into fixed income. In any case, as stocks remain at/near record highs and pension deficits, generally speaking, are much narrower now thanks to record-high equity prices, we can’t imagine where U.S. Treasury rates might be if/when equity markets were to take some (more) chips off the table. Clearly this relates back to the question/response just above and low rates NOT equating to a bubble, just because...

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