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The US Treasury market is facing a train wreck

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The US Treasury market, supposed to be the supplier of the world’s risk-free assets, is facing a very educational 2021. As Mark Cabana, head of US rates strategy for BofA Securities, says: “There is going to be a train wreck at the front end of the [Treasury] curve next year. There is way too much cash chasing too little paper.”

Given what we know today about the US government’s likely spending over the next several months and its cash on hand, it is possible, even likely, that Treasury bill rates will be negative for a significant period of time. Other key interest rates, such as SOFR, the new lending benchmark, could well follow T-bills into negative territory.

Managing the effects of negative bill rates on banks and other market participants will require the ingenuity of the Federal Reserve and the new Treasury staff in applying their policy “toolbox”. All while avoiding any unforeseen consequences, such as we saw in March this year.

It would help everyone concerned if there were anything close to a political consensus on the path of federal spending and borrowing over the near future, never mind major policy changes. At the moment, the Treasury dealers and market participants are like an engine-room gang in a nuclear aircraft carrier, fighting over who occupies the bridge while there’s a slow-burning fire (the pandemic) in the crew’s quarters. 

Overstatement? Consider this: under one of the laws governing Treasury issuance, the Treasury General Account (the US government’s current account) has a present balance of a bit more than $1.5tn. That is historically high. Under the budget law adopted in August 2019, which includes a debt ceiling limit, the TGA should be reduced to $133bn by August of next year.

Assuming, generously, that something like the current stimulus bill outline turns into executable law, that leaves the Treasury needing to allow somewhere between $500bn and $900bn of T-bills to mature in the first half of the year without being replaced by new issuance. Depending on the breaks.

That is a lot of cash that money market funds and others would need to redeploy. Oh, and Treasury securities provide another essential function, in that they can be pledged as collateral for variation margin calls at dealers or clearing houses if there’s any market volatility next year.

Credit Suisse strategist Zoltan Pozsar says: “Yes, a bill shortage would radiate out the curve, to the two-year and three-year, out to the belly. If on top of that there is a flight to quality, it would exacerbate that move. But I don’t think SOFR would go negative because the Fed could use their reverse repo facility.”

On one hand, the Treasury would have a very low, even negative, notional cost of funds. On the other, as the department’s Treasury Borrowing Advisory Committee wrote in November, “A substantial decline in T-bills supply is not desirable” and “stable value government money market funds face challenges should T-bill yields become negative for sustained periods”.

So, after arranging photo ops, Treasury secretary Janet Yellen will have to decide whether or not to hold off on running down bill issuance in the hope of negotiating a budget with Senate Republicans and her own liberal Democrats. Then there is that hard stop of a $133bn TGA on August 1.

Ah, but if the Democrats should win both Senate races on January 5, there might be a Democratic Senate majority in favour of lifting the budget caps and passing an even bigger stimulus package.

Life might become less problematic for the Fed’s Soma desk and the administration but then, the dealers worry, the volume of new issuance would put enormous strain on their balance sheets. For the largest banks, there is the added problem of compliance with the “G-SIB” regulations intended to limit their absolute size and consequent systemic risk concentration.

Really, it is enough to drive you to buy up canned goods, ammunition and iodine pills.

Or, you might agree with the other dealers and the regulators that it might be the time to set up a dedicated CCP, or clearing house, just for Treasuries. As one official who has been on the calls discussing the logistics of such a CCP said: “Eventually, it might have to be bailed out. The political cost of that bailout would, however, be lower than bailing out any banks.”



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ExxonMobil proposes carbon storage plan for Texas port

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ExxonMobil is pitching a plan to capture and store carbon dioxide emitted by industrial facilities around Houston that it said could attract $100bn in investment if the Biden administration put a price on the greenhouse gas.

The oil supermajor is touting the scheme ahead of the US climate summit starting on Thursday, where President Joe Biden plans to announce more aggressive national emissions targets and hopes to spur world leaders to increase their own carbon-cutting goals.

Carbon capture and storage, or CCS, “should be a key part of the US strategy for meeting its Paris goals and included as part of the administration’s upcoming Nationally Determined Contributions”, said Joe Blommaert, head of Exxon’s low-carbon focused business, referring to the targets that countries are required to submit under the 2015 Paris climate agreement.

Oil and gas producers have sought to highlight their commitments to tackle emissions ahead of this week’s climate talks, which promise to heap pressure on the fossil fuel industry. BP pledged to stop flaring natural gas in Texas’ Permian oilfields by 2025, while EQT, the country’s largest natural gas producer, said it backed federal methane regulations.

The International Energy Agency has called carbon capture and storage, which uses chemicals to strip carbon dioxide from industrial emissions, “critical for putting energy systems around the world on a sustainable path”.

But the technology has struggled to gain traction as costs have remained persistently high. The most recent setback in the US came last year with the mothballing of the Petra Nova project, the country’s largest, which captured carbon from a Texas coal-fired power plant.

Many environmental groups have been critical of the oil and gas industry’s focus on carbon capture, arguing it is used to justify continued investment in oil and gas production and is not economical, especially as the costs of zero-carbon wind and solar power have plummeted.

Exxon said that establishing a market price on carbon — which has been attempted by a handful of US states, Texas not among them — would be important. The US government should “implement policies to enable CCS to receive direct investment and incentives similar to those available to other efforts to reduce emissions”, Blommaert said.

Exxon declined to comment on the carbon price it thought was needed to justify the investment, but said its plan would generate $100bn of investment from companies and government in the Houston region.

The company’s plans call for a hub that would capture emissions from the 50 largest emitting industrial facilities along the Houston Ship Channel, such as oil refineries and petrochemical plants, and ship the carbon by pipeline to reservoirs for storage deep under the sea floor of the Gulf of Mexico.

The project could capture and store about 100m tonnes of CO2 a year by 2040 if developed, Exxon said. That is 2 per cent of the roughly 4.6bn tonnes of US energy-related carbon emissions in 2020, according to the Energy Information Administration.

Exxon has been under intense pressure from investors, including a proxy fight with the activist hedge fund Engine No 1, to bolster its strategy for the transition to cleaner fuels. In February, it created a low-carbon business line that it said would spend about $3bn over the next five years.

Biden’s $2tn clean-energy focused infrastructure plan would expand carbon capture and storage tax credits. The administration said it would back 10 projects focused on capturing carbon from heavy industry, but it did not endorse a price on carbon.

Climate Capital

Where climate change meets business, markets and politics. Explore the FT’s coverage here 



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European stocks hit record after strong US earnings and economic data

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European equities hovered around record levels, the dollar dropped and government bonds nudged higher on Monday as markets continued to cheer strong economic data while also banking on continued support from the US Federal Reserve.

The regional Stoxx Europe 600 index gained 0.3 per cent during the morning to set a new record, before falling back to trade flat.

This follows a week of upbeat earnings from US banks as investors await results from big businesses including Coca-Cola and IBM later on Monday. Data released last week showed US homebuilding surged to a near 15-year high in March while retail sales increased by the most in 10 months.

The dollar, as measured against a basket of currencies, fell 0.4 per cent as bets on higher interest rates receded. The euro rose 0.4 per cent against the dollar to buy at $1.203. Sterling also gained 0.4 per cent to €1.389.

Federal Reserve chair Jay Powell told the Economic Club of Washington DC last week that the central bank would not taper its $120bn of monthly asset purchases until it saw “substantial further progress” towards full employment.

Haven assets such as government debt remained in demand. As prices ticked up, the yield on the benchmark 10-year US Treasury note fell 0.02 percentage points to 1.557 per cent, while the yield on the equivalent German Bund slid 0.01 percentage points to minus 0.271 per cent.

Investing convention assumes that US Treasuries and global equities move in opposite directions to cushion against falls in either asset class, but both have now rallied in tandem for an unusually sustained period.

The S&P 500, the blue-chip US stock index, has risen for four consecutive weeks to set new records. The yield on the 10-year Treasury has fallen from about 1.74 per cent at the end of March to just under 1.56 per cent on Monday as investors bought the debt. Treasuries and US stocks not have risen together for so long since 2008, according to Deutsche Bank.

Futures markets indicated the S&P would drift 0.2 per cent lower as Wall Street trading opens.

“I am not saying it’s a rational time in the markets,” said Yuko Takano, equity fund manager at Newton Investment Management. A reason for caution, she added, was signs of “bubbles” in alternative assets such as cryptocurrencies and non-fungible tokens. “There is really an abundance of liquidity. There will be a correction at some point but it is hard to time when it will come.”

“Markets may have become temporarily overbought,” strategists at Credit Suisse commented. “For now, we prefer to keep equity allocations at neutral” rather than buying more stocks, they said.

In Asia, Hong Kong’s Hang Seng index closed up 0.5 per cent and Japan’s Topix slid 0.2 per cent.

Global oil benchmark Brent crude fell 0.3 per cent to $66.57 a barrel.



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EU split over delay to decision on classing gas as green investment

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The European Commission is split over whether to postpone a decision on classifying gas generated from fossil fuels as green energy under its landmark classification system for investors.

Brussels had planned to publish an updated draft of a taxonomy for sustainable finance later this week. The document is designed to guide those who want to direct their money into environmentally friendly investments, and help stamp out the misreporting of companies’ environmental impact, known as greenwashing. 

The commission was forced to revamp its initial proposals earlier this year after the text was criticised by member states which want gas to be explicitly recognised as a low-emission technology that can help the EU meet its goal of becoming a net-zero polluter by 2050. 

Now the publication of the draft rules could be postponed again as the commission seeks to resolve the impasse. According to a draft of the text seen by the Financial Times, the commission proposed to delay the decision in order to carry out a separate assessment of how gas and nuclear “contribute to decarbonisation” to allow for a more “transparent” debate about the technologies.

But officials told the FT that some commissioners were pushing for gas to be awarded the green label now, rather than delaying the decision until later this year. 

“There are a sizeable number of voices in the commission who want gas to be included in the taxonomy,” said one official. A final decision on whether to approve the current text or delay it again for further redrafting is likely to be made on Monday.

The EU’s taxonomy is being closely watched by investors as the first big attempt by a leading regulatory body to create a labelling scheme that will help guide billions of euros of investment into green financial products.

But the process has proved divisive, as several EU governments have demanded recognition for lower-emissions energy sources such as gas. 

Coal-reliant countries such as Poland, Hungary, Romania and others that are banking on gas to help reduce their emissions do not want the labelling system to discriminate against them. France and the Czech Republic, meanwhile, are also pushing for the recognition of nuclear as a “transitional” technology in the taxonomy.

A leaked legal text seen by the FT earlier this month paved the way for gas to be considered green in some limited circumstances. That has since been removed along with other sensitive topics such as how best to classify the agricultural sector, according to the latest draft the FT has seen.

EU governments and the European Parliament have the power to block the draft if they can muster a qualified majority of countries and MEPs against it. 

Environmental groups have hailed the exercise, and urged Brussels to stick to science-based criteria in defining the thresholds for sustainable economic activity.

Luca Bonaccorsi from the Transport & Environment NGO said delaying decisions on gas and nuclear risked allowing pro-nuclear countries like France and the Czech Republic to join up with pro-gas member states “to forge an alliance that will obtain the greening and inclusion of both energy sources”.

“Should they ally, it will be impossible to resist the greenwashing of these two unsustainable energy sources,” said Bonaccorsi. 

The delays in agreeing the taxonomy have forced Brussels to abandon an attempt to use it as the basis for EU green bonds that will be issued as part of the bloc’s €800bn recovery and resilience fund. About €250bn of debt will be issued in the form of sustainable bonds over the next few years, which will make the commission one of the world’s biggest issuers of sustainable debt.



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