QE Seignorage PDF

www.morganmarkets.
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Global Asset Allocation
12 October 2012
Flows & Liquidity
QE's seignorage benefit
Nikolaos Panigirtzoglou
AC
(44-20) 7134-7815
nikolaos.panigirtzoglou@jpmorgan.com
J.P. Morgan Securities plc
Seamus Mac Gorain
(44-20) 7134-7761
seamus.macgorain@jpmorgan.com
Matthew Lehmann
(44-20) 7134-7813
matthew.m.lehmann@jpmorgan.com
Leo Evans
(44-20) 7742-2537
leonard.a.evans@jpmorgan.com
Jigar Vakharia
(91-22) 6157-3281
jigar.r.vakharia@jpmorgan.com
J.P. Morgan India Private Limited
See page 13 for analyst certification and important disclosures.
The giant carry trade that G4 central banks are engaged in via QE and
repo operations is currently producing a seignorage profit of around
$140bn per year.
The Fed is returning $80bn to the Treasury every year. The BoE has so
far accumulated coupons of 28bn in its APF Company and is
currently adding 14bn of coupons every year, or 1% of UK GDP.
QE shortens the liabilities of the consolidated public sector by replacing
government bond liabilities with overnight central bank reserve
liabilities.
And this is where the cost of QE lies. When the interest on excess
reserves rises in the future, above 2.5%or so, the QE trade will become
a negative carry trade for the Fed or the BoE.
A downgrade of Spain to junk by Moodys only, would mechanically
generate very little forced selling by bond funds, likely around 400mn.
Around 260bn of European government securities are trading at
negative yields, down from over 700bn in July.
EMs share of global debt securities markets continues to rise but
remains low compared to EMs share of global GDP.
We have discussed the impact of QE in the past (e.g. F&L, Jun 22), focusing on
2 main channels: 1) the price channel i.e. QE not only lowers real government
bond yields but also induces investors to shift to other asset classes with more
attractive yields relative to government bonds; 2) the quantity channel: QE
increases the capacity of debt capital markets by bolstering issuance in substitute
asset classes such as HG corporate and hard currency EM bonds.
But one QE related flow which is often overlooked is the profit that central
banks make as a result of QE or more broadly as a result of the expansion of
their balance sheets. This profit is called seignorage and is effectively the
carry that central banks receive by buying securities or making loans such as
repos. These central bank assets are funded via the creation of central bank
reserves on which central banks pay a zero or close to a zero rate. The ECB
currently pays a zero rate on its excess reserves, the BoJ pays 10bp, the Fed pays
25bp and the BoE pays 50bp. The yield on the assets they buy starts from 75bp
for the ECBs refinancing operations and the BoEs Funding for Lending
Scheme to 2% for US MBS, 3% for long-dated Gilts and 5% for peripheral
bonds. .
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Indeed these seignorage profits are shown in the annual accounts of central
banks. The Fed made a profit of more than $80bn in net interest income in
2011 on a balance sheet of almost $3tr, i.e. a yield of 2.7%. The BoJ made a
profit of more than $8bn in net interest income in 2011 on a balance sheet of
$1.8tr, i.e. a yield of 45bp. The BoE accumulated coupons of more than $14bn
during 2011 alone in its Asset Purchase Facility on a (APF) balance sheet of
$530bn, a yield of 2.6%. The ECB does not produce annual accounts for the
Eurosystem as a whole but based on a current stock of $1.5tr of repo
operations with a yield of 75bp and $780bn of securities with an assumed yield
of 3%, we estimate that the Eurosystem makes a profit of close to $34bn a
year.
In total, the giant carry trade that G4 central banks are engaged in via
QE and repo operations is currently producing a profit of around $140bn
per year. This number is likely to increase by between 10%-20% as we
anticipate that G-4 central banks will add close to $1tr of bonds over the next
year, assuming (i) $480bn of MBS purchases from the Fed; (ii) some 15tr of
short-dated JGB purchases from the Bank of Japans Asset Purchase Facility;
(iii) a further 50bn of gilt purchases from the Bank of England, beyond what
has already been announced; and (iv) say, 100bn of OMT bond purchases by
the ECB.
The Fed, the BoJ and the Eurosystem return most of these seignorage profits to
their respective Treasuries. The Bank of England does not return its profits via
its QE portfolio to the Treasury but accumulates the coupons from its Gilt
purchases in the form of cash holdings of the APF company. The Companys
operations are fully indemnified by HMTreasury and in return any surplus
from these operations after the deduction of fees, operating costs and any tax
payable are due to HM Treasury. That is, the BoE does not immediately
return these profits to the government but these profits are nevertheless due to
the Treasury.
We estimate that so far 28bn of coupons have been accumulated which are
due to HMs Treasury. This 28bn represents 1.8% of GDP and compares to
annual government debt servicing costs of around 2.6% of GDP. It is also half
of the fiscal thrust, i.e. change in cyclically-adjusted primary balance, that
the UK is expected to apply between this year and 2015.
Looking at the US, seignorage profits are comparable. The $80bn per year that
the Fed returns to the US Treasury represents 0.5% of GDP or 20% of the
annual interest costs on government debt.
It is sometimes stated that QE cancels government debt in the sense that the
consolidated public sector that includes both the government and the central
bank has its total debt reduced by the amount of QE purchases. This is
incorrect, in our view. QE does not cancel public sector debt. QE simply
shortens the liabilities of the consolidated public sector by replacing long-
term government bond liabilities with overnight central bank reserve liabilities.
In theory, the government could have achieved the same shortening in the
maturity of its liabilities by deciding to issue a lot more of Tbills instead of
government bonds, but obviously it would a take a lot longer.
It is true however that QE provides interest relief to the government and it
indeed becomes equivalent to government debt cancellation, but only for as
long as the interest the central bank pays on reserves is close to zero. But these
reserves, which are central bank liabilities, do not disappear from the system
and the central bank might need to pay a higher interest on these reserves in
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the future when monetary policy is normalized.
And this is where the cost of QE lies. If inflation becomes a problem in the
future, the central bank might need to raise its policy rate sharply increasing
the cost for the central bank in terms of servicing its reserve liabilities. If the
interest on reserves rises sufficiently, the central bank might face negative
carry on its bond holdings.
What is the threshold for the interest on excess reserves for the QE trade to
become a negative carry trade? We estimate that this threshold is around 3%
for the BoEs APF and around 2.5% for the Feds UST holdings. So it will
take some time before a rise in the interest on excess reserves starts generating
losses in the form of negative carry for the BoE or the Fed. The negative carry
problem is not relevant for refinancing operations such as those conducted by
the ECB or the BoE, as these operations are always conducted at a spread over
the policy rate.
But the negative carry issue changes the incentives for how central banks exit
their currently ultra-accommodative policy in the future, i.e. whether they
choose to raise the interest on excess reserves or to shrink their balance sheet
by reducing the stock of their bond holdings.
In fact these two policy actions are distinct. All major G4 central banks have
introduced paying interest rate on reserves which they use as the effective
policy instrument. The interest on excess reserves serves as a floor for short-
term market interest rates as lenders will never lend their overnight funds at a
rate below the one they receive at central banks deposit facility. The last
major central bank to introduce paying interest on excess reserves was the BoJ
in November 2008, a month after the Fed started paying interest on excess
reserves
This means that central banks can tighten policy i.e. raise interest rates without
the need to reduce reserves or deposits. In other words the interest on excess
reserves can serve as the effective policy instrument in a world of large excess
reserves. The ECB rate hikes in the spring of 2011 are a good example of how
central banks can tighten monetary policy in a world of large excess reserves
or deposits.
One technical issue arises when the market for overnight funds includes
institutions that do not earn interest on central bank deposits. This is the case
in the US (with agencies) and the UK. But even in these cases where the
federal funds rate or the SONIA rate traded below the interest paid on excess
reserves, the deviations were rather contained. And central banks can always
expand the number of financial institutions which earn interest on central bank
deposits to prevent market overnight rates falling below the interest on excess
reserves.
All this means, we believe, that when the need for policy tightening arises, this
policy tightening does not need to begin with a rise in short rates, which in turn
is going to bring the central bank more quickly to the negative carry position.
Policy tightening can also begin via rises in long-term interest rates. And most
likely, such a rise in long rates does not even require Large Scale Asset Sales
by central banks. In fact, the mere announcement by central banks that the
stock of their securities holdings will be allowed to roll off over time is likely
to cause a sharp rise in long-term interest rates. Such a rise in long-term rates
reduces both the speed and the amount of short interest rate increases needed
to apply enough tightening in the economy. In turn this should delay the time
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at which the central bank starts suffering from negative carry i.e. the time
at which the interest paid on reserves rises above the locked-in yield on its
bond holdings.
In fact, such a sequence, allowing long-term market interest rates to rise first
before the policy rate is increased, is not only motivated by P&L
considerations. It seems logical if one thinks about how central banks eased
policy in the first place. Short term rates were lowered first and when the
policy rate hit the zero bound, central banks engaged in QE to lower long rates.
A reversal of this sequence would imply a rise in long rates first, i.e. a
steepening of the yield curve first, followed by a rise in the policy rate.
What about potential markingto-market or capital losses from QE? Marking-
to-market is not relevant if the securities are kept to maturity. The BoEs APF
says: The majority of the Companys holdings of securities are gilts, which
are liabilities of the broader public sector. So the impact on the public sector
as a whole of any change in the market value of the gilts held by the Company
is matched by changes in the market value of those gilts on the liability side of
the public sector balance sheet.
Admittedly, the public sector might face capital losses if central banks decide
actively to sell their securities before they mature at a lower price than they
bought. From a P&L perspective alone, there is little incentive to do so
especially if, as we mentioned above, long rates rise significantly by the mere
announcement that the stock of bond holdings will be let to roll off. And this
rolling off process can reduce QE holdings relative quickly at least in the case
of the Fed. The Fed currently owns $1.7tr of UST and Agency securities
2/3rds of which matures by 2020. The Fed also owns $835bn of Agency MBS
securities which is currently paying down at a rate of $330bn a year. The
maturity schedule is slower in the case of the BoE, where 46% of the current
Gilt stock matures by 2020.
But if central banks had to actively sell a portion of their security holdings, by
the time they decide to do this they will have accumulated a cushion from
accumulated coupons and/or unrealized capital gains. For example, the BoEs
APF Company has already accumulated coupons of 28bn and unrealized
capital gains of 25bn. So they could theoretically withstand a 150bp rise in
the yield of their total stock of Gilts or 300bp if 50% of the stock had to be
sold today. But of course this cushion rises over time by the amount of
coupons central banks accumulate each year. The BoE looks set to accumulate
close to 14bn of coupons every year assuming a weighted average coupon of
4.4% currently. This means that by 2015 for example, the total coupon cushion
that the BoE will have accumulated would be 70bn on top of unrealized
capital gains of 25bn. In other words, if the BoE had to start raising interest
rates in 2016, they could theoretically withstand a 270bp rise in the market
yield of their total stock of Gilts or 540bp if 50% of the stock had to be sold.
But again central banks have a choice and they do not need to actively sell a
big part of their bond holdings, risking capital losses in the future. The P&L
considerations described above favour an unwinding of QE holdings
predominantly via a passive rolling off process. But whether these P&L
considerations will have a significant influence on how central banks exit their
accommodative policy and unwind their bond holdings eventually, remains to
be seen. Our economist Malcolm Barr reminds us that BOE policy makers
have already signaled that they will actively sell at least a portion of their Gilt
holdings as part of their exit process.
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GBI EMU would generate 370mof forced selling if Spain
is downgraded to junk by Moodys only
S&Ps decision to downgrade Spain to BBB-, from BBB+, with negative
outlook came as markets anxiously await the outcome of Moodys downgrade
review, expected some time this month. Whilst S&Ps rating doesnt carry as
much significance (at current levels) as either Moodys (to high-yield) or
DBRSs (ECB haircuts), this weeks events have reignited questions about
selling flows from benchmarked managers should Moodys decide to cut.
Across major IG sovereign bond indices, JPMs GBI EMU has the most
stringent ratings thresholds. For instance, to be excluded from the EMU
IG index JPM requires 1 of 3 ratings to be below IG, Barclays Capital
requires 2 of 3 to be below IG, Citigroup requires both Moodys and S&P to
be below IG and iBoxx uses an average rating methodology across all three.
Therefore, the most immediate source of selling pressure on Spanish bond
yields if Moodys does downgrade would likely come from funds
benchmarked to JPMs bond indices.
Using Bloombergs fund search function, we find 306 funds specify their
primary benchmarks as either GBI Global, GBI broad, GBI EU, GBI EMU
and GBI EMU IG, i.e. are European sovereign bond funds benchmarked to a
JPM index. These funds account for 107bn of AUM, although this estimate
of the total AUM benchmarked to these indices is low, as many funds report a
maturity bucket sub-index, of which there are too many to search manually,
among other estimation issues. However only 3.7bn, i.e. 3.4%, is directly
benchmarked to GBI EMU IG, which is the only index that would generate
forced selling in the event of a Moodys downgrade and according to our index
teams, the weight of Spanish bonds in this index is10%, so the maximum
potential selling from it 370mn.
Spains weight in the other indices, i.e. GBI Global, GBI broad, GBI EU, GBI
EMU, ranges from 2.5% for the GBI Global up to 10% for GBI EMU, so if we
continue to assume that in aggregate these funds are aligned with their
benchmarks, this suggests they hold around 6.2bn of Spanish bonds (Figure
1). Whilst Spain will remain in all of these indices if it is downgraded to high-
yield, many managers may be forced to sell anyway due to riders in their
mandates which stipulate they cannot invest in sub-investment grade debt.
Even is such riders are in place, they do not necessarily trigger via a Moodys
only downgrade to junk.
Tracking the negative yield universe
Investors must accept negative nominal interest rates, that is, pay money in
order to place cash, if central banks establish very low or negative unsecured
rates, and/or if there is strong demand for the safest collateral, pushing repo
rates and government yields significantly below unsecured interbank rates.
Both these factors have been to the fore this year, leading to an increased
incidence of negative nominal rates. Overnight rates in both Switzerland
and Denmark have been persistently negative, the former marginally and
intermittently for over a year, the latter only since June, but with rates getting
as low as negative 50bp. The persistence of negative market rates pressures
banks to pass them through to their depositors, with press reports this week
suggesting that a number of banks were charging investors for taking
DKK and CHF deposits, with one reportedly charging 75bp per annum for
taking CHF deposits. The Danish Bankers Association also said that its
Figure 1: Mutual fund AUM benchmarked to the
major JPM Government bond indices
bn
Source: Bloomberg, J.P.Morgan
Figure 2: Euro area government bonds and bills
trading at negative interest rates
bn
Source: Bloomberg, J.P.Morgan
AUM % Spain AUM Spain
GBI Global 42.8 2.7 1.1
GBI Broad 9.0 2.5 0.2
GBI EU 19.5 8.3 1.6
GBI EMU 32.0 10.0 3.2
GBI EMU IG 3.7 10.4 0.4
Total 107.0 100 6.6
0
100
200
300
400
500
600
700
800
Jan-12 Mar-12 May-12 Jul-12 Sep-12
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12 October 2012
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members were considering whether to pass negative market rates on to
customers.
The ECB's deposit rate cut to zero in July brought euro unsecured rates to
around 10 basis points, and they appear set to remain around that level, with
the ECB now looking unlikely to move to a negative deposit rate.
The cut in the deposit facility rate has been followed by a small number of
trades at negative rates in the market for unsecured euro deposits in London
(EURONIA rather than the much larger EONIA market), likely triggered by
operational factors (e.g. cash payments late in the day for institutions without
access to the ECB's deposit facility), and perhaps stronger credit quality among
the much smaller EURONIA panel. But the magnitude of these trades is
limited, with around 16bn in cumulative volume at negative rates since July,
less than the daily volume in EONIA.
In repo markets, euro general collateral secured rates have been hovering just
above zero, with lenders of cash very reluctant to accept negative interest rates.
But with GC rates around zero that means that investors looking to cover short
positions in scarce collateral routinely have to lend cash at negative rates.
Negative nominal rates have been far more prevalent in short-dated
government bonds than in repo or unsecured markets. Figure 2 shows an
estimate of the amount of Euro area government bonds and bills trading at
negative yields over time. We use pricing data from our JPM bond indices for
bonds of over one year's maturity, and Bloomberg bid prices for bills and sub-
1yr bonds, while recognizing that there is greater uncertainty over the yield of
less-frequently-traded money market instruments.
On this estimate, around 190bn of Euro area government securities are
currently trading with negative nominal yields, almost all of them with
maturities of one year or lower, and almost all of them German government
bonds or bills. To this we can add CHF45bn of Swiss government securities,
and DKK220bn of Danish government bonds, for a total of around 260bn of
European government bonds trading at negative yields.
Back in July, before the ECB's shift towards bond purchases, as much as
700bn of Euro area government securities were trading with negative
yields, of which almost half had more than one year to maturity, and 80% were
from Germany.
The climate of persistently low money market rates in the Euro area is likely to
keep money market funds under pressure, although they saw an inflow in
August, after two months of outflows. The pass-through to Euro area corporate
and retail deposit rates is less clear though. Despite recent improvements,
peripheral banks still remain under severe funding pressure, and even in the
core, banks have passed only around half the fall in money markets rates over
the past year on to depositors.
EM continues to grow as an asset class
Our colleagues in emerging markets strategy this week reported that the EM
corporate asset class reached the $1tr milestone (see EMOS, Joyce Chang, 4
Oct). We take this opportunity to look at the whole of the emerging market
asset class and see where we stand.
In order to get a more complete picture of the size of the EM debt market, we
use data from the BIS on total debt securities outstanding as opposed to our
EM bond indices, which cover a much smaller universe of purely the tradable
Figure 3: EM vs. DM outstanding debt securities
as a share of GDP
Share of GDP. Includes external and local debt
securities issued by governments and corporates.
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
220%
Dec-94 Jun-98 Nov-01 May-05 Nov-08 May-12
DM
EM
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bonds. The BIS statistics include outstanding debt securities not eligible for
inclusion in our bond indices for a variety of tradability reasons.
According to these BIS data, the total EM debt security universe is currently
around $12tr. This includes external and local currency debt issued by both
sovereigns and corporates. This equates to around 45% of EM GDP, a still
very small amount relative to GDP when compared to developed markets. DM
debt securities are currently in the region of $86tr, or almost 190% of GDP
(Figure 3).
Figure 4 shows EMs share of total debt and equity markets, which continues
to rise for debt but has stalled somewhat for equities. EM equities account for
16% of global equity market capitalization and EM debt securities account for
12% of total outstanding debt securities. But these EM equity and debt security
shares are still well below the EM share in global GDP, which stood at 35% in
2011.
Source: BIS, IMF and J.P.Morgan
Figure 4: EM share of global debt and equity
markets
Share of total global equity market cap and
outstanding debt securities. Equity market is proxied
by the Datastream global equity index. Total debt
outstanding is using BIS data.
Source: BIS, Datastream and J.P.Morgan
4%
6%
8%
10%
12%
14%
16%
18%
Dec-95 Mar-99 Jun-02 Sep-05 Nov-08 Feb-12
Debt
Equities
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Table A1: Weekly Flow Monitor
Based on 4-week averages. Gross bond issuance includes all corporates incl.
financials. The diamond is the current observation. The thin blue line marks the
distance between the min and max for the complete time series. The thick blue
bar shows the interquartile range. MF flows use Lipper data for the current
week and ICI for historical data. Current weeks observation is in column on the
right. ETF flows are from Bloomberg. (in $bns).
Source: Bloomberg, ICI, Lipper, Dealogic, Reuters, Federal Reserve, ECB, J.P. Morgan
Table A2: Monthly Trading Volume Monitor
Based on YoY changes. USTs are primary dealer transactions in all US
government securities. JGBs are OTC volumes in all Japanese government
securities. Bunds, Gold, Oil and Copper are futures. Gold includes Gold ETFs.
The diamond is the current observation. The thin blue line marks the distance
between the min and max for the complete time series. The thick blue bar
shows the interquartile range.
Source: Bloomberg, FE Reserve, Trace, Japan Securities Dealer Association, WFE, J.P. Morgan.
* Data with one month lag.
Chart A1: Weekly Spec Position Monitor
Net spec positions are the number of long contracts minus the number of short
using CFTC futures only data. This net position is then converted to a USD
amount by multiplying by the contract size and then the corresponding futures
price. To proxy for speculative investors, commodity positions use the managed
money category, while the other assets use the non-commercial category. The
chart shows the z-score of these net positions, i.e. the current net position
minus the average over the whole sample divided by the standard deviation of
the weekly positions over the whole sample. US rates is a duration-weighted
composite of the individual UST series plus the Eurodollar contract. The sample
starts on the 13th of June 2006.
Source: Bloomberg, CFTC, J.P. Morgan
Chart A2: Equity vs. UST positions
Equity positions include the S&P500, Dow Jones, Nasdaq and the Nikkei. The
UST series is a duration weighted aggregate of the Eurodollar, UST2YR,
UST5YR, UST10YR, UST long bond and the UST Ultra long bond futures.
Source: Bloomberg, CFTC J.P. Morgan
MF & ETF Flows(4wk avgs) MIN MAX 10-Oct
All Equity 0.44
All Bond 3.24
US Equity -1.24
Intl. Equity 1.89
Taxable Bonds 3.18
Municipal Bonds 0.98
Equity Supply (YoY changes in rolling 4wk flows) 12-Oct
Global IPOs 0.84
Global Secondary Offerings 1.81
Gross bond issuance (YoY changes in rolling 4wk flows) 12-Oct
US Bond Issuance 7.01
WE Bond Issuance 13.61
Corporate activity (YoY changes in rolling 4wk flows) 12-Oct
Global M&A 28.11
US buybacks 0.61
Non-US buy backs 1.03
Equities MIN MAX Sep-2012 (tr)
EM Equity $0.97
DM Equity $2.77
Govt Bonds
USTs $1.77
JGBs* 752
Bunds 2.51
Credit
US HG $0.24
US HY $0.11
US Convertibles $0.02
Commodities
Gold $0.64
Oil $0.77
Copper $0.20
-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
VIX
BRL
USD
EUR
RUB
US Equities
CHF
US 5YR
Crude Oil
GBP
JPY
US 2YR
US 10YR
US T-Bonds
AUD
Copper
Gold
Corn
NZD
US Rates (incl. ED)
Wheat
MXN
CAD
Silver
25-Sep 12 02-Oct 12
Standard devations from mean weekly position
-600
-400
-200
0
200
400
600
-6
-4
-2
0
2
4
6
8
Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12
$bn $bn
Equity positions
UST positions
Last observation: 2-Oct-12
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Chart A3: Market health map
Each of the six axes corresponds to a key indicator for markets. The position
of the blue line on each axis shows how far the current observation is from
the extremes at either end of the scale. The dotted line shows the same but
at the beginning of 2012 for comparison. For example, a reading at the
centre for value would mean that risky assets are the most expensive they
have ever been while a reading at the other end of the axis would mean they
are the cheapest they have ever been. See explanation on the right for each
indicator. Overall, the larger the blue area within the hexagon, the better for
risky markets.
Explanation of indicators
All variables are expressed as the percentile of the distribution that the
observation falls into. I.e. a reading in the middle of the axis means that the
observation falls exactly at the median of all historical observations.
Equity trading volumes: The YoY change in the average daily trading
volume of stocks on the NYSE.
Value: The slope of the risk-return tradeoff line calculated across USTs, US
HG and HY corporate bonds and US equities (see GMOS p. 6, Loeys et al,
Jul 6 2011 for more details).
Positions: The difference between flows into US domiciled equity and bond
funds. Chart at top left of page 9. We then smooth this using a Hodrick-
Prescott filter with a lambda parameter of 0.1. We then take the weekly
change in this smoothed series as shown in the fund flow indicator on page
9.
Flow momentum: The difference between flows into equity and HY credit
mutual funds (incl ETFs) and flows into bond funds. Chart at top left of page
9. We then smooth this using a Hodrick-Prescott filter with a lambda
parameter of 0.1. We then take the weekly change in this smoothed series as
shown in the fund flow indicator on page 9.
Economic momentum: The 2-month change in the global manufacturing
PMI. (See REVISITING: Using the Global PMI as trading signal, Nikolaos
Panigirtzoglou, Jan 2012).
Equity price momentum: The 6-month change in the S&P500 equity index.
Chart A4: Probability that the S&P500 rises over the next month
The probability is based on a probit regression of 3 variables, economic momentum, price momentum and positions on the S&P500 as described in the blue
box. The dotted line shows the average probability over the whole history of the time series since June 2006.
Source: Bloomberg, ICI, CFTC, Datastream, J.P. Morgan
To summarise the Market Health Map in one metric, we develop a regression model of the probability of the equity market
(the S&P500 index) rising over the next 4 weeks. In statistics, this regression model is called a probit model and it is a natural
way of summarising our Market Health Map given that the 6 signals are already expressed in percentile terms, i.e. the position
in each of the 6 axes reflects the percentile within the empirical probability distribution of each of the 6 signals. In this way, by
measuring the distance in probability rather than linear space we suppress the impact of outlier outcomes.
A model estimating the probability of a rise in
the S&P500 over the next month
P(S&P500t+4 > S&P500t) = -0.04
+ 1.29 x 2M change in the global PMI t (p-
value:0%)
+ 0.6 x 6M change in the S&P500 indext (p-
value:12%)
- 1.1 x positionst (p-value:0%)
Probit regression using weekly data. All explanatory
variables are expressed in percentile terms.
Source: J.P. Morgan
The regression uses only 3 signals out of the six in our Market
Health Map. Positions proxied by our risky vs. safe asset spec
position indicator (see Chart at top right of page 9), macro
momentum proxied by the 2-month change in the global PMI, and
price momentum proxied by the 6-month change in the S&P500
index. These three signals have the most significance in our
model for explaining whether equities go up or down over the
following 4-weeks. The remaining three signals in the Market
Health Map are less significant for the near term, so we exclude
them from the model.
Equity trading volumes
Positions
Inversed
Flows
Economic
momentum
Equity price
momentum
Value
600
800
1000
1200
1400
1600
1800
0%
20%
40%
60%
80%
100%
Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12
S&P500
Probability that the S&P500 rallies over the next 4-weeks
12-Oct-12
S&P500
Last observation:
10
Flows & Liquidity
12 October 2012
(44-20) 7134-7815
ETF Flow Radars (data as Oct 10
th
)
Flow Radars summarize total weekly ETF flows, as well as the relative movement across fund types. The charts are in percentile terms, such that for a
particular fund type, the center of the radar is the largest recorded weekly outflow (since 2005), and the outer-most point represents the largest inflow. The
position of the triangle on the axis give the historical ranking of last weeks flow. I.e. if the triangle crosses 66% of the way up the axis, only 33% of past flows
were larger and vice versa. The crosses on the axes give the zero flow points, i.e. crossing the axis above it represents an inflow and crossing the axis below
it represents an outflow.
Chart A5: Global Cross Asset Flow Radar Chart A6: US Bond Flow Radar
Source: J.P. Morgan. Bloomberg Source: J.P. Morgan. Bloomberg
Chart A7: Global Equity Flow Radar Chart A8: Mutual Fund Cash Radar
For US (Aug) and Euro area (July) domiciled funds. The centre of the radar
denotes low cash positions relative to total assets over the past 2 years of
data, i.e. UW cash. The outer edge of each axis denotes cash OWs.
Source: J.P. Morgan. Bloomberg Source: J.P. Morgan, ECB, ICI
Equities Money Markets
Bonds US HG
US HY Munis
US
EM
DM ex US
US
Europe
Equity
Bond
Hybrid
11
Flows & Liquidity
12 October 2012
(44-20) 7134-7815
Chart A9: Fund flow indicator
Difference between flows into Equity and Bond funds and ETFs
The thin blue line shows the 4-week average of this difference. The thick
black line shows a smoothed version of the same series. The smoothing is
done using a Hodrick-Prescott filter with a Lambda parameter of 0.1.
Source: Bloomberg, J.P. Morgan
Chart A11: Hedge fund monitor
Hedge fund equity exposure
Rolling 21-day beta of macro fund returns to returns on the S&P500. The
beta represents the average exposure of macro hedge funds to equities over
the previous 21-days.
Source: Datastream, Bloomberg J.P. Morgan
Chart A10: Spec position indicator
Difference between net spec positions on risky and safe haven
assets
We calculate the net spec position in USD across 8 "risky" and 7 "safe"
assets. These positions are then scaled by open interest and we take an
average of "risky" and "safe" assets to create two series. The chart is then
simply the difference between the "risky" and "safe" series. The final series
shown in the chart below is demeaned using data since 2006. The risky
assets are: Copper, GSCI, AUD, NZD, CAD, RUB, MXN and equities (an
aggregate of the S&P500, Dow Jones, NASDAQ and Nikkei). The safe
assets are: Gold, VIX, JPY, CHF, Silver, an aggregate of the UST and
Eurodollar futures and an aggregate USD index. The USD series is the
inverse of the sum of positions in EUR, JPY, GBP, CHF, AUD, NZD, CAD,
RUB and MXN futures. The UST series is a duration weighted aggregate of
the Eurodollar, UST2YR, UST5YR, UST10YR, UST long bond and the UST
Ultra long bond futures.
Source: CFTC, J.P. Morgan
Chart A12: Option skew monitor
Skew is the difference between the implied volatility of out-of-the-money
(OTM) call options and put options. A positive skew implies more demand
for calls than puts and a negative skew, higher demand for puts than calls. It
can therefore be seen as an indicator of risk perception in that a highly
negative skew in equities is indicative of a bearish view. The chart below
shows a z-score of the skew, i.e. the skew minus a rolling two-year average
skew divided by a rolling two-year standard deviation of the skew. A positive
skew on iTraxx Main means investors favour buying protection, i.e. a short
risk position. A positive skew for the Bund reflects a long duration view, also
a short risk position.
Source: Bloomberg, J.P. Morgan
-20
-15
-10
-5
5
10
15
Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12
$bn per week
0
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12
10-Oct-12 Last observation:
-0.4
-0.3
-0.2
-0.1
0.0
0.1
0.2
0.3
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
-1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5
German Bund
Crude
iTraxx Main
EURUSD
S&P500
11-Oct-2012 05-Oct-2012
12
Flows & Liquidity
12 October 2012
(44-20) 7134-7815
European Funding market monitor
Table A3: Bank deposits and ECB reliance
Deposits are non-seasonally adjusted Euro area non-bank, non-government deposits as of Aug 2012. We take total deposits (item 2.2.3. in MFI balance
sheets minus deposits from other financial institutions, which includes deposits from securitized vehicles and financial holding corporations among others.
We also subtract repos (item 2.2.3.4) from the total figures to give a cleaner picture of deposits outside interbank borrowing. ECB borrowing and Target 2
balances are latest available. ECB borrowing is gross borrowing from regular MROs and LROs. ELA is Emergency Liquidity Assistance. The Chart shows the
ECB borrowing and Target 2 liability, i.e. the inverse of the Target 2 balance column in the table. The ECB borrowing in the chart is the same data as the ECB
borrowing column in the table.
Source: ECB, National Central Banks, J.P. Morgan Source: ECB, National Central Banks, J.P. Morgan
Chart A13: Euro area gross bank debt
issuance
Chart A14: US CP issued by non-US
financials
Includes secured, unsecured and securitized issuance in any currency.
Excludes short-term debt (maturity less than 1-year) and self funded
issuance (where the issuing bank is the only book runner).
Commercial paper issued by non-US financial institutions in the US.
Source: Dealogic, J.P. Morgan Source: Federal Reserve
bn Target 2 balance ECB borrowing ELA Deposit 3m chng Deposit 12m chng
Austria -45 18 0.6% 4.7%
Belgium -29 40 1.5% 5.1%
Finland 70 4 0.9% 4.6%
France -4 176 1.8% 7.6%
Germany 695 77 1.9% 5.1%
Greece -108 30 101 -2.7% -18.6%
Ireland -111 79 40 -2.5% 2.6%
Italy -281 277 0.0% 1.8%
Luxembourg 113 5 0.8% -9.5%
Netherlands 125 28 1.2% 7.0%
Portugal -68 56 -0.4% 0.7%
Spain -400 383 -1.8% -6.5% -1000 -500 0 500
Germany
Netherlands
Luxembourg
Finland
France
Belgium
Austria
Portugal
Greece
Ireland
Italy
Spain
Gross total ECB
borrowing
Target 2 liability
(i.e. negative
means asset)
bn
5
10
15
20
25
Jun-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jun-12 Aug-12
Periphery
Core
EMU bank unsecured gross issuance
bn
350
370
390
410
430
450
470
490
510
Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12
$bn
10-Oct-12 Last observation:
13
Flows & Liquidity
12 October 2012
(44-20) 7134-7815
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