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The wary canary and the LIBOR OIS spread



Phil Milburn

By Phil Milburn, co-manager on the Global Fixed Income team at Liontrust Asset Management

In financial markets, some dislocations occur where the causality is not entirely clear. Rather than trying to retrofit an exact explanation, I find it helpful to examine each potential factor in turn to reach a conclusion: Sir Arthur Conan Doyle’s fictional detective would be very proud.

I will follow this methodology to ascertain whether the first quarter’s widening in the US 3-month LIBOR OIS (Overnight Indexed Swap) spread is a sign of something amiss or whether the proverbial canary is returning safely from the coal mine.

The canary is worried about the money market plumbing

In the first quarter of 2018, the financial market’s view of the path of US interest rates increased with the 3- month OIS moving from 1.44% to 1.72% over the period. However, the movement in US 3-month LIBOR has been more pronounced: it closed the quarter at 2.31%, over 60 basis points higher than the start of the year.

This divergence means there has been a rapid and dramatic widening in the LIBOR minus OIS spread, a frequently followed barometer of market stress. For those long in the tooth, this is very similar to the TED spread (between Treasuries and Eurodollar futures), except with the OIS replacing 3-month treasury bills in the equation.

Source: Liontrust, Bloomberg April 2018

Source: Liontrust, Bloomberg April 2018

Is this a sign of stress in the market for the wholesale liability financing of US banks? It clearly was during the credit crunch of 2007-2009 and the longer-term perspective in the chart below helps to frame the relative lack of size of the recent moves.

Source: Liontrust, Bloomberg April 2018

Source: Liontrust, Bloomberg April 2018

However, outside of the US and Australia, we are not witnessing such pressures in the Euro, Yen or Swiss Franc funding markets and only the slightest rise in Sterling (see the chart below). Furthermore, many of the other indicators that scare the canaries are also notable by their absence: volatility measures, such as the VIX, have increased but this is mostly correlated to fluctuations in the FAANGs (Facebook, Apple, Amazon, Netflix, and Google) stocks and President Trump’s tariff talks.

Source: Liontrust, Bloomberg April 2018

Source: Liontrust, Bloomberg April 2018

Therefore, it looks like the only mine the canary does not want to go into is the US LIBOR one. But going back to my previous point on causality, what is the issue here? There is a danger of over-extrapolating as US LIBOR is not the cleanest signal of bank funding conditions (note that I am assuming LIBOR is not being manipulated after the myriad fines that banks have endured for their past misdemeanours).

Actual 3-month bank funding is a relatively small market at an approximate volume of $1bn a day, and thus US LIBOR submissions look to other inputs such as repo, forwards and swaps to help triangulate the daily fixes. These other inputs are impacted by many factors outside of the demand and supply of unsecured bank funding. Let’s look at the three suggested causes of the widening.

  1. Treasury bill supply: is the mine being flooded?

There was a tsunami of Treasury bill issuance from early February until the end of March, which followed directly from the ending of the latest debt ceiling impasse. It is a relatively rare event for the US Treasury to issue a net $325bn of bills over a two-month period, with the last occurrence being targeted to accommodate the money market fund reforms in 2016.

Treasury repo closely tracks bills, and thus repo rates have increased over the period. But there is little direct causality between the two as suppliers of bank funding and buyers of bills see little overlap. It is more likely to have gone through a market-based transmission mechanism, with marginal lenders such as commercial paper managers demanding higher rates with bills as an alternative. Effectively, this is a classic economic crowding out of the funding markets represented by higher prices paid for the marginal borrower.

  1. The great repatriation: mining a few rich seams

The second explanation posited for the spread widening is connected to the anticipated repatriation of overseas earnings by large US corporations. With the reduced tax rate, post the fiscal reforms, the formerly “trapped” overseas earnings are expected to flow back into the US. Analysis of the flows is subject to idiosyncratic risk as they can be driven by a few key decision makers, with 40% of the overseas cash stock held by just 10 firms.

The repatriations themselves are not the key driving factor here, rather it is the realised tax liability that they crystallise. Although these can be amortised over an eight-year period, some companies may opt for accelerated tax payments in order to enact special dividends or massive share buybacks.

There has been an increase in non-financial commercial paper issuance and some have suggested this is to pre-fund the tax liabilities; I view this as plausible but only likely to have a small marginal impact.  The companies involved in the repatriations are sitting on vast swathes of cash, maybe money market funds are scared of redemptions? It sounds like a good story but the collective evidence simply does not fit here.

The most likely scenario is that the companies which are facing an impending tax liability have been providing some of the financing for banks. Post the 2016 money market fund reforms, banks were pushed into seeking short-term wholesale funds elsewhere and a cash rich treasury part of a large corporation must have been a great hunting ground. However, the reduction in demand from this source is realistically unlikely to have contributed more than a handful of basis points of LIBOR OIS spread widening.

  1. QE reversal: the Federal Reserve clips the market’s wings

The reduction in reinvestment of the coupon and maturities from the stock of bonds purchased during the Federal Reserve’s quantitative easing (QE) programme is shrinking its balance sheet. As the Fed’s assets reduce, there must, by definition, be a reduction in liabilities within the financial system. Ultimately, as the Fed’s balance sheet shrinks, commercial banks’ reserves decline and excess liquidity reduces. Furthermore, the US Treasury’s cash reserves, built up during the bill issuance, are kept at the Fed, which has a draining impact on the financial system. With US banks being deposit rich and lending conditions pretty sanguine, I believe it is too soon for this to be having a large impact on bank funding rates, but clearly its influence will increase as the excess systemic liquidity is mopped up.

Is it safe for the canary to go back into the mine in the second quarter?

In my opinion, the short answer is yes. Bill issuance is set to slow through the rest of the year as the US Treasury approaches its target cash reserve. In addition, seasonally US tax receipts pick up in April with the 15th representing the deadline for 2017 tax returns.

Examining the evidence, I believe that bill issuance has been the biggest driver of the LIBOR OIS spread widening. The confluence of this with the fears around tax on repatriation flows and the reduction of the Fed’s balance sheet has magnified the movements.

 I suggest most of the impact of the latter two factors has been market-fear related, with relevant constituencies repricing their lending rates just in case. I anticipate a reversal of some of the widening in the second quarter and would estimate the spread to settle into a 30 to 40 basis points range. If this part reversal does not happen, I would start to become concerned that I had missed a fourth explanation and then listen to what the canary had to say for itself.

On a multi-year view, the oscillations in Treasury bill issuance are likely to be transitory in nature.  The repatriation, and corresponding tax crystallisation, is likely to redistribute the stock of excess asset liquidity from shorter dated credit instruments into equities via share buybacks. However, this has no long-term impact on the stock of liabilities, it just will reduce marginal demand and therefore slightly increase the price of bank funding. The largest long-term driver is likely to be the continued reversal of QE and at some stage the Fed’s balance sheet will have shrunk far enough that banks’ liquidity and funding conditions become tight.

How to seek to make money out of this in a bond fund

Even though we are bond fund managers and not money market fund managers, we can still seek to make some money for clients from this. The Liontrust GF Strategic Bond Fund, which is launching on 13 April, will have a mid-single digit weighting in US floating rate notes. These are unlikely to provide significant capital upside but some extra yield never goes amiss.

Additionally, some shorter dated credit spreads have been under pressure and this has created some opportunities to source cheap 4 to 5 year maturity corporate debt. Finally, the yield benefit one receives from hedging other currencies into US dollars has increased; but clearly the converse applies if one is a non-USD investor.


Hong Kong’s Cathay Pacific warns of capacity cuts, higher cash burn



Hong Kong's Cathay Pacific warns of capacity cuts, higher cash burn 1

(Reuters) – Cathay Pacific Airways Ltd on Monday warned passenger capacity could be cut by about 60% and monthly cash burn may rise if Hong Kong installs new measures that require flight crew to quarantine for two weeks.

Hong Kong’s flagship carrier said the expected move will increase cash burn by about HK$300 million ($38.70 million) to HK$400 million per month, on top of current HK$1 billion to HK$1.5 billion levels.

Hong Kong is set to require flight crew entering the Asian financial hub for more than two hours to quarantine in a hotel for two weeks, the South China Morning Post reported last week, citing sources.

“The new measure will have a significant impact on our ability to service our passenger and cargo markets,” Cathay said in a statement, adding that expected curbs will also reduce its cargo capacity by 25%.

The airline, in an internal memo seen by Reuters, requested for volunteers among its crew who could fly for three weeks, followed by two weeks of quarantine and 14 days free of duty, adding it will be a temporary measure and not all its flight will require such an operation.

“We continue to engage with key stakeholders in the Hong Kong Government,” the memo said.

The government did not immediately respond to a request for comment.

Separately, a company spokeswoman said the airline could not detail the impact on vaccine transport specifically in terms of cargo shipments.

The aviation industry has been hit hard by the COVID-19 pandemic as many countries imposed travel restrictions to contain its spread.

In December, Cathay’s passenger numbers fell by 98.7% compared to a year earlier, though cargo carriage was down by a smaller 32.3%.

($1 = 7.7512 Hong Kong dollars)

(Reporting by Shriya Ramakrishnan in Bengaluru; Additional reporting by Jamie Freed in Sydney and Twinnie Siu in Hong Kong; Editing by Bernard Orr and Arun Koyyur)

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Travel stocks pull FTSE 100 lower as virus risks weigh



Travel stocks pull FTSE 100 lower as virus risks weigh 2

By Shashank Nayar

(Reuters) – London’s FTSE 100 fell on Monday, with travel stocks leading the declines, as rising coronavirus infections and extended lockdowns raised worries about the pace of economic growth, while fashion retailers Boohoo and ASOS gained on merger deals.

The British government quietly extended lockdown laws to give councils the power to close pubs, restaurants, shops and public spaces until July 17, the Telegraph reported on Saturday.

The blue-chip FTSE 100 index dipped 0.1%, with travel and energy stocks falling the most, while the mid-cap index rose 0.1%.

“Stock markets are crawling between optimism around the rollout of vaccines and worries that a jump in virus infections and fresh local lockdowns could further affect recovery prospects,” said David Madden, an analyst at CMC Markets.

Britain has detected 77 cases of the South African variant of COVID-19, the health minister said on Sunday while urging people to strictly follow lockdown rules as the best precaution against the country’s own potentially more deadly variant.

Prime Minister Boris Johnson had earlier warned that the government could not consider easing lockdown restrictions with infection rates at their current high levels and until it is confident that the vaccination programme is working.

The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy.

Online fashion retailers Boohoo and ASOS surged 4.8% and 5.9%, each. Boohoo bought the Debenhams brand, while ASOS was in talks to buy the key brands of Philip Green’s collapsed Arcadia group.

Recruiter SThree Plc gained 0.9% after its profit, which nearly halved, still managed to beat market expectations and the company said it had resumed dividends.

(Reporting by Shashank Nayar in Bengaluru; editing by Uttaresh.V)

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Top 8 Tax Scams to Watch Out For



Top 8 Tax Scams to Watch Out For 3

It is tax time and that means finding the best way to file your taxes and to get a refund of any amount you’ve overpaid. Unfortunately, tax time also means plenty of scammers are thinking of new and clever ways to try and get their hands on your money or on your personal information (which they can use to get money).

Those who specialize in IRS tax scams are clever and can be very convincing. Your first line of defense is to always know what to be looking for in terms of common tax fraud in order to avoid being another victim.

8 Most Common Tax Scams

Protecting yourself from IRS tax scams can be tricky if you’re not aware of what the threats are. A good tax scam seems legitimate, and that is what makes them dangerous. Always be on the lookout for the eight most common tax scams, including:

  • IRS Phone Scams
  • Fake IRS Emails
  • Fraudulent Tax Preparers
  • Fraudulent Tax Refunds
  • Fake Charities
  • Set Up Offshore Accounts
  • Empty Promises
  • Frivolous Returns

To know what exactly you need to watch out for, let’s look at them in more detail.

1. IRS Phone Scams

If someone calls you claiming to be from the IRS, it is almost certainly one of many IRS phone scams. The IRS will never call you to demand money for back taxes or to confirm your personal information, so be immediately alert. Never give personal information over the phone, and don’t head to the bank to follow the demands for money.

If you do wind up on the end of an IRS phone scam, don’t become flustered by aggressive tactics by the fake “agent”. They are good at sounding threatening and demanding information or payments. Remain calm and ask for contact information. Tell the scammer you’ll call them back with the information. Either the scammer will give you fake information or he will work to avoid leaving any information at all. Regardless, don’t call him back. Simply report the call to the local police or the IRS.

2. Fake IRS Emails

Another very common fake IRS scam is phishing, or sending fake IRS emails, in a ploy to gather personal information. Fake emails will look authentic and will ask you to click on a link or to log in to a fake IRS website. The purpose of these emails is to simply gather your personal information to be used for other fraudulent purposes.

Just like with IRS phone scams, you should be immediately wary if the IRS appears to send you an email. The IRS does not contact citizens through email. All official IRS communication will come through standard mail. If you do find a fake IRS email in your inbox, forward it to the IRS. The IRS investigates these scams and has a dedicated email address for this very purpose: [email protected].

3. Fraudulent Tax Preparers

Some scam artists show up in a suit, open a storefront and offer to prepare your tax return for you. These tax preparers appear by all accounts to be absolutely legitimate, and many go to great lengths to convince customers of their years of experience and authenticity.

As a fraudulent tax preparer, however, the person is not legitimate. The scam artist can use your tax return in many ways for his own benefit. He can inflate your refund and skim off the top. He can charge outrageous fees for filing on your behalf. He can file your return correctly this year and gather all of your information to make a fake return for his benefit next year.

If you are going to have someone else prepare your taxes, be sure to look carefully through tax service reviews. Tax service reviews are available on many different websites that offer feedback on companies and services. These reviews will give you a very good idea about the legitimacy of the business and the reliability of the preparer. If a company doesn’t have any tax service reviews on any website, like e.g, or BBB, that may be a sign that it’s a pop-up company that will disappear as soon as the scammer has what he wants.

4. Fraudulent Tax Refunds

Another very popular tax scam starts well before the tax season. To file a fraudulent tax return, the scammer must gather all pertinent personal information including a social security number. He then uses the information he gathered to file a fake tax return on your behalf. Naturally, he’s not going to send you the refund he’s claiming – that goes into the scammer’s pocket.

The best way to prevent a fake tax return is to guard your personal information close at all times. If nobody is able to steal your identity, they can’t file a tax return. Another good step is to file your own tax return as early as possible. That way, even if your information was stolen somehow, you will get your refund correctly and the IRS will be alerted when someone files a second return using your information.

5. Fake Charities

Charitable donations are tax-deductible if you’re itemizing your deductions. This creates possibilities for scammers to take advantage of others who are looking to reduce their tax burden and increase their refund by making donations. Fake charities can take on many shapes and forms.

Some may appear conveniently around tax time or be affiliated with fraudulent tax preparers. The claim is that by donating to a fake charity you will help others and reduce your own tax liability. Instead, you’re giving someone free money and you won’t be able to deduct the donation as it’s not a real charitable organization. Other fake charities involve you in a scam by promising to give you back your donation as soon as the tax return is filed, for example. It goes without saying that claiming a donation you didn’t actually make is tax fraud and highly illegal.

At the advice of his tax preparers, a famous country singer Willie Nelson moved some of his money into tax shelters and charities to help reduce his tax bill. The IRS grew suspicious of the moves and investigated. In one of the most famous IRS cases in the United States, Willie Nelson was hit with a tax bill in the millions when his charities and shelters were found to be invalid.

Willie didn’t have the funds to make the payments, so the bill continued to grow until the IRS finally grew so frustrated they raided and seized all of Willie Nelson’s properties including a recording studio, a ranch, and his home. Even that wasn’t enough to pay the bill, so eventually, Willie made a deal with the IRS. He recorded an album and all proceeds from that album went directly to the IRS to whittle away his debt. Willie did file suit against the accounting firm that advised the tax shelters in the first place, but the two parties settled out of court.

6. Set Up Offshore Accounts

Some tax scams sound good but require your participation in illegal activities. For example, you may meet an unscrupulous tax “professional” who offers to help you move some of your money into an offshore account.

This sounds legitimate as many people use offshore accounts for valid reasons, but by moving your funds into an offshore account with the intent of hiding that income from the IRS, you’re committing tax fraud. Additionally, if you’re working with a shady professional, it’s highly likely that neither you nor the IRS will see your extra income ever again. And you can still wind up with a legal case with your money stolen and gone.

7. Empty Promises

The tax preparer who encourages you to sign a blank tax form is nobody you want to work with. These preparers encourage you to simply sign the form because he or she is going to work out the numbers for you so that you can get the highest possible refund. If you do this, you are almost certainly subjecting yourself to tax filing scams.

Signing a blank tax form is potentially worse than simply signing a blank check for a stranger. Not only are you at risk of losing your personal information and any refund you might be owed, but you are also at risk of legal action by the IRS for signing your name on a refund that is almost certainly going to contain false and fraudulent information.

8. Frivolous Returns

The IRS sees a ridiculous number of what they call “frivolous returns” every year. A frivolous return is a tax return that is filed with the intent of simply wasting time. These frivolous claims have already been thrown out in court, so filing a tax refund making a frivolous claim is simply opening yourself up to additional action by the IRS including fines of at least $5,000. The top “frivolous claims” include:

  • Refusing to pay taxes on moral or religious grounds
  • “Opting out” of paying taxes
  • Invoking the First Amendment to “protect” you from taxes
  • Claiming only Federal Employees pay federal taxes
  • Claiming you have no income and therefore no tax liability (when you clearly do)

Top 3 Tips on How to Protect Yourself from IRS Tax Scams

Protecting yourself from tax fraud is a matter of being vigilant and mindful that there is always a possibility of something going wrong. Work with a trusted advisor or study up and file taxes yourself to avoid the uncertainty of allowing others to handle your financial matters. Often a bit of knowledge goes a very long way.

1. Know How the Tax System Works

One of the most common negative IRS reviews is that the tax refunds aren’t released immediately. In many IRS complaints, customers complain that they don’t get their refunds immediately.

While frustrating to wait, the IRS is usually very clear about processing times and has never sent refunds immediately after the filing window opens. The government doesn’t move quickly and reviews of documents and financial information submitted in your returns are necessary.

Additionally, relying on others to help you file your taxes every year can open you up to the possibility of fraudulent activities. Reviewing the tax codes and reading through the laws and requirements may not be exciting, but it will give you at least a basic understanding of how the process works so that you can look out for problems if you are trusting someone else with your information and money.

2. Always Read Carefully

The safest way to file your taxes is to do them by hand on the original IRS paper forms and to mail them using certified mail. Many people don’t choose to do this, however, as it can be very tedious and confusing if you do not know the tax system backward and forwards.

Instead, many filers rely on tax software and paid tax preparers. When using software or allowing someone to use the software on your behalf, it never gets too comfortable. There might be hidden fees in the software or glitches to overcome.

Reviewing choices carefully as the software takes you from screen to screen is a good way to avoid accidentally accepting hidden fees. Another option to avoid paying for fees you aren’t comfortable with is to simply abandon the return on one piece of online software and to try again with another – there are multiple tax return software options available.

3. Always Look for Tax Filing Scams

If you always expect to find a scam, you’ll never be surprised when one appears. Even tax preparers who have been in business for years can have some deceptive business practices that others assume are necessary or haven’t noticed them at all.

Tax time can be exciting if you’re entitled to a large refund, but it can be stressful if you don’t feel in control of the tax filing process. Educate yourself on the risks and tax scams that exist, and always exercise caution when choosing a method to file your taxes. Your personal information is closely tied to your money, so protecting both of them is often simply a measure of keeping your eyes wide open and using your knowledge to avoid traps and scams.

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