Category: Macro Posts

Doug Noland writes…

After years of increasingly close cooperation and collaboration, the relationship has turned strained. Both sides are digging in their heels. Credibility is on the line. If one side doesn’t back down, things could really turn problematic. The Fed is asserting that it’s not about to lower the targeted Fed funds rate. Markets are strident: You will cut, and you will cut soon. Bonds are instructing the world to prepare for the Long March.

Market probability for a rate cut by the December 11th FOMC meeting jumped to 80% this week, up from last week’s 75% and the previous week’s 59%.

May 22 – Reuters (Howard Schneider and Jason Lange): “U.S. Federal Reserve officials at their last meeting agreed that their current patient approach to setting monetary policy could remain in place ‘for some time,’ a further sign policymakers see little need to change rates in either direction. ‘Members observed that a patient approach…would likely remain appropriate for some time,’ with no need to raise or lower the target interest rate from its current level of between 2.25 and 2.5%, the Fed… reported in the minutes of the central bank’s April 30-May 1 meeting. Recent weak inflation was viewed by ‘many participants…as likely to be transitory,’ while risks to financial markets and the global economy had appeared to ease – a judgment rendered before the Trump administration imposed higher tariffs on Chinese goods and took other steps that intensified trade tensions.”

Analysts have been quick to point out that additional tariffs along with the breakdown in trade negotiations unfolded post the latest FOMC meeting. True, yet several Fed officials have recently reiterated the message of no urgency to lower rates. This week Atlanta Federal Reserve President Raphael Bostic said he doesn’t see the Fed reducing rates. In a Thursday Bloomberg interview, Federal Reserve Bank of Cleveland President Lorretta Mester went so far as to state that reducing rates (to boost inflation) would be “bad policy.” This followed New York Fed President John Williams’ Wednesday comment: “I don’t see any strong argument today, based on what we have seen in the data or other information, to move interest rates one way or the other.” On Thursday, Dallas Fed President Robert Kaplan stated he was “agnostic at this point about whether the next move is up or down.”

Agnostic the markets are not. Ten-year Treasury yields dropped another seven bps this week to the lows (2.32%) since December 15th, 2017. Two-year yields declined four bps to 2.17%, the low going back to February 2018. Sinking market yields are anything but a U.S. phenomenon. German 10-year bund yields declined another basis point to negative 0.11%, trading this week at low yields going all the way back to the summer of 2016. Swiss yields fell four bps this week to negative 0.45% (low since October 2016). Japanese JGB yields fell two bps to negative 0.07%.

Curiously, yields dropped 15 bps in Italy (2.55%), nine bps in Portugal (0.97%) and six bps in Spain (0.82%). Yields this week were down to 0.04% in Denmark, 0.07% in the Netherlands, 0.11% in Finland, 0.17% in Sweden, 0.19% in Austria, 0.37% in Belgium, 0.38% in Slovakia, 0.45% in Latvia and 0.54% in Slovenia. We have become numb to an incredible market spectacle.

Global “risk off” gathered some momentum this week. The Shanghai Composite declined 1.0%, trading back to around February lows. China’s growth/tech ChiNext index sank 2.4% to the lowest level since February 22nd. Hong Kong’s Hang Seng China Financials index dropped 1.5% to the low going back to January 21st. China’s renminbi mustered a 0.26% gain versus the dollar, a notably unimpressive recovery considering its recent walloping.

“Risk off” was pervasive throughout European equities. Germany’s DAX index fell 1.9%, with France’s CAC40 down 2.2%. Led by a 6.6% drubbing in Italian bank shares, Italy’s MIB index sank 3.5%. Europe’s STOXX 600 Bank index fell 3.0%.

The S&P500 declined 1.2%, with the tech-heavy Nasdaq100 down 2.7%. The Semiconductors were hammered 6.4%. The Dow Transports fell 3.4%.

The unfolding “risk off” backdrop became too much for some key commodities markets. WTI crude was hammered 6.6% this week (biggest decline of the year), trading to a two-month low. Copper declined 1.7%, approaching January lows. Aluminum fell 2.0%, Zinc 1.5%, and Tin 1.0%. The Bloomberg Commodities Index traded Thursday at the lows since “U-turn” January 4th.

May 22 – Reuters (Michael Martina and David Lawder): “China must prepare for difficult times as the international situation is increasingly complex, President Xi Jinping said in comments carried by state media…, as the U.S.-China trade war took a mounting toll on tech giant Huawei… During a three-day trip this week to the southern province of Jiangxi, a cradle of China’s Communist revolution, Xi urged people to learn the lessons of the hardships of the past. ‘Today, on the new Long March, we must overcome various major risks and challenges from home and abroad,’ state news agency Xinhua paraphrased Xi as saying, referring to the 1934-36 trek of Communist Party members fleeing a civil war to a remote rural base, from where they re-grouped and eventually took power in 1949.”

May 19 – Bloomberg (Karen Leigh): “President Donald Trump said he was ‘very happy’ with the trade war and that China wouldn’t become the world’s top superpower under his watch. ‘We’re taking in billions of dollars,’ Trump told Fox News Channel’s Steve Hilton when asked about the end game on the trade war. ‘China is obviously not doing well like us.’ Trump’s comments signal he’s in no rush to get back to negotiating with Beijing… The president also told Hilton he believed China wants to replace America as the world’s leading superpower, and it’s ‘not going to happen with me.’ ‘I think that’s their intention… Why wouldn’t it be? I mean they’re very ambitious people, they’re very smart.’”

If it is negotiation posturing, it’s a rather convincing effort from both sides. Hopes for de-escalation from rapidly deteriorating Chinese/U.S. relations were tempered to start the week. “China is in ‘no rush’ to restart trade talks,” read the headline. President Trump’s comments regarding China not attaining superpower status under his watch played right into Beijing’s narrative.

May 20 – Bloomberg (Ian King, Mark Bergen, and Ben Brody): “The impact of the Trump administration’s threats to choke Huawei Technologies Co. reverberated across the global supply chain on Monday, hitting some of the biggest component-makers. Chipmakers including Intel Corp., Qualcomm Inc., Xilinx Inc. and Broadcom Inc. have told their employees they will not supply Huawei until further notice, according to people familiar with their actions. Alphabet Inc.’s Google cut off the supply of hardware and some software services to the Chinese mobile phone equipment giant, another person familiar said, asking not to be identified discussing private matters. The Trump administration on Friday blacklisted Huawei — which it accuses of aiding Beijing in espionage — and threatened to cut it off from the U.S. software and semiconductors it needs to make its products.”

With technology stocks in the crosshairs, equities were under heavy selling pressure in Monday trading (S&P500 down 2.4%, with the Dow sinking 617 points). In an effort to contain market and supply chain fallout, the administration after Monday’s close moved to grant tech firms a three-month license (with stipulations) to do business with Huawei. Tuesday’s rally suffered a short half-life.

By Tuesday evening, concerns were mounting after reports the Trump administration was considering adding Chinese surveillance firms to the blacklisted companies to be cut off from U.S. technology suppliers. It was the opposite of de-escalation.

Ten-year Treasury yields fell four bps Wednesday and another six on Thursday (to 2.32%). The Shanghai Composite dropped 1.4% in Thursday trading. In U.S. markets, the VIX popped to 18, as a whiff of vulnerability emerged in U.S. corporate credit. Junk bond spreads increased to near the widest – and investment-grade CDS prices near the highest – level since late-March. U.S. bank stocks dropped 1.8% in Thursday trading, as bank CDS prices widened moderately. For the week, investment-grade corporate bond funds suffered their first outflow ($756 million) in 17 weeks.

May 24 – Bloomberg (Brian Smith): “Like a punch-drunk boxer saved by the bell, the Memorial Day weekend couldn’t have come at a better time for the high-grade credit market. Credit spreads have blown out to the widest levels since March, the new issue market screeched to a halt mid-week… Total high-grade new issue volume (including EM) totaled just shy of $17 billion, well below projections of $20b-$25b, as at least three potential borrowers were said to have punted until next week… Three of this week’s new issue tranches failed to price at the tight end of the guidance range, a rare occurrence and clear signal of investor pushback… Nearly 75% of this week’s deals are trading wide to their new issue pricing levels.”

A Wall Street Journal article (James Mackintosh) headline resonated: “Investors Slowly Wake Up to Fears of a New Cold War – The U.S.-China Trade Conflict Might be a Repeat of a Pattern All-Too Common in Markets When it Comes to Geopolitical Risks: Ignore Them, Then Panic.”

It’s worth generally examining The “Ignore Them, Then Panic” Dynamic. At this point, perpetual monetary stimulus has become deeply imbedded within inflated securities prices across asset classes around the globe. One can disagree on potential catalysts and circumstances, but the most extreme global bond pricing dynamics clearly incorporate prospective rate cuts and additional QE. Meanwhile, risk markets are bolstered by collapsing market yields along with the perception of multiple market backstops (Fed/global central banks, Chinese stimulus, Trump/2020 elections, corporate buybacks, etc.).

Early on in the global government finance Bubble, I advanced the concept of the “Moneyness of Risk Assets.” This was an evolution from the mortgage finance Bubble period’s “Moneyness of Credit” market distortion. The aggressive use of rate policy and central bank balance sheets/Credit to promote stock and bond price inflation nurtured the (central bank backstop-induced) perception of risk assets as safe and liquid stores of value (i.e. money-like). Over time, this had momentous effects throughout the markets, certainly including the booming ETF and derivatives complexes.

When it comes to various risks, over years it became increasingly easy to simply “Ignore Them.” Central banks have repeatedly stepped up to backstop vulnerable risk markets. At the same time, the central bank “put” has ensured readily available inexpensive market insurance (i.e. put options). Why not write flood insurance when the authorities control the weather? And with market protection so cheap, is it not rational to partake in rewarding risk-taking activities? Moreover, with QE having become the principal instrument in the central banking toolkit, prices for Treasury, Bund, JGB and other “safe haven” bonds are essentially guaranteed to rise in the event of heightened systemic risk. Superior to even cheap derivative protection, can’t lose holdings of safe haven bonds offer protection while also inflating in value.

As I’m fond of discussing, crises typically erupt in the money markets. It is when the perception of safety and liquidity is suddenly questioned that all hell breaks loose. And never before have risk markets so harbored the misperception of money-like attributes. This explains the “Then Panic” Dynamic.

I have argued that contemporary finance functions poorly in reverse. The market-based global financial apparatus seemingly performs wondrously so long as securities prices rise, the cost of market protection remains cheap and risk embracement holds sway. And it is almost as if the system has evolved to operate quite splendidly under moderate degrees of apprehension. Such a backdrop provides the Buy the Dip Crowd easy opportunities, while lavishing effortless profits upon the writers/sellers of market protection. To be sure, a hospitable marketplace of mild pullbacks and robust rallies further emboldens the prevailing view that markets always go up (so ignore risk!).

As we witnessed in December, things can start to unwind rather quickly when markets begin questioning the timeliness and scope of the central bank backstop. When the faithful dip buyers reverse course and turn urgent sellers, there’s an immediate market liquidity issue. Worse yet, when the protection sellers (i.e. put writers) suddenly fear they might end up on the hook for substantial market losses, it’s “Then Panic.” They must either buy protection for themselves or start shorting securities to offset their exposure to escalating losses. Any time writers of derivative protection are forced into aggressive selling, markets quickly face a major liquidity problem.

I have argued that the bursting of China’s historic Bubble presents a catalyst for the piercing of the global Bubble. And I posited as recently as last week that the breakdown in U.S. trade negotiations risks pushing China over the edge. I also suggested that acute Chinese fragility likely explains the extraordinary drop in global safe haven bond yields. While this is reasonable analysis, it is surely too simplistic.

Crisis unfolding in China has become a high probability catalyst for bursting the global Bubble. Yet it is structurally-impaired global financial and economic systems that explain virtual panic buying of safe haven bonds in the face of resilient risk markets. For decades now, risk markets have climbed the proverbial “wall of worry” – seemingly scaling new heights after overcoming one potential crisis after another (i.e. deep U.S. recession, European crisis, geopolitical flashpoints, Brexit, multiple China scares, “flash crashes,” the winding down of QE, etc.). It’s rational for risk markets to welcome risk as an opportunity to capitalize on additional central bank and Beijing stimulus measures.

Safe haven bond markets view the backdrop altogether differently. Current market structure is unsustainable. Treasuries, bunds, JGBs, etc. are zeroed in on the risk markets’ proclivity for Ignore Them, Then Panic. The safe havens are now preparing for the Panic Phase, with the presumption that dysfunctional speculative dynamics and deep structural maladjustment ensure the next bout of “risk off” (de-risking/deleveraging) deteriorates into illiquidity and market dislocation.

The assumption is that central bankers will have no alternative than to cut rates and aggressively resort to even greater marketplace liquidity injections (QE). Considering the scope of speculative leverage permeating global markets, along with structural dependency to unending liquidity abundance, I don’t disagree with the safe haven perspective.

Highly speculative risk markets, heartened by extremely low yields and prospects for monetary stimulus, confront a major timing issue. They envisage the Fed and global central banks moving quickly and forcefully to reverse “risk off” before it gains momentum – emboldened by the January U-turn and the belief that the Fed learned from its December blunder.

The Fed, however, is signaling it sees no justification for an itchy trigger finger. There is a contingent within the FOMC surely not overjoyed by the speculative melee incited by their January “pivot”. Believing the markets and economy are fundamentally sound, the Fed back in December was caught unprepared for the intensity of market instability. Many on the FOMC likely view the markets’ rapid recovery as confirming their confidence in underlying system soundness and resiliency. I’ll also assume that Chairman Powell and some committee members are uncomfortable with the view of a “Fed put” not far below current market prices.

The huge 2019 risk market rally has only exacerbated underlying market and economic fragilities. Safe haven bonds concur with this view, while the collapse in global market yields works to support the speculative Bubble raging in the risk markets. Corporate Credit, in particular, has been underpinned by sinking sovereign bond yields. It has made it especially easy to Ignore Them – myriad risks including collapsed trade talks, rising U.S./China tensions, a fragile Chinese Bubble, waning global growth, vulnerable EM, susceptible European finance and economies, and the rapidly deteriorating geopolitical backdrop.

Healthy markets would adjust and correct to reflect heightened uncertainties and deteriorating prospects. Speculative markets instead promote excess and the ongoing accumulation of imbalances, maladjustment and impairment. There’s no operable release valve. Pressure builds and builds – risks accumulate in all the wrong places – Then Panic.

The flaw in contemporary finance – especially within market psychology over recent years – is to believe central bankers have nullified market, economic and Credit cycles. They have certainly averted a number of market crises over recent years, in the process significantly extending cycles. Along the way risk market participants grew greatly overconfident in the capacity of central bankers to permanently forestall crisis. Moreover, they have turned completely blind to the historic crisis festering just below the surface of their delusional view of a “Permanently High Plateau” of global peace and prosperity.

Read Full post below

http://creditbubblebulletin.blogspot.com/

Mehul Daya writes and I concur….
it’s simple: it’s all about Dollar-Liquidity. Slowdown in global trade is putting pressure on creation and velocity of Dollars via value-chains/Dollar-leverage since the Dollar is the lubricant of the global financial system.

See charts below in thread. Long USD

Chart 1 – this is how the dollar gets transmitted into the world

Chart 2 – global trade vs USD vs Triffin dilemma

BIS writes in ” The geography of dollar funding of non US banks”

• US dollar liabilities of non-US banks grew after the Great Financial Crisis (GFC). At end-June 2018, they stood at $12.8 trillion ($14.0 trillion including net off-balance sheet positions) – as large as at the peak of the GFC.
• Banks raise relatively fewer dollar liabilities in their affiliates in the US since the GFC. This is due to a rise in the share of dollar liabilities booked in the country where banks are headquartered.
• European banks, which traditionally have had a large US footprint, have shrunk their dollar business and the role of their US affiliates since the GFC. At the same time, non-European banks expanded their dollar borrowing quite rapidly, but in recent years have also raised relatively fewer dollars in the US.
• A large share of US dollar liabilities of non-US banks are cross-border (51% at end-June 2018), implying that the location where US dollar funding is raised is different from the location of the funding provider.
• The global share of US dollar funding provided by US residents is significantly higher than that raised at foreign banks’ US branches and subsidiaries, though these shares vary across banking systems.

The global trade is slowing down and cross border trade is the largest supplier of USD into the global economy and financial system and as BIS summaries….How might this funding configuration behave in times of market stress? Non-US creditors may be pressured to withdraw funding as they might face a dollar funding squeeze themselves. This in turn is akin to margin call on all assets which were beneficiary of dollar based monetary system.

Key highlights of the fortnight:

• The oversupply of bonds and liquidity tightness is keeping the 10 year G-sec curve range bound. With headline inflation still below 3%, moderating core inflation, slowing industrial growth and GDP growth likely to be below 6.5% in 4QFY19, we expect the rate easing cycle to continue.
•  IIP growth remained sluggish in March 2019, declining 0.1% YoY, after a meagre increase of 0.1% in the previous month. The soft growth was mainly due to decline in manufacturing growth led by auto and auto component segment

• The slowdown in consumption space is led by auto sector which has now percolated down to staples. This is a worrying development
• Trade deficit widened to USD 15.3 billion on account of weak external demand. Export growth slid to 0.6% YoY from 11.0% YoY in March, as the base effect turned unfavourable. Weakness was mainly driven by non-oil exports, as oil exports registered strong YoY growth. Gold and silver imports registered solid improvement, though non-oil non gold imports contracted for the fourth consecutive month indicating weak domestic demand.

• CPI inflation inched up to 2.92% in April 2019. Food and beverage inflation stood at 1.38% YoY, up from 0.66% in the previous month. Core inflation stood at 4.58%, down from 5.0% earlier. On the contrary WPI slowed down marginally but sharp rise in food inflation despite high base. The food WPI increased to 5.1% YoY in April from 3.9% in March.

by Apra Sharma

Tackling Income Inequality Requires New Policies

The hollowing out of the middle class, rising social and political tension, lack of education, globalization, and rapid technological change are just a few of the many drivers of growing income inequality.

“Inclusive growth is one of the critical challenges of our time,” IMF Managing Director Christine Lagarde said at a recent event on income inequality at the IMF Spring Meetings.

“The bitter-sweet reality is that despite economic growth there are still far too many people who are left out,” Lagarde added.

“If you look at advanced economies there’s certainly a trend towards an increase in inequality between 1990 and now,” she said. “But then when you look at emerging and developing economies, it’s more mixed.”

Though global income inequality has dramatically decreased, lifting millions out of poverty over the last several decades, inequality has risen dramatically within countries. For instance, the top one percent owns about half of the world’s wealth.

House Prices Are Up: Should We Be Happy?

IMF research shows that there is a tight link between movement’s in house prices, on the one hand, and economic and financial stability, on the other.

In fact, more than half of the banking crises in recent decades were preceded by boom-bust cycles in house prices. So it’s no wonder that central bankers in Australia, Canada, Europe, and elsewhere have expressed concern about the potential for large declines.

The Chart of the Week shows average annual price changes in 32 advanced and emerging market economies and their major cities from 2013 through the second quarter of 2018. Dublin tops the gains among major cities in advanced economies, at 10 percent. Among cities in emerging market economies, Shanghai takes the prize, with an annual increase of almost 9 percent.

Fintech Can Cut Costs of Remittances to Latin America

For Latin Americans living abroad, sometimes sending money back home can be a complicated and costly ordeal. Most people rely on traditional banking methods and money transfer operators to send their remittances. But using these financial services for cross-border payments is costly—about a 6 percent charge on the total amount—and these fees are typically paid by the sender. This means less money left over for the family or friends receiving the money.

A more cost-effective approach for Latin American countries relies on using fintech, like mobile banking, to send money across borders, according to a recent IMF staff Working Paper.

Our chart of the week shows Latin America’s share of remittances transmitted with mobile money along with its overall share of remittances on a global scale. As the chart shows, Latin America’s use of mobile money both to send and receive remittances is relatively low—despite the region’s high share in total world remittances, which was about $80.5 billion in 2017.  This stands in contrast to Sub-Saharan Africa, which is more advanced in using mobile money for remittances. Globally, Latin America’s share of remittances is larger than Sub-Saharan Africa’s share. But, as the chart shows, Sub-Saharan Africa accounts for the bulk of global mobile money remittance transactions, followed by East Asia and the Pacific.

According to the paper, mobile operators and mobile money can transmit remittances at a relatively low-cost, about 3 percent, compared to the cost of transfers using more traditional financial service providers, which is about 6 percent. Global Fintech companies are starting to partner with local mobile network operators, money transfer operators, and banks in the region to provide financial services. Across the region policymakers are already taking measures to improve the efficiency of payment systems. In addition, a supportive regulatory environment will be crucial to spur the development of Fintech solutions for remittance transfers in Latin America.

Tackling Income Inequality Requires New Policies

House Prices Are Up: Should We Be Happy?

https://blogs.imf.org/2019/05/07/fintech-can-cut-costs-of-remittances-to-latin-america/

The print writes…..
Yet another instance of a successful public sector company coming to the aid of the Indian government by helping its finances – which faced a massive shortfall in tax revenues at the fag end of fiscal 2018-19 – has come to light. The state-run firm, Container Corporation of India, has made an advance freight payment of Rs 3,000 crore to Indian Railways in 2018-19 by taking a working capital loan and liquidating its investments.

Read Full post below

Navratna PSU sells investments, takes loan to ‘bail out’ railways with Rs 3,000 cr payment

Doug Noland writes..

Let’s begin with the markets. Ten-year Treasury yields dropped eight bps this week to 2.39%, nearing the March 27th low (2.37%). Two-year yields fell seven bps to 2.20%, a 13-month low. German bund yields declined six bps to negative 0.10%, the low closing yield going back to September 2016. German two-year yields dipped another three bps to negative 0.65%. Swiss 10-year yields declined four bps to negative 0.40%, and Japanese 10-year yields slipped a basis point to negative 0.06%. Spanish 10-year yields at 0.88% and Portuguese yields at 1.05% make no sense whatsoever unless huge new ECB QE programs are in the offing. The market now prices a 75% probability of a Fed rate cut by December, up from the previous week’s 59%.

China’s renminbi dropped 1.38% versus the dollar this week to 6.9179, the low since November 30th (offshore renminbi at all-time lows). It’s worth noting that the renminbi is now only 1.2% from breaching the key psychological 7.00 level versus the dollar. Currencies were under pressure throughout Asia. The South Korean won declined 1.5%, the Singapore dollar 1.1%, the Taiwanese dollar 1.0%, the Philippine peso 1.0% and the Indonesian rupiah 0.9%. Weakness spread into EM more generally. The Brazilian real fell 3.5%, the South African ran 1.8%, the Hungarian forint 1.5%, the Chilean peso 1.5%, and the Colombian peso 1.0%.

For the most part, EM bond market calm endured. Problem child Lebanon saw local bond yields surged 24 bps to an almost five-month high 10.65%, with yields up 87 bps so far this month. More concerning, Brazil’s local (real) yields surged 31 bps to 9.09%, the highest level since March.

After somewhat stabilizing (courtesy of “national team” buying), Chinese equities this week resumed their descent. The Shanghai Composite dropped 1.9%, with the CSI Financials index down 2.7% and the ChiNext Index sinking 3.6%. Hong Kong’s Hang Seng Index declined 1.3%, led lower by a 2.1% drop in the Hang Seng China Financials index. Stocks were down 2.5% in South Korea, 6.2% in Indonesia, 3.1% in Taiwan, 2.5% in Thailand and 1.3% in the Philippines. Brazil’s Ibovespa index sank 4.5%.

Though major U.S. equities indices ended the week down less than 1%, there’s a story to tell. Monday trading saw the S&P500 sink 2.4% (DJIA down 617 pts). The President began the morning with a tweet: “China should not retaliate – will only get worse! I say openly to President Xi & all of my many friends in China that China will be hurt very badly if you don’t make a deal because companies will be forced to leave China for other countries.” Less than two hours later, Beijing announced retaliatory tariffs on $60 billion of U.S. goods.

Markets rallied on Tuesday, nerves calmed by the President’s comment that the trade war with China was a mere “little squabble;” “We have a good dialogue going. It will always continue.” “When the time is right we will make a deal with China. It will all happen, and much faster than people think!” A Chinese Foreign Ministry spokesperson said that China and the U.S. had agreed to continue “pursuing relevant discussions.” Treasury Secretary Mnuchin suggested he was planning for a trip to China to resume negotiations.

May 15 – Associated Press (Yanan Wang and Sam McNeil): “What do tilapia, Jane Austen and Chinese revolutionary poster art have in common? All have been used to rally public support around China’s position in its trade dispute with the U.S., as the ruling Communist Party takes a more aggressive approach — projecting stability and stirring up nationalistic sentiment in the process. ‘If you want to negotiate, the door is open,’ anchor Kang Hui said Monday on state broadcaster CCTV. ‘If you want a trade war,’ however, he added, ‘we’ll fight you until the end.’ ‘After 5,000 years of wind and rain, what hasn’t the Chinese nation weathered?’ Kang said. The toughly-worded monologue on the banner evening news program followed days of muted official responses to President Donald Trump’s decision to hike tariffs…”

May 14 – Bloomberg: “Chinese President Xi Jinping denounced as ‘foolish’ foreign efforts to reshape other nations as he pushes back against U.S. trade demands. ‘To think that one’s own race and civilization are superior to others, and to insist on transforming or even replacing other civilizations, is foolish in understanding and disastrous in practice,’ Xi said… at the opening ceremony of the Conference on Dialogue of Asian Civilizations in Beijing… ‘The Chinese people’s beliefs are united and their determination as strong as a rock to safeguard national unity and territorial integrity, and defend national interests and dignity,’ Xi said Tuesday when meeting with visiting Greek President Prokopis Pavlopoulos.”

By Wednesday morning, it was becoming increasingly clear that the “little squabble” was more than a little fib. China’s vice-premier Liu He had stated that China (negotiators and the Chinese people) would never “flinch” in the face of tariffs. After showing restraint over recent weeks, the Chinese media was unleashed. State media declared that China would “never surrender” to external pressure. And from the communist party’s People’s Daily: “At no time will China forfeit the country’s respect, and no one should expect China to swallow bitter fruit that harms its core interests.” CCTV’s “If you want a trade war, we’ll fight you until the end” video (from above) was quickly viewed more than 3.3 billion times.

U.S equities markets opened poorly Wednesday morning, quickly giving back much of Tuesday’s recovery. If Monday’s lows were to have been taken out, market technicals could have quickly turned problematic. Especially after the previous week’s instability, there were large quantities of put options outstanding in the marketplace. Had the markets weakened going into Friday’s expiration, there was a distinct possibility of intense self-reinforcing derivatives-related selling.

About 40 minutes after Wednesday’s open, Bloomberg reported that President Trump was preparing to offer the EU and Japan a six-month window to “limit or restrict” auto exports to the U.S. before imposing new tariffs. The S&P500 jumped as much as 1.4%, a rally that carried into Thursday’s session.

The auto tariff news came at a critical market juncture. Whether it was or wasn’t a coincidence hardly matters. At this point, markets have become quite enamored with the notion of Quadruple Puts – the Fed, Trump, Xi/Beijing and corporate buybacks. When historians look back at this period, they will surely be baffled by the markets’ capacity for disregarding major risks and negative developments. We’re at the stage of a historic – and especially protracted -cycle where it has repeatedly paid to ignore risk. Over time, the successful risk ignorers and dip buyers have ascended to the top. Risk-takers systematically rewarded; the cautious banished. And, once again, those that had recently purchased put options to hedge market risk were left unsatisfied.

The official announcement of the six-month delay in auto tariffs came Friday, along with news that the President was lifting tariffs on Canadian and Mexican steel and aluminum imports. The FT headline: “Trump Eases Trade Conflicts with US Allies.” Rallying markets were receptive to seemingly positive news – that is until a Friday afternoon report from CNBC (Kayla Tausche and Jacob Pramuk): “Negotiations between the U.S. and China appear to have stalled as both sides dig in after disagreements earlier this month. Scheduling for the next round of negotiations is ‘in flux’ because it is unclear what the two sides would negotiate…” One can assume the administration is now working to generate some positive news flow as it hunkers down for a tough fight with the Chinese.

The U.S./Chinese relationship was never going to end well. The lone superpower versus the rising superpower. Vastly different systems, cultures and values. And it would be such a different world these days if not for a decade (or three) of unprecedented global monetary stimulus – cheap (i.e. nearly free) finance that allowed the U.S. to run endless huge Current Account Deficits coupled with easy finance that bestowed upon the Chinese (the curse of) unlimited monetary resources for the most outrageous Credit and investment booms in history. I always expected markets would at some point put a kibosh to this perilous dynamic. It was instead the embittered U.S. electorate and the architect of “Make America Great Again.”

It sure appears as if the Rubicon has been crossed. Beijing has called out the dogs (i.e. state-controlled media) – and public anti-U.S. sentiments have been inflamed. I’ll assume they’re now executing a contingency plan some time in the making: Trump is the unreasonable and disrespectful bully. China will never again be disrespected and pushed around. President Xi – general secretary of the Communist Party, President of the People’s Republic of China, chairman of the Central Military Commission, China’s ‘Paramount Leader’ and revered ‘Core Leader’ – is precisely the great commander to confront the U.S. hegemon determined to repress China’s strength, advancement and rightful standing in the world.

It’s become difficult to envisage Trump and Xi exchanging pleasantries and doing beaming photo ops next month at the G-20 summit (June 28-29) in Osaka, Japan. President Trump has often touted his close personal relationship with China’s Xi, and the U.S. side seems to believe that a private meeting between the congenial leaders can get talks back on track (worked in Argentina!). Let’s ignore U.S. freedom of navigation voyages through the South China Sea; the administration cozying up with Taiwan; Secretary Pompeo meeting this Thursday with a pro-democracy leader in Hong Kong, etc. Let’s disregard the trail of condescending tweets. And Huawei.

May 16 – Bloomberg: “The Trump administration is pulling out the big guns in its push to slow China’s rise, with potentially devastating consequences for the rest of the world. The White House on Wednesday initiated a two-pronged assault on China: barring companies deemed a national security threat from selling to the U.S., and threatening to blacklist Huawei Technologies Co. from buying essential components. If it follows through, the move could cripple China’s largest technology company, depress the business of American chip giants from Qualcomm Inc. to Micron Technology Inc., and potentially disrupt the rollout of critical 5G wireless networks around the world.”

From CNBC: “Reacting to U.S actions on Huawei, China’s Commerce Ministry said in a statement, ‘We firmly oppose the act of any country to impose unilateral sanctions on Chinese entities based on its domestic laws, and to abuse export control measures while making ‘national security’ a catch-all phrase. We urge the US to stop its wrong practices.’”

My view is that China is adamantly opposed to the U.S.’s use of “unilateral sanctions.” The administration’s insistence on a sanction enforcement regime as integral to the trade deal was a red line the Chinese refused to cross. The U.S. doubled-down with sanctions on Huawei – and until proven otherwise I’ll assume both China’s and the U.S.’s positions have further hardened.

This is a critical juncture for China’s faltering Bubble. Fragilities are acute. The assumption is that China will now move aggressively with additional fiscal and monetary stimulus. Conversely, it’s not an inopportune time for Beijing to take some pain. They have a scapegoat – a villainous foreigner determined to contain China’s rising power. For Beijing, the greatest risk is that its population loses trust in the phenomenal communist party meritocracy.

As noted above, the Chinese renminbi dropped 1.4% this week versus the dollar – and is now just a little over 1% away from the key psychological 7.00 level. “China’s Central Bank Won’t Let Yuan Weaken Past 7 to the Dollar (Reuters’ Zheng Li and Kevin Yao): ’At present, rest assured they will certainly not let it break 7,’ a source told Reuters. A defense of the 7 level could help boost confidence in the currency and soothe investor fears about a sharp depreciation in the yuan… ‘Breaking 7 is beneficial to China because it can reduce some of the effects of tariff increases, but the impact on our renminbi confidence is negative and funds will flow out,’ the source said.”

“At present, rest assured…” Excluding its massive surplus with the U.S., China runs a significant trade deficit with the rest of the world. There’s a scenario where President Trump places hefty tariffs on all Chinese imports into the U.S., levies that over time would be expected to significantly reduce demand for Chinese goods. At the same time, a weakening renminbi would see China expend more for much of its imports. Keep in mind, as well, that Beijing’s current stimulus measures are further fueling its apartment Bubble and resulting consumption boom. It’s possible that China’s trade position is poised to radically deteriorate.

Let’s assume the PBOC does move to defend the 7.0 level (renminbi vs. $). Markets will instinctively test this support – while closely monitoring for indications of the scope of reserves (and forward contracts) expended in the process. And China (and the world) better hope reserves prove more resilient than back in 2015, when they proceeded to collapse by $580 billion over a twelve-month period. If China’s reserves begin to rapidly deplete, expect stringent capital control and other measures to stem outflows. And while everyone believes China will resort to fiscal and monetary stimulus until the cows come home, EM Crisis Dynamics invariably force authorities to tighten conditions to bolster currency and financial system stability.

Friday’s report on University of Michigan Consumer Confidence had consumer sentiment at a 15-year high. Consumer Expectations surged almost nine points to 96 (up from January’s 79.9), to the highest reading since January 2004 – and the second strongest reading going back to November 2000. With stock prices recently (May 1st) hitting record highs and the unemployment rate at 50-year lows, consumer optimism is not unreasonable.

Increasingly, it appears as if the respite from Q4 global market instability has about run its course. As an economy – from governments to corporations to households – I can’t imagine a more poorly prepared system for the gathering storm. I know: fundamentals are “sound” and the banking system is “well capitalized.” Besides, there’s the Quadruple Puts – a deeply entrenched market misperception that really concerns me. Complacency is pervasive – epically so. Ignore fundamental developments, while placing faith in the power of politicians and central bankers (and corporations forever enjoying access to cheap finance to fund buybacks). Such a backdrop creates extraordinary risk for an abrupt change in perceptions and resulting crisis of confidence – in policymakers and the markets.

We started with the markets and will end with the markets. At this point, I don’t see great contradictions between the markets: Safe haven bonds and the risk markets are not actually telling wildly different stories. Seeing low market yields, loose financial conditions, seemingly great underlying U.S. economic fundamentals and Quadruple Puts, highly speculative (trend-following and performance-chasing) markets have been behaving about as one would expect near the end of a historic cycle: an intense, overarching short-term focus on speculative market gains. The safe havens, much less concerned with timing, see speculative Bubbles primed for bursting. Treasuries, bunds, JGBs, Swiss bonds, etc. see an acutely fragile global market structure.

May 14 – Bloomberg (Steve Matthews): “Federal Reserve Bank of Kansas City President Esther George said she’s opposed to cutting interest rates in order to raise inflation to the central bank’s 2% target, warning that could lead to asset-price bubbles and ultimately an economic downturn. ‘Lower interest rates might fuel asset price bubbles, create financial imbalances, and ultimately a recession,’ George… said… ‘In current circumstances, with an unemployment rate well below its projected longer-run level, I see little reason to be concerned about inflation running a bit below its longer-run objective.’”

Markets are not pricing in a 75% probability for a rate cut by December because of current Fed thinking. Chairman Powell is joined by sound thinkers including Esther George that recognize the risks associated with even looser monetary conditions. Markets are instead discerning the high probability of a market dislocation that would so significantly tighten financial conditions that the Fed and global central bankers will have no option other than cutting rates and resorting to more QE.

The breakdown in China/U.S. trade talks provides the initial catalyst. The 3.3% one-month decline in the renminbi (offshore renminbi down 3.9%) is indicative of acute vulnerability in the Chinese currency. And if PBOC support fails to stabilize the market, a crisis of confidence and run on Chinese assets cannot be ruled out. I don’t think one can overstate the financial, economic and geopolitical ramifications of China succumbing to Crisis Dynamics. The world becomes a much more uncertain place. Deleveraging in China would surely equate to global de-risking/deleveraging and highly destabilized global financial flows.

And for the crowd that these days harbors delusions of U.S. markets and economic activity largely immune to global issues, I pose the question: How do U.S. markets perform in the event of illiquidity and a “seizing up” of global markets? As I’ve posited before, the U.S. economy is extremely vulnerable to a dramatic market-induced tightening of financial conditions. What would markets look like if the marketplace turns against negative cash-flow enterprises? How would the U.S. economy function in the event of if debt market illiquidity?

The Powell U-turn granted markets four months of fun and games – and only greater systemic vulnerability. Now comes the downside, with a Fed that just might prove somewhat slower to come to the markets’ rescue than everyone presumes. This week marked the True Start to the U.S. vs. China Trade War. The degree of cluelessness is shocking.

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Lacy said he has never shown the next chart before. Adding, there are certain things in economics that “hold true.” This is one of the most important charts in economics:

• The green line shows the national savings rate. It is currently at 3%. It is historically 6%. We are running half of normal. The shaded area shows the private sector, which is running at 9%. That’s pretty good. The red line shows the government sector and it is running at -6% and dragging down national savings. That is where the problem lies.
• But it is not going to stay there – the government deficit is moving even lower into negative territory.
• The government deficit will continue to grow. Tax cuts and the bipartisan agreed-upon increase in spending do not lead to deficit reduction.
• Bottom line: What it says is there is an insufficiency of savings to absorb ever-larger budget deficits. National savings is not staying at 3%, it is going to decline. Real investment is going to decline. It is possible the private sector will save more but that means there will be less consumption.
• In other words, the public sector is going to constrain the private sector and the economy. (SB: Debt acts as a noose around the economy’s neck.)… and guess which sector provides the basis for better growth, the private sector or the public sector?
• In other words, the government sector’s budget deficits are too large for the level of savings

Given the political structure of our country, it is unlikely the situation will change. Lacy added, “impossible.”

Bottom line: We simply have an insufficiency of savings and it cannot be corrected.

The Production Function – it is dependent upon technology and the three factors of production: land, labor and capital.

• The production function states that if you overuse one of the three factors of production, output will initially rise and will then flatten out and then turn down.
• In other words, there is a non-linear relationship between debt and economic activity.
• The simple-minded solution that if a $3 trillion program doesn’t work you try a $6 trillion program… that doesn’t work when diminishing returns takes effect.
• The evidence here is increasingly dire.

Latest Evidence of Diminishing Returns:

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On My Radar: Mauldin Strategic Investment Conference 2019 (Part I – Dr. Lacy Hunt)

Russell Napier writes in Solid ground….

On October 8th 2018 The Solid Ground commented upon Vice-President Mike Pence’s October 5th speech on US China relations – Desolation Row: Which Side Are You On?
While a bit of sabre rattling ahead of mid-term elections is to be expected, this speech, in the opinion of your analyst, changes the world. It changes not just the world of finance and money but, very probably the world of geopolitics…… In the context of this speech trade sanctions are a lever for change in many areas well beyond the issues of trade themselves. It is incredibly difficult to see how the Chinese Communist Party genuflects, or perhaps kowtows, to such major and wide-ranging criticisms of their behavior. To bend to the will of the US administration on these multiple issues is to back away from the political control that is at the heart of the Chinese Communist Party and Xi’s Presidency. For all of us as citizens this raises the prospects of a much more confrontational relationship between Washington DC and Beijing, and for investors it means a whole new monetary order must now be developed. The development of that new monetary order will be as important for investors as the breakdown of the Bretton-Woods agreement was for their predecessors.

Russell further writes

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The chart below is the Global manufacturing PMI of major economies over last one year. As most of you know, a reading above 50 is expansion and below 50 is contraction. We are seeing clear signs of weakness in Germany which derives most of its GDP through manufacturing exports. China is hovering around 50 inspite of huge credit creation this year, staring in early February, showing signs of slowdown in global demand and lack of domestic demand. US is by far the strongest and in my view the reason is inventory building to beat tariffs and a relatively stronger manufacturing sector as compared to rest of the world.But I think the best of US Manufacturing PMI is behind us as inventory needs to be drawn down before it can be rebuilt again. This is against the backdrop of less than 4% unemployment in US. India is facing its own election and the recent data from consumer discretionary and Industrial production is not positive.

All these major countries are already getting some helping hand from either monetary or fiscal policy with US running a trillion dollar deficit, Germany getting extreme monetary support from ECB, China throwing fiscal kitchen sink to get some growth and even lending money through MLF facilities to its bank so that it flows into real economy. India is having a compliant central bank governor who is helping on the monetary side and on fiscal side a shortfall in tax collection to the tune of almost USD 15 billion acts like a fiscal stimulus.

Even after all this the Global manufacturing activity refuses to pick up. The reason is, we have reached a point where any addition in debt does not lead to increase in productivity or generation of economic activity. This is when the world economy reaches a tipping point known as secular stagnation.

By Apra Sharma

Risk appetite of investors is a major driver of returns that financial markets provide. Thinking about US, the rate hikes of which big beneficiaries were Emerging Market Countries, might be taking a toll on US itself with equities crashing relatively and a weaker USD. For Fed, waiting time is coming to an end and they have only one way to go, get dovish. If they hike rates further, it would be a disaster for US as $62T GDP is on the outside and $18T on the inside.

In a liquid market, an adjustment in prices in response to a news shock would happen rapidly. However, if the market is not very liquid, the jumps are sluggish. Big Price movements in bond markets tends to be more reflective of liquidity strain. Recent events like flash rally in US Treasuries in 2018, Sharp drop of S&P500 futures in December 2018 or yen spike in January 2019 have raised concerns about fragility of market liquidity.

‘Global USD liquidity is vulnerable to the downside’, says Nedbank’s Global Macro Insight. In our history, investor sentiments have played a crucial role whenever crisis occurred.

‘All of the elements of our theory of animal spirits are essential to understanding the depression of 1890s: a crash of confidence associated with remembered stories of economic failure, including stories of growth of corruption in years that preceded the depression; a heightened sense of unfairness of economic policy; and money illusion in the failure to comprehend the consequences of the drop in consumer prices’, said Akerlof and Shiller in Animal Spirits.

Alfred Noyes, a then financial editor of New York Times pointed out, “…the first act of frightened bank depositors was to withdraw these very legal tenders from their banks. Experience has taught these depositors that in a general collapse of credit the banks would probably be the first mark of disaster.”

When Fed was founded in 1913 and subsequently FDIC was the answer to liquidity problems then. In 1998 with LTCM, 2008 Bear Sterns rescue (to name a few), Fed was the banker of last resort to prevent liquidity crisis. The powers of central banks and their actions decide the impact on the economy and investors hope that they always proceed with best interests.

The most recent spike could be attributed to investors readjusting to monetary policy normalization and change in outlook of growth. The effects of structural change in the provision of liquidity is more pronounced in sovereign bond markets than equity or cash segments.

An escalation in US – China trade war or Fed’s no cut stand has left liquidity of in particular, USD vulnerable. Trading volumes  has clearly decreased post financial crisis which is a function of investor sentiment ,may not the only factor affecting market liquidity but has always been the key factor which cannot be ignored.