Weekly Commentary: Thoughts on Liquidity

“Money” challenged - and often confounded - economic thinkers for centuries. It functions both as a “medium of exchange” and “unit of account.” Simple enough. Too often the focus has been how to use money to stimulate economic activity and achieve political gains. From my perspective, money’s importance rests with its fundamental roles as a “Store of Value” and as the bedrock of financial systems. Unsound money has been a root cause of a lot of turmoil throughout history – including the monetary fiasco that collapsed in 2008. Yet concerns for the soundness of contemporary “money” these days are viewed as hopelessly archaic.

My thinking on contemporary “money” has been adapted from a much earlier focus on money’s “preciousness.” Traditionally, money was precious either because it was made of or backed by gold/precious metals. It retained preciousness only so long as its quantity remained carefully contained. Throughout history, the value of “paper money” has invariably moved inversely to the quantity issued – fits and starts, enthusiasm and revulsion and, too often, a path to worthlessness.

Today, “money” is largely electronic/digitized IOUs/Credit – but a special kind of Credit. Money is a perceived safe and liquid store of (nominal) value. This perception assures essentially insatiable demand. Unlimited demand creates a powerful propensity for over-issuance. Historically, monetary inflation ensured the Scourge of Inflationism. Monetary excess distorted flows to goods markets, setting in motion problematic inflationary dynamics in incomes, spending patterns and economic structure.

Despite money’s critical role within an economy, a consensus view on how best to define, monitor and manage the “money supply” escaped both the economics community and policymakers more generally. Too often, politics and ideology muddied already murky analytical waters. What is money these days, and how best to manage monetary matters? Does anyone even care – so long as the securities markets are strong?

If issues surrounding “money” aren’t confusing enough, how about this thing we refer to as “Liquidity.” As we wrap up a wild year in global markets, it would be fitting to label 2018 “The Year of Liquidity.” The year began with a bang, as liquidity inundated the emerging markets. It’s easy to forget that the Shanghai Composite jumped 5.3% in January. Brazil’s Ibovespa surged 11.1% in January and was up almost 15% by late February. The emerging market ETF (EEM) had jumped 10.5% by January 26th. South Korea’s KOSPI index rose 4.0% in January, and India’s Sensex gained almost 6%.

One could reasonably assert that “Liquidity” was in great abundance – in EM and global markets well into 2018. “Money” was flowing readily into the emerging markets, although it would be more accurate to state “finance” was flowing. Speculative Credit was most certainly expanding rapidly, as “carry trades” and a multitude of derivatives strategies funneled newly generated purchasing power into “developing” markets and economies. To be sure, the perception of a world awash in “Liquidity” ensured a problematic buildup of speculative leverage.

In general, free-flowing Credit is inherently self-reinforcing and validating (ongoing expansion supporting the perceived creditworthiness of the existing Credit structure) – hence unstable. Credit for securities speculation – speculative leveraging – is acutely unstable. The expansion of speculative Credit creates a flow of buying power, or Liquidity, that inflates securities prices and engenders only greater demand for speculative Credit. Resulting Liquidity abundance fosters confidence that markets will continue to boom skyward. “Money” everywhere.

The expansion of GSE Credit was key to the perception of Liquidity abundance early in the mortgage finance Bubble period. The expansion of GSE liabilities generated a powerful flow of buying power/Liquidity into the marketplace. Moreover, the ability and willingness to aggressively expand GSE Credit in the event of heightened market stress fostered the perception that a governmental quasi-central bank entity was available to backstop system liquidity when needed. By late in the cycle, a booming Credit expansion was creating such a prodigious flow of Liquidity that markets had little concern that fraud at the GSEs essentially eliminated their capacity to backstop market Liquidity.

Simplifying the analysis, we can consider four key – and interrelated - elements to market “Liquidity.” First, the actual purchasing power (i.e. deposits, money market funds, etc.) available to purchase securities. Second, the ease of availability of speculative Credit for the leveraging of securities. Third, the willingness and capacity of market-makers and operators to accumulate holdings in the face of intense selling pressure. And, fourth, the perception of Liquidity flows that could be injected into the system in the event of market instability and illiquidity risk (GSE backstop bid during the mortgage finance Bubble - and central bank QE throughout the global government finance Bubble).

M1 money supply ended last week at $3.736 TN, with M2 at $14.415 TN. M2 is a rather straightforward calculation adding Currency, Deposits (checking/saving/small time/other) and Retail Money Market Funds. The Federal Reserve in the past calculated M3, a broader measure of money (adding large time deposits, institutional money funds and repurchase agreements). Long arguing that broad “money” was analytically superior to the narrow aggregates, I nonetheless lost no sleep when the Fed discontinued publishing M3 (still too narrow!). Our analytical frameworks should strive to incorporate the broadest view of “money,” Credit and “finance,” although the broader the view taken the more challenging the analysis.

I would posit that some time ago Liquidity completely supplanted the monetary aggregates as the key focal point for market flow analysis. Unfortunately, there is no quantity of “Liquidity” to measure and tabulate. I am not familiar with an adequate definition or even common understanding. The concept of contemporary “money” has proved highly problematic for the economics community. Yet Liquidity makes “money” appear quite straightforward. If it can’t be defined or calculated, it’s certainly not worthy of inclusion in econometric models.  Liquidity Disregarded.

Liquidity is an amalgam of real financial flows and intangible market perceptions. There is no aggregate that would signal whether Liquidity is either expanding or contracting. Even if overall Liquidity is viewed as either abundant or deficient, there would still be widely divergent Liquidity manifestations for individual sectors, markets, countries and regions. And how can seeming Liquidity overabundance so briskly transform into illiquidity?

“Money supply” was an invaluable tool for gauging system “Liquidity” back when bank liabilities (i.e. deposits) were the prevailing mechanism for money and Credit expansion. Analysis has changed profoundly with the adoption globally of non-bank market-based Credit. I have argued that market-based Credit is highly unstable – speculative Credit perilously so. I would contend that “Liquidity” is typically steady but at times highly erratic. So long as the global Credit boom is ongoing, speculative Credit expands, and markets remain stable, the perception of Liquidity abundance ensures ample purchasing power to sustain the bull market. But the Wildness Lies in Wait.

For years now, global central bank policies have been fundamental to the perception of uninterrupted Liquidity abundance. Chairman Bernanke’s zero rates and QE measures caused a historic flow of purchasing power (Liquidity) into stock and fixed-income funds. This evolved into a momentous shift of financial flows into “passive” risk market strategies (perceived as low-risk and, often, money-like). Ultra-low rates and the belief that central banks were backstopping market Liquidity fundamentally altered both the flow of Liquidity and, over time, the structure of the marketplace.

The flow of Trillions into ETF and other “passive” strategies changed the nature of global leveraged speculation. Not only were the leveraged speculators incentivized by near zero (and even negative) borrowing costs and confidence in the central bank Liquidity backstop, they were now emboldened by the predictability of huge “retail” flows (domestic and international) into stock and fixed-income funds. Booming flows into equities and bonds fundamentally loosened financial conditions on an unprecedented global basis.

Loose finance stoked asset inflation, booming M&A and buybacks, all conducive to economic expansion and surging corporate profits. Liquidity circulating briskly throughout both the Financial and Economic Spheres bolstered the perception of an endless Liquidity boom. Booming securities markets fueled U.S. consumption and ongoing huge trade deficits, dollar Liquidity flowing out to the world - only to be recycled right back into U.S. securities and asset markets (i.e. EM central bank Treasury/agency purchases, hedge funds borrowing in offshore markets to leverage in U.S. securities, Chinese buying U.S. Treasuries and real estate, etc.). Meanwhile, booming global markets and the ease of “investing” passively through the ETF complex stoked unprecedented U.S. flows to global markets – once again generating a flow of global Liquidity that would be readily “recycled” back into U.S. markets.

Early CBBs introduced the concept of the “infinite multiplier effect.” Contemporary finance (largely devoid of capital and reserve requirements) left the old fractional reserve banking deposit “money multiplier” in the dust. The flow of purchasing power/Liquidity would circulate and recirculate, in the process fueling both unfettered Credit expansion and asset inflation. The global government finance Bubble period – with its zero rates, Trillions of new “money,” and central bank liquidity backstops – has seen the “infinite multiplier” at work on an unprecedented global scale. Liquidity created by the central banks, as well as through massive government debt expansion and leveraged speculation, has circulated freely on a global basis, inflating securities/asset prices, stoking economic expansion and promoting a self-reinforcing perception of endless Liquidity.

For the most part, contemporary market Liquidity is not real. It’s primarily a market perception. It’s based on the view that financial flows into markets will remain positive and, on those rare occasions when they’re not, central banks will step in and ensure “money” flows unabated into the financial markets. It’s based on confidence and faith - in contemporary central banking, in market structure, in the derivatives complex, in modern technologies and ingenuity. It’s based on the view that global Credit will continue to expand, premised on confidence that Beijing will ensure ongoing Credit expansion and that U.S. Credit is fundamentally robust. It’s based on the overarching belief that global finance is fundamentally sound, policymakers possess acumen and enlightenment, central bank power is boundless, and the global economy is on solid footing.

I believe the February blow-up of “short vol” strategies was a key initial crack in the global Bubble. Huge speculative excess had accumulated in a major market used for acquiring protection against market declines – writing “flood insurance” during a protracted central bank-induced drought. Abrupt market losses and illiquidity changed the risk/reward calculus for “selling” market “insurance” – reducing the supply and increasing the price of protection. Not long after, indications of fledgling risk aversion began to beset the global “Periphery.” EM Liquidity began to wane, an especially problematic dynamic following a speculative blow-off period. As EM flows reversed, de-risking/deleveraging dynamics took hold. Liquidity that seemed so abundant early in the year suddenly disappeared, replaced by faltering markets, dislocation and fear of expanding market illiquidity throughout the “Periphery.”

On a global basis, the Liquidity backdrop had changed momentously. For the first time in several years, a significant de-risking/deleveraging dynamic was unfolding without the benefit of huge central bank QE liquidity injections. Rapid currency collapses in Turkey and Argentina signaled a critical global Liquidity inflection point. And as de-risking/deleveraging gained momentum, Contagion became a major concern. China and Asia, the epicenter of Liquidity excesses over this cycle, saw their currencies, equities and bonds fall under significant pressure. Dollar-denominated debt, having so flourished during Liquidity abundance, was suddenly facing sinking prices and Liquidity issues. The shifting Liquidity backdrop was also manifesting in the colossal international derivatives markets (i.e. currency, swaps and fixed-income).

Market perceptions with regard to international Liquidity changed meaningfully. The same could not be said for the U.S. If anything, expectations for ongoing Liquidity abundance became only more deeply ingrained. Keep in mind that the Federal Reserve concluded QE operations in 2014. With the bull market having not missed a beat, it was widely believed that QE was irrelevant for the U.S. Not appreciated was the major role QE was having on international Liquidity, with “money” created by the ECB, BOJ and others finding its way into U.S. securities markets and the American economy. This year’s instability at the “Periphery” initially exacerbated flows to “Core” U.S. markets, pushing already highly speculative markets into Melt-Up Dynamics.

From a Liquidity perspective, speculative blow-offs are highly problematic. A bout of manic buying and leveraging culminates in highly elevated and unsustainable prices and financial flows. The perception of Liquidity abundance sows the seeds of its own destruction. When prices inevitably reverse, the onset of de-risking/deleveraging dynamics ensures a highly problematic Liquidity environment.

When The Crowd is fully on board, who is left to buy? When the leveraged speculating community reverses course, who but central banks have the capacity to accommodate deleveraging? If a significant segment of the marketplace moves to hedge market risk, where is the wherewithal to shoulder such risk? And let’s not overlook the critical issue of market risk shifting to speculators and traders that expect to dynamically-hedge option risk written/sold in the marketplace (planning, when necessary, to establish short positions in a declining marketplace). Current Market Structure ensures serious Liquidity issues upon the inevitable bursting of speculative Bubbles. Who wants to get in front of the algos?

Progressively more reckless central bank measures over the past decade have been necessary to promote the perception of ample and sustainable Liquidity. But with Crisis Dynamics having recently afflicted the “Core,” it is difficult for me not to see a Liquidity environment fundamentally altered. Confidence has taken a significant hit. I believe the leveraged speculating community has been impaired, with outflows and general risk aversion ensuring ongoing de-risking/deleveraging. Similarly, with confidence in “passive” (stock, fixed-income, international) ETF strategies now badly shaken, it's difficult to envisage a return to booming industry inflows. And with derivatives players stung by abrupt market losses and a spike in volatility (option premiums), I expect we’ve passed a critical inflection point in the pricing and availability of market protection.

The backdrop points to an inhospitable Liquidity backdrop. Serious market structural issues have bubbled to the surface, issues market participants either haven’t appreciated or simply believed would be readily rectify by central banks before confidence was impacted. The orientation of powerful financial flows has been upset. Hedging and derivatives markets have dislocated. The great fallacy of “moneyness” for risky stocks, bonds and derivatives is being laid bare.

Importantly, I view speculative Credit as the marginal source of global Liquidity. I believe a historic Bubble in securities and derivatives-related Credit has been pierced. This Bubble was fueled by years of zero/negative rates and Trillions of central bank "money". As we saw this week, bear market rallies tend to be ferocious. And when a short squeeze and unwind of hedges is in play, surging prices will spur hope that the sell-off has run its course and that Liquidity has returned to the markets.

It’s just not going to be that simple. Global markets face serious structural issues years and decades in the making. Hopefully markets can avoid crashes and make necessary adjustments over an extended period of time. For a while now, I’ve feared a scenario where illiquidity becomes a systemic global issue. From closely analyzing previous booms and bust episodes, things often prove even worse than I expect.


For the Week:

The S&P500 rallied 2.9% (down 7.0% y-t-d), and the Dow gained 2.7% (down 6.7%). The Utilities fell 1.8% (down 0.3%). The Banks gained 3.2% (down 20.2%), and the Broker/Dealers recovered 3.9% (down 11.3%). The Transports rose 2.6% (down 14.2%). The S&P 400 Midcaps increased 2.2% (down 13.4%), and the small cap Russell 2000 jumped 3.5% (down 12.9%). The Nasdaq100 recovered 3.9% (down 1.7%). The Semiconductors surged 4.2% (down 8.4%). The Biotechs jumped 4.7% (down 2.3%). With bullion jumping $25, the HUI gold index increased 1.1% (down 17.8%).

Three-month Treasury bill rates ended the week at 2.32%. Two-year government yields dropped 12 bps to 2.52% (up 63bps y-t-d). Five-year T-note yields declined eight bps to 2.56% (up 35bps). Ten-year Treasury yields fell seven bps to 2.72% (up 31bps). Long bond yields slipped a basis point to 3.02% (up 28bps). Benchmark Fannie Mae MBS yields dropped nine bps to 3.53% (up 53bps).

Greek 10-year yields added two bps to 4.35% (up 27bps y-t-d). Ten-year Portuguese yields gained three bps to 1.72% (down 22bps). Italian 10-year yields fell nine bps to 2.74% (up 73bps). Spain's 10-year yields added a basis point to 1.42% (down 15bps). German bund yields slipped one basis point to 0.24% (down 19bps). French yields gained a basis point to 0.71% (down 8bps). The French to German 10-year bond spread widened two to 47 bps. U.K. 10-year gilt yields fell five bps to 1.27% (up 8bps). U.K.'s FTSE equities index increased 0.2% (down 12.4%).

Japan's Nikkei 225 equities index declined 0.8% (down 12.1% y-t-d). Japanese 10-year "JGB" yields fell four bps to 0.00% (down 5bps). France's CAC40 slipped 0.3% (down 11.9%). The German DAX equities index declined 0.7% (down 18.3%). Spain's IBEX 35 equities index fell 0.7% (down 15.4%). Italy's FTSE MIB index slipped 0.4% (down 16.1%). EM equities were mixed. Brazil's Bovespa index jumped 2.6% (up 15.0%), while Mexico's Bolsa was little changed (down 16.0%). South Korea's Kospi index declined 1.0% (down 17.3%). India's Sensex equities index gained 0.9% (up 5.9%). China's Shanghai Exchange declined 0.9% (down 24.6%). Turkey's Borsa Istanbul National 100 index fell 1.6% (down 21.6%). Russia's MICEX equities index increased 0.5% (up 11.8%).

Investment-grade bond funds saw outflows of $4.416 billion, and junk bond funds posted outflows of $3.938 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell seven bps to a four-month low 4.55% (up 56bps y-o-y). Fifteen-year rates declined six bps to 4.01% (up 57bps). Five-year hybrid ARM rates added two bps to 4.00% (up 53bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to a ten-month low 4.42% (up 27bps).

Federal Reserve Credit last week declined $4.1bn to $4.044 TN. Over the past year, Fed Credit contracted $374bn, or 8.5%. Fed Credit inflated $1.233 TN, or 44%, over the past 320 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt fell $6.3bn last week to $3.397 TN. "Custody holdings" rose $35bn y-o-y, or 1.0%.

M2 (narrow) "money" supply slipped $8.2bn last week to $14.415 TN. "Narrow money" gained $566bn, or 4.1%, over the past year. For the week, Currency increased $1.5bn. Total Checkable Deposits dropped $82.9bn, while Savings Deposits jumped $61.6bn. Small Time Deposits gained $5.0bn. Retail Money Funds rose $6.6bn.

Total money market fund assets jumped $30.3bn to $3.039 TN. Money Funds gained $193bn y-o-y, or 6.8%.

Total Commercial Paper dropped $18.7bn to near an eight-month low $1.056 TN. CP declined $24bn y-o-y, or 2.2%.

Currency Watch:

The U.S. dollar index declined 0.6% to 96.402 (up 4.6% y-t-d). For the week on the upside, the South African rand increased 1.5%, the Mexican peso 1.4%, the Swiss franc 0.9%, the Japanese yen 0.9%, the Norwegian krone 0.7%, the euro 0.6%, the Brazilian real 0.6%, the South Korean won 0.6%, the Singapore dollar 0.6%, the Swedish krona 0.5%, the British pound 0.4% and the Australian dollar 0.1%. For the week on the downside, the Canadian dollar declined 0.3% and the New Zealand dollar dipped 0.2%. The Chinese renminbi increased 0.41% versus the dollar this week (down 5.41% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index declined 1.4% (down 15.2% y-t-d). Spot Gold jumped $25 to $1,281 (down 1.7%). Silver surged 5.0% to $15.436 (down 10%). Crude slipped 26 cents to $45.33 (down 25%). Gasoline recovered 0.6% (down 26%), while Natural Gas sank 13.4% (up 12%). Copper increased 0.3% (down 19%). Wheat declined 0.5% (up 20%). Corn fell 0.8% (up 7%).

Market Dislocation Watch:

December 25 – Wall Street Journal (Gregory Zuckerman, Rachael Levy, Nick Timiraos and Gunjan Banerji): “Behind the broad, swift market slide of 2018 is an underlying new reality: Roughly 85% of all trading is on autopilot—controlled by machines, models, or passive investing formulas, creating an unprecedented trading herd that moves in unison and is blazingly fast. That market has grown up during the long bull run, and hasn’t until now been seriously tested by a prolonged downturn… Today, quantitative hedge funds, or those that rely on computer models rather than research and intuition, account for 28.7% of trading in the stock market, according to data from Tabb Group--a share that’s more than doubled since 2013… Add to that passive funds, index investors, high-frequency traders, market makers, and others who aren’t buying because they have a fundamental view of a company’s prospects, and you get to around 85% of trading volume, according to Marko Kolanovic of JP Morgan . ‘Electronic traders are wreaking havoc in the markets,’ says Leon Cooperman… [from] Omega Advisors. Behind the models employed by quants are algorithms, or investment recipes, that automatically buy and sell based on pre-set inputs… ‘The speed and magnitude of the move probably are being exacerbated by the machines and model-driven trading,’ says Neal Berger, who runs Eagle’s View Asset Management… ‘Human beings tend not to react this fast and violently.’”

December 26 – Reuters (Charles Stein): “Investors are bailing out of mutual funds as if it were 2008. Mutual funds suffered redemptions of $56.2 billion in the week ended Dec. 19. That’s the biggest outflow since the week ended Oct. 15, 2008, according to… the Investment Company Institute. And the numbers over the last several weeks have only gotten worse…”

December 26 – Reuters (Trevor Hunnicutt): “U.S. fund investors battered bond markets with the biggest withdrawals in seven weeks and snatched the most cash from foreign stocks since mid-2015 as the Federal Reserve hiked interest rates, Investment Company Institute (ICI) data showed… Some $12.2 billion tumbled from U.S.-based bond funds during the week ended Dec. 19…”

December 24 – Bloomberg (Christopher DeReza): “U.S. investment-grade bond spreads widened every day last week to end Friday at 148 bps, the highest since July 2016.”

December 24 – Bloomberg (Kelsey Butler): “The Markit CDX North America High Yield Index dropped 0.20% to 100.84 -- lowest since March 8, 2016… amid plunging equity and oil markets.”

December 26 – Reuters (Richard Leong): “A barometer of overall demand for U.S. five-year Treasury note supply on Wednesday declined to its weakest in nearly 9-1/2 years with the note being sold at a yield at its lowest level since March… The ratio of bids to the amount of five-year notes came in at 2.09, the lowest reading since July 2009.”

December 26 – Wall Street Journal (Dawn Lim): “The investor pullback from the asset-management industry in 2018 is the most severe since the last financial crisis, a sign that doubts about the direction of global markets are intensifying. Net inflows for U.S. mutual and exchange-traded funds in the first 11 months of the year fell to $237 billion, according to… Morningstar. That was down 62% from the year-ago period, the steepest decline since 2008. Asset managers attracted a record $629.5 billion in net flows during the same period in 2017, a boom year for the industry.”

December 26 – Reuters (Trevor Hunnicutt): “U.S. fund investors battered bond markets with the biggest withdrawals in seven weeks and snatched the most cash from foreign stocks since mid-2015 as the Federal Reserve hiked interest rates, Investment Company Institute (ICI) data showed… Some $12.2 billion tumbled from U.S.-based bond funds during the week ended Dec. 19…”

December 27 – Bloomberg (Sarah Ponczek): “Exchange-traded fund investors who use factor-based products to juice returns or protect themselves from wild swings will probably look back on 2018 as the year when nothing worked. ETFs that promised everything from defensive characteristics like low volatility to more aggressive strategies such as growth and momentum suffered this year, with the largest funds for each factor tracked by Bloomberg set to end in the red. And as equity market performance took a marked shift from gung-ho to risk averse in the second half of the year, the leader-board for performance and flows has experienced a makeover.”

December 26 – Bloomberg (Vildana Hajric and Carolina Wilson): “Investors are fleeing the largest exchange-traded fund tracking U.S. financial stocks at the fastest monthly pace on record, having withdrawn more than $3.5 billion from it through Dec. 24. Outflows from the $21 billion Financial Select SPDR Fund, or XLF, are driving the record $9.2 billion that’s been pulled from all ETFs tracking financials this year.”

December 24 – Reuters: “Japanese government bond yields hit multi-month lows on Tuesday, with the benchmark 10-year yield hitting zero percent, as U.S. political chaos engulfed global financial markets causing the worst day for Tokyo stock prices in more than two years. Demand for the safety of government bonds increased as investors have grown increasingly nervous about the political outlook in the United States in addition to concerns about a global economic slowdown.”

December 26 – Reuters (Lewis Krauskopf): “The Dow Jones Industrial Average surged more than 1,000 points for the first time on Wednesday, leading a broad Wall Street rebound after a report that holiday sales were the strongest in years helped mollify concerns about the health of the economy. Following Wall Street’s worst-ever Christmas Eve drop in the previous session, the advance was also fueled by investors’ reversing bets against a wide range of stocks. By the close, the Dow, S&P 500 and Nasdaq had notched their largest daily percentage gains in nearly a decade… The Dow Jones Industrial Average rose 1,086.25 points, or 4.98%, to 22,878.45, the S&P 500 gained 116.6 points, or 4.96%, to 2,467.7, and the Nasdaq Composite added 361.44 points, or 5.84%, to 6,554.36.”

December 26 – Reuters (Saqib Iqbal Ahmed and Lewis Krauskopf): “One notable factor in Wall Street’s monster rally on Wednesday was a record gain in an index of stocks that have the largest bets placed against them by market contrarians. The Thomson Reuters United States Most Shorted Index rose 6%, the biggest percentage rise in its six-year history, as some investors moved to cover bearish bets on the 51 stocks in the index…”

Trump Administration Watch:

December 21 – Bloomberg (Jennifer Jacobs, Saleha Mohsin and Margaret Talev): “President Donald Trump has discussed firing Federal Reserve Chairman Jerome Powell as his frustration with the central bank chief intensified following this week’s interest-rate hike and months of stock-market losses, according to four people familiar with the matter. Advisers close to Trump aren’t convinced he would move against Powell and are hoping that the president’s latest bout of anger will dissipate over the holidays… Some of Trump’s advisers have warned him that firing Powell would be a disastrous move.”

December 24 – Reuters (Saleha Mohsin, Lananh Nguyen and Jennifer Jacobs): “Treasury Secretary Steven Mnuchin looked to quash big-bank worries over plunging stock markets and reports that President Donald Trump might move on his Federal Reserve chief by assuring the financial community on Sunday that market liquidity is in good shape. Some market participants, however, questioned why Mnuchin answered a question that no one was asking. Even after recent market losses, a liquidity squeeze or fresh financial crisis hadn’t been on the market’s mind. Mnuchin’s assertion of ample liquidity risked raising doubts. Mnuchin tweeted late Sunday afternoon that he’d called the chief executive officers of the nation’s six largest banks and that those chiefs ‘confirmed they have ample liquidity available for lending to consumer, business markets, and all other market operations.’”

December 24 – Reuters (Jason Lange): “The Trump administration is arranging a phone call on Monday with top regulators to discuss financial markets amid a rout on Wall Street. Treasury Secretary Steven Mnuchin will host the call with the president’s Working Group on Financial Markets, known colloquially as the ‘Plunge Protection team.’”

December 24 – Reuters (Andrew Mayeda and Mike Dorning): “President Donald Trump renewed his attacks on the Federal Reserve, commenting publicly on the central bank for the first time following last week’s interest-rate hike and reports he has discussed firing Chairman Jerome Powell. ‘The only problem our economy has is the Fed. They don’t have a feel for the Market, they don’t understand necessary Trade Wars or Strong Dollars or even Democrat Shutdowns over Borders,’ Trump said in a tweet Monday. ‘The Fed is like a powerful golfer who can’t score because he has no touch - he can’t putt!’”

December 26 – Associated Press: “President Donald Trump says parts of the government will stay shut as long as Democrats refuse to build more barriers on the U.S.-Mexico border, seemingly dashing hope for a Christmas miracle that would soon allow several departments to reopen and employees to return to work. Asked when the government would reopen, Trump said: ‘I can’t tell you when the government’s going to be open. I can tell you it’s not going to be open until we have a wall or fence, whatever they’d like to call it.’ ‘I’ll call it whatever they want but it’s all the same thing,’ he said…”

December 26 – Reuters (Makini Brice): “President Donald Trump on Tuesday expressed confidence in Treasury Secretary Steven Mnuchin amid worries over a weakening economy and a stock market slump, but repeated his criticism of the U.S. Federal Reserve, saying it has raised interest rates too quickly. Speaking to reporters in the Oval Office… Trump also said U.S. companies were ‘the greatest in the world’ and presented a ‘tremendous’ buying opportunity. Asked if he has confidence in Mnuchin, Trump said: ‘Yes, I do. Very talented guy. Very smart person,’ he said. His comments came after Mnuchin on Monday held a conference call with U.S. regulators to discuss plunging U.S. stock markets.”

December 26 – Reuters (Eric Beech): “A U.S. trade team will travel to Beijing the week of Jan. 7 to hold talks with Chinese officials, Bloomberg reported… The delegation will be led by Deputy U.S. Trade Representative Jeffrey Gerrish and will include David Malpass, Treasury under secretary for international affairs, Bloomberg said.”

December 21 – Reuters (Makina Brice and Jason Lange): “The United States and China might not reach a trade deal at the close of a 90-day negotiating window unless Beijing can agree to a profound overhaul of its economic policies, White House trade adviser Peter Navarro said. In an interview with Japanese business daily Nikkei published on Friday, Navarro said it would be ‘difficult’ to strike a deal without China being ready for a full overhaul of its policies for trade and industry.”

December 22 – Wall Street Journal (Nick Timiraos): “President Trump hasn’t suggested firing Federal Reserve Chairman Jerome Powell and doesn’t believe he has the authority to do so, Treasury Secretary Steven Mnuchin said Saturday. Mr. Trump has been furious over the Fed’s decision to raise interest rates this past week, say people familiar with the matter, and he is also unhappy over the central bank’s effort to shrink its holdings of bonds acquired after the 2008 financial crisis. ‘I think the increasing of interest rates and the shrinking of the Fed portfolio is an absolutely terrible thing to do at this time, especially in light of my major trade negotiations which are ongoing,’ Mr. Trump said in a statement to Mr. Mnuchin that the Treasury secretary posted on Twitter.”

December 26 – Reuters (Trevor Hunnicutt): “The head of the U.S. Federal Reserve faces no risk of losing his job and President Donald Trump is happy with his Treasury secretary, a White House official said in an apparent attempt to calm Wall Street nerves frayed by Trump’s criticism of the Fed. Asked on Wednesday if Fed Chairman Jerome Powell’s job was safe, White House economic adviser Kevin Hassett told reporters: ‘Yes, of course, 100%.’”

December 26 – Reuters (David Shepardson and Diane Bartz): “President Donald Trump is considering an executive order in the new year to declare a national emergency that would bar U.S. companies from using telecommunications equipment made by China’s Huawei and ZTE, three sources familiar with the situation told Reuters. It would be the latest step by the Trump administration to cut Huawei Technologies and ZTE… out of the U.S. market. The United States alleges that the two companies work at the behest of the Chinese government and that their equipment could be used to spy on Americans.”

Federal Reserve Watch:

December 26 – Bloomberg (Alyza Sebenius): “President Donald Trump won’t try to fire Federal Reserve Chairman Jerome Powell, a top White House economic adviser said. Kevin Hassett, chairman of the White House Council of Economic Advisers, told reporters “yes, of course, a hundred percent” on Wednesday after he was asked whether Powell’s job is safe. Hassett also said that U.S. banks aren’t facing a liquidity crisis.”

December 24 – Wall Street Journal (Michael S. Derby): “Four veteran Federal Reserve officials—most of whom have signaled support for more interest-rate increases—will step into the limelight in 2019 as they become voters on the central bank’s rate-setting committee. That status prompts greater scrutiny of their views because they will be taking an official and public stand by voting on monetary policy—and will have the opportunity to directly dissent to Federal Open Market Committee decisions and detail their objections. The turnover comes at an uncertain time for the central bank…”

U.S. Bubble Watch:

December 25 – Wall Street Journal (Jessica Menton): “Investors are running out of places to hide as the stock-market rout accelerates. The S&P 500 and the Dow Jones Industrial Average have slumped 19% from their recent highs… The technology-heavy Nasdaq Composite, the Russell 2000 index of small-capitalization stocks and the Dow Jones Transportation Average have already breached those levels… Only the defensive sectors of the S&P 500—utilities, real estate, health care and consumer staples—that are known for their steady dividend payments have avoided such steep declines, for now. All are down at least 9% from their highs. ‘I haven’t seen managers this shell-shocked and confused in a very long time,’ said Robert Duggan, senior portfolio manager at… SkyBridge Capital. ‘People have been heading for the exits and selling their positions over the last two weeks.’”

December 25 – Wall Street Journal (Sarah Nassauer): “Shoppers delivered the strongest holiday sales increase for U.S. retailers in six years… Total U.S. retail sales, excluding automobiles, rose 5.1% between Nov. 1 and Dec. 24 from a year earlier, according to Mastercard SpendingPulse, which tracks both online and in-store spending with all forms of payment. Overall, U.S. consumers spent over $850 billion this holiday season, according to Mastercard.”

December 26 – Bloomberg (Molly Schuetz): “Amazon.com Inc. reported a record-breaking holiday season as shoppers loaded their online baskets with items from Echo speakers to Calvin Klein clothes, suggesting consumer optimism isn’t being deterred by a tumbling stock market. The internet retailer said ‘tens of millions of people worldwide’ signed up for its Prime service… In the U.S. alone, more than 1 billion items were shipped for free using Prime…”

December 26 – Bloomberg (Jeff Kearns): “The Federal Reserve Bank of Richmond’s manufacturing gauge fell by a record as shipments and new orders weakened, the fourth district bank factory index to drop this month and the latest evidence that President Donald Trump’s trade war is becoming a greater headwind for U.S. producers.”

December 26 – Associated Press: “U.S. home price growth slowed in October, a likely consequence of higher mortgage rates having worsened affordability and causing sales to fall. The S&P CoreLogic Case-Shiller 20-city home price index rose 5% from a year earlier, down from an annual gain of 5.2% in September. That’s down from a 5.5% yearly gain in the previous month.”

December 23 – Wall Street Journal (Laura Kusisto): “A long rally in the housing market stumbled in 2018 and looks poised to slow further, another headwind for a U.S. economic expansion already contending with choppy financial markets and global trade tensions. The recent decline in home sales reflects a lack of inventory and the rising cost of homes… Home prices are now at all-time highs and inventory levels in recent months have begun climbing back from their lowest level in three decades. Rising mortgage rates, which nearly touched 5% late this year as they climbed to their highest level in more than seven years, are the latest blow. ‘Suddenly the light turned off in the second half of the year, with sales tumbling down and inventory rising,’ said Lawrence Yun, chief economist at the National Association of Realtors.”

December 23 – Financial Times (Ed Crooks): “All industrial revolutions need two things: technology and finance. The US shale revolution was made possible by the advances in horizontal drilling and hydraulic fracturing that allowed oil and gas to be released from previously unyielding rocks. But the industry’s financing was equally important in turning those innovations into a production boom that has shaken the world… Often they use derivatives to hedge some or all of their revenues, giving lenders confidence in their ability to make interest payments if oil and gas prices fall. For most of the shale boom, that financial infrastructure has been underpinned by the low interest rates and quantitative easing that followed the financial crisis. The surge in US oil production has been a result of monetary stimulus, just as much as the tech start-up boom and the rise in the S&P 500 have been.”

December 23 – Reuters (Devika Krishna Kumar and Jennifer Hiller): “U.S. shale producers are slamming the brakes on next year’s drilling with crude prices off 40% and mounting fears of oversupply, paring budgets that in some cases were set only weeks earlier. The reversal is alarming because blistering growth in shale fields has propelled U.S. crude output 16% to about 10.9 million barrels per day for 2018, above Saudi Arabia and Russia. Production has been expected to rise 11% more in 2019 as large oil firms and independents added wells this year.”

December 26 – Bloomberg (James Tarmy): “Ten people (or companies, or people masquerading as companies) spent a combined half-billion dollars on their Manhattan apartments this year. Impressive as it might seem, the numbers are down significantly from the previous three years. The highest point in the market, which this year was represented by a $73.8 million duplex penthouse in a new tower designed by Robert Stern, was down 26% from the 2014 high. (That year a penthouse on 57th street with views of Central Park sold for just over $100 million.) Moreover, in the last 12 months, eight out of the top 10 sales were heavily discounted—one apartment at 157 West 57th street took a $17 million price cut before it found a buyer.”

China Watch:

December 26 – Bloomberg: “China enters trade talks said to begin early next month in Beijing having made concerted efforts to end the standoff with the U.S., and also unsure it’s done enough. Since Presidents Xi Jinping and Donald Trump came to a temporary truce almost a month ago, China’s removed a retaliatory duty on U.S. automobiles and is drafting a law to prevent forced technology transfers. It’s also slashed import tariffs on more than 700 products and began buying U.S. crude oil, liquefied natural gas and soybeans again. Officials have been in constant contact with the U.S. to try to determine what else is needed to move things forward in January… It appears to Chinese officials that the U.S. itself isn’t clear on what it wants, said the people…”

December 27 – Bloomberg: “China’s economy is deteriorating and risks heading for a much weaker 2019 as plentiful borrowing by state and private firms is failing to boost growth, according to the China Beige Book. Borrowing was strong for a third consecutive quarter in the final three months, contradicting the mainstream view that risk-averse lenders want nothing to do with capital-starved firms, according to CBB International… State-owned and large companies borrowed more often but private firms and small- and medium-size enterprises continued to borrow at elevated levels and loan rejection rates remained close to an all-time low, it said. ‘The problem isn’t lack of borrowing, it’s that plentiful borrowing isn’t boosting growth,’ said CBB… ‘CBB numbers show firms borrowing already, yet not investing. They are paying bills or otherwise cushioning cash flow problems while economic growth continues to slow.’”

December 22 – Reuters (Philip Wen): “The head of China’s top economic planning agency said it would roll out more supportive measures to boost the economy especially in the advanced manufacturing sector, state media reported on Saturday. China will vigorously support the private sector and resolve the financing difficulties of private firms, the official Xinhua news agency quoted National Development and Reform Commission chairman He Lifeng as saying…”

December 26 – Bloomberg: “Chinese authorities are studying plans to help banks replenish capital as they look to continue with their crackdown on financial risk without hurting credit growth. The move to promote sales of perpetual bonds as soon as possible comes as new regulations on asset management force banks to absorb off-balance-sheet debts. Swelling soured loans and a slump in share prices are making it harder for banks to raise money. Stronger capital buffers also put the banks in a position to increase lending to private companies and help meet the government’s vow to support the struggling sector.”

December 24 – Reuters: “Business confidence among entrepreneurs in China worsened in the fourth quarter compared with the previous one, and was at the lowest since the second quarter of 2017, according to a survey by the People’s Bank of China… The entrepreneurs’ confidence index dropped to 67.8% in the fourth quarter, 3.4 percentage points lower than in the third quarter… A separate PBOC survey of urban households showed a decline in the number of respondents believing housing prices will continue to rise in the next quarter.”

December 25 – Financial Times (Lucy Hornby and Archie Zhang): “Shanghai office worker Jin Linglan had just put a downpayment on a car when she realised her savings were gone. Like many prosperous Chinese, Ms Jin invested in financial products that promised a high rate of return. And, like many of her fellow investors, she has made the painful discovery that her money has been swallowed up by the recurring defaults in China’s shadow banking market. The losses absorbed by middle class families in a nation famous for its diligent savers have taken a quiet financial and emotional toll. Many of the failures have been peer-to-peer lending platforms. Outstanding peer-to-peer loans in China topped Rmb1.2tn ($174bn) in the first quarter this year, before sliding to about Rmb800bn as hundreds of peer-to-peer platforms shut, according to… Moody’s.”

December 26 – Reuters (Stella Qiu, Min Zhang and Ryan Woo): “Earnings at China’s industrial firms in November dropped for the first time in nearly three years, as slackening external and domestic demand left businesses facing more strain in 2019 in a sign of rising risks to the world’s second-largest economy. The gloomy data points to a further loss of economic momentum as a trade dispute with the United States piles pressure on China’s vast manufacturing sector and as firms, bracing for a tough year ahead, shelve their investment plans, executives say.”

December 27 – Bloomberg (Alfred Cang): “China is the latest victim of the wild swings in oil prices that have roiled trading firms across the globe this year. Two top officials at Unipec, one of the country’s most powerful trading companies, were suspended this week following losses on bets related to oil prices in the second half of the year… Trading companies from Azerbaijan to Russia and the U.S. have been forced to overhaul their strategy, restructure operations or cut jobs in a year when oil surged to a 2014 high and then dramatically tumbled into a bear market within a matter of weeks.”

Global Bubble Watch:

December 25 – Wall Street Journal (Trefor Moss): “A downturn in China’s car market has wrong-footed some of the world’s biggest auto makers, saddling them with factories they no longer need and that are costly to retool. Ford Motor Co., Peugeot SA and Hyundai Motor Co. especially mistimed recent expansions, opening new plants just as the seemingly unstoppable growth of China’s auto market went into reverse… At a Ford plant, workers’ shifts have been reduced to a few days a month… Now these auto makers face a painful dilemma: Abandon those big investments, or invest even more to turn around dying plants at an uncertain time in a crucial market. ‘Looking back, it wasn’t the right choice’ to build new factories, said Paul Gong, an auto analyst at UBS Group AG . ‘No one was willing to predict that they might ever lose market share in China.’”

December 26 – Wall Street Journal (Jean Eaglesham and Dave Michaels): “About a year ago, Charles and Claudia Wildes maxed out their credit cards and invested more than $40,000 in a hot new digital currency, just as the crypto mania peaked. Now, all that money is gone—a small part of the billions investors lost as cryptocurrencies plunged in recent months. But the Wildeses’ losses aren’t just because of bad timing: The digital coin they bought, called BitConnect, was one of many alleged frauds pervading the market. The Securities and Exchange Commission is investigating BitConnect, people close to the probe said…”

Japan Watch:

December 25 – Reuters (Tetsushi Kajimoto): “A Japanese official said… that volatility was rising in the currency market and the government stands ready to take necessary steps if the market becomes too erratic. ‘Volatility is rising. Each country shares the G7/G20 view that excess volatility and disorderly moves are undesirable for the economy,’ Masatsugu Asakawa, vice finance minister for international affairs, told reporters.”

Leveraged Speculation Watch:

December 27 – Bloomberg (Saijel Kishan and Shelly Hagan): “It has been yet another year to forget in the world of hedge funds. Hardly a month went by without news of the high-fee money managers -- young and old, running large and small shops, big and little-known names -- shutting down. Many struggled to navigate markets marked by violent stock swings and slumping oil prices, others decided to restructure their firms to make riskier or longer-term bets, while some said they simply had enough of trading. Now as the year comes to a close, the $3.2 trillion industry is headed for its worst annual performance since 2011… About 444 funds shuttered in the first nine months of the year, the data provider said. That’s well below the record 1,471 liquidations during the 2008 financial crisis.”

Geopolitical Watch:

December 26 – Associated Press (Vladimir Isachenkov): “Russian President Vladimir Putin oversaw a test… of a new hypersonic glide vehicle, declaring that the weapon is impossible to intercept and will ensure Russia's security for decades to come. Speaking to Russia's top military brass after watching the live feed of the launch of the Avangard vehicle from the Defense Ministry's control room, Putin said the successful test was a ‘great success’ and an ‘excellent New Year's gift to the nation.’ The test comes amid bitter tensions in Russia-U.S. relations, which have sunk to their lowest level since the Cold War times…”

December 26 – Bloomberg (Henry Meyer and Stepan Kravchenko): “Russia warned the U.S. against any effort to influence the royal succession in Saudi Arabia, offering its support to embattled Saudi Crown Prince Mohammed bin Salman, who’s under continuing pressure over the killing of a government critic. President Vladimir Putin’s envoy to the Middle East said Prince Mohammed has every right to inherit the throne when the ailing 82-year-old King Salman dies. ‘Of course we are against interference. The Saudi people and leadership must decide such questions themselves,’ Mikhail Bogdanov… ‘The King made a decision and I can’t even imagine on what grounds someone in America will interfere in such an issue and think about who should rule Saudi Arabia, now or in the future. This is a Saudi matter.’”

Friday Evening Links

[Reuters] Wall Street rally pauses, but stocks mint weekly gain

[Reuters] Gold holds near 6-month high on softer dollar, tumultuous stocks

[Reuters] Treasuries-U.S. 10-year yield hits 10-month lows amid Wall St volatility

[CNBC] Wild swings, a government shutdown and Fed fears: Stocks wrap up 2 weeks of ‘disturbing’ moves

[Reuters] Sears Chair Lampert makes $4.6 billion bid to keep retailer alive: sources

[WSJ] A Trump-Powell Meeting: Chance of Rapprochement Fraught With Risks—for Both Sides