Friday, January 11, 2019

Market Commentary: Issues 2019

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When I began posting the CBB some twenty years ago, I made a commitment to readers: “I’ll call it as I see it - and let the chips fall where they will.” Over the years, I made a further commitment to myself: Don’t be concerned with reputation – stay diligently focused on analytical integrity.

I attach this odd intro to “Issues 2019” recognizing this is a year where I could look quite foolish. I believe Global Financial Crisis is the Paramount Issue 2019. Last year saw the bursting of a historic global Bubble, Crisis Dynamics commencing with the blow-up of “short vol” strategies and attendant market instabilities. Crisis Dynamics proceeded to engulf the global “Periphery” (Argentina, Turkey, EM, more generally, and China). Receiving a transitory liquidity boost courtesy of the faltering “Periphery,” speculative Bubbles at “Core” U.S. securities markets succumbed to blow-off excess. Crisis Dynamics finally engulfed a vulnerable “Core” during 2018’s tumultuous fourth quarter.

As we begin a new year, rallying risk markets engender optimism. The storm has passed, it is believed. Especially with the Fed’s early winding down of rate “normalization”, there’s no reason why the great bull market can’t be resuscitated and extended. The U.S. economy remains reasonably strong, while Beijing has China’s slowdown well under control. A trade deal would reduce uncertainty, creating a positive boost for markets and economies. With markets stabilized, the EM boom can get back on track. As always, upside volatility reenergizes market bullishness.

I titled Issues 2018, “Market Structure.” I fully anticipate Market Structure to remain a key Issue 2019. Trend-following strategies will continue to foment volatility and instability. U.S. securities markets rallied throughout the summer of 2018 in the face of a deteriorating fundamental backdrop. That rally, surely fueled by ETF flows and derivatives strategies, exacerbated fragilities. Speculative flows fueling the upside destabilization eventually reversed course - and market illiquidity soon followed. Yet short squeezes and the unwind of market hedges create the firepower for abrupt rallies and extreme shifts in market sentiment.

Market Illiquidity is a key Issue 2019. Its Wildness Lies in Wait. Rallying risk markets create their own liquidity, with speculative leverage and derivative strategies in particular generating self-reinforcing liquidity. Recovering stock prices ensure bouts of optimism, along with confidence that robust markets enjoy liquidity abundance. Problems arise with market downdrafts and De-Risking/Deleveraging Dynamics. Rally-induced optimism feeds unreasonable expectations and eventual disappointment.

Crisis Dynamics tend to be a process. There’s the manic phase followed by some type of shock. There is at least a partial recovery and a return of optimism – often bolstered by a dovish central bank response. It’s the second major leg down when things turn more serious – for sentiment, for market dynamics and illiquidity. Disappointment turns to disenchantment and, eventually, revulsion. It’s been a long time since market participants were tested by a prolonged, grinding bear market.

The February 2018 “short vol” blowup was a harbinger of trouble to come. I believe the January 3, 2019 “flash crash” portends serious Issues 2019 in global currency markets. An 8% intraday move in the yen vs. Australian dollar exposed problematic liquidity dynamics. Last year, the “short vol” market signal was initially dismissed then soon forgotten. The recent currency market “flash crash” is an ominous development of potentially momentous significance.

Our so-called “king dollar” is indicating some vulnerability to begin the new year. Newfound Fed dovishness has caught many traders too long the U.S. currency and short the yen, Canadian dollar, renminbi and EM currencies more generally. A clash among a band of fundamentally weak currencies is a critical Issue 2019. When the current currency market short squeeze runs its course, I see a marketplace that’s lost its bearings. A new global currency regime of extraordinary uncertainty, instability and volatility is an Issue 2019. This unsettled new regime is not conducive to speculative leverage.

The U.S. dollar has serious fundamental issues: Trillion-dollar fiscal deficits; large structural Current Account Deficits; huge government, corporate and household debt loads; fragile securities markets; a maladjusted Bubble Economy; political dysfunction and, potentially, Washington chaos; and festering geopolitical risks.

The world’s reserve currency is fundamentally unsound. The dollar is also the nucleus for a financial apparatus financing much of the world’s levered speculative holdings. De-risking/Deleveraging Dynamics in 2018 saw waning liquidity and widening funding and hedging costs in the entangled world of dollar funding markets. With the likes of Goldman Sachs and Deutsche Bank seeing CDS prices rise significantly late in 2018, mounting systemic fragility would appear a serious Issue 2019.

China’s currency has serious fundamental issues: A vulnerable banking system approaching $40 TN of assets (more than quadrupling since the crisis), with Trillions of potentially suspect loans; a troubled “shadow” banking apparatus; an historic housing Bubble with an estimated 65 million vacant units; a deeply maladjusted economic structure; Bubble economic and financial structures dependent upon ongoing loose financial conditions and rapid Credit expansion; huge financial and economic exposures to the emerging markets and the global economy more generally; a population with significantly elevated expectations prone to disappointment and dissatisfaction; and mounting geopolitical risks. In short, China’s historic Bubble is increasingly susceptible to a disorderly collapse.

Hong Kong’s Hang Seng China H-Financial Index dropped 18% in 2018, although China’s banks outperformed the 28% fall in Japan’s TOPIX Bank Index. I would tend to see Asian finance as especially vulnerable to the unfolding global Bubble collapse. Waning confidence in the region’s financial stability would portend acute currency market instability. China’s currency is especially vulnerable to capital flight and the imposition of draconian capital controls. The big unknown is how much “hot money” and leverage has accumulated in Chinese markets. The Indonesia rupiah remains vulnerable to tightening global finance. I worry about India’s banking system after years of Bubble excess. I have concerns for the region’s financial institutions generally. The stability of the perceived stable Hong Kong and Singapore dollars is on the list of Issues 2019.

Fragile Asian finance has company. Italian banks sank 30% in 2018, slightly outperforming the 28% drop in European bank shares (STOXX 600). Italy’s 10-year yields traded to 3.72% in late-November, before ending 2018 at 2.74% (up 73bps in ’18). Italian – hence European – stability is an Issue 2019.

I believe a problematic crisis is likely to unfold in 2019, perhaps sparked by dislocation in Italian debt markets and the resulting crisis of confidence in Italy’s fragile banking system. Serious de-risking/deleveraging in Italian debt would surely see contagion in the vulnerable European periphery – including Greece, Spain and Portugal. Italy’s Target2 balances (liabilities to other eurozone central banks) almost reached $500 billion in 2018. Heightened social and political instability would appear a major Issue 2019, not coincidental with the end of ECB liquidity-creating operations. Draghi had kicked the can down the road. Markets, economies, politicians and protestors have about reached the can.

A crisis of confidence in Europe would ensure problematic currency market instability. Such a scenario would portent difficulties for vulnerable “developing” Eastern European markets and economies. Many economies would appear vulnerable to being locked out of global financing markets. A full-fledged financial crisis engulfing Turkey cannot be ruled out. Last year saw significant currency weakness also in the Russian ruble, Iceland krona, Hungarian forint and Polish zloty. I would see 2018 difficulties as a harbinger of much greater challenges ahead.

Bubbles are mechanism of wealth redistribution and destruction. This reality has been at the foundation of my ongoing deep worries for the consequences of history’s greatest global Bubble. We’ve witnessed the social angst, a deeply divided country and waning confidence in U.S. institutions following the collapse of the mortgage finance Bubble. I fear that the Bubble over the past decade has greatly increased the likelihood of geopolitical tensions and conflict. Aspects of this risk began to manifest in 2018, as fissures developed in the global Bubble. Geopolitical conflict is a critical Issue 2019. Trade relations are clearly front and center. Going forward, I don’t believe we can disregard escalating risks of military confrontation.

Bubbles inflate many things, including expectations. I worry that the protracted Chinese Bubble has so inflated expectations throughout China’s large population. With serious cracks in their Bubble, Beijing will continue to craft a strategy of casting blame on the U.S. (and the “west”). The administration’s hard line creates a convenient narrative: Trump and the U.S. are trying to hold back China’s advancement and ascendency to global superpower status. A faltering Bubble and deteriorating situation in China present Chinese leadership a not inconvenient time to confront the hostile U.S. The South China Sea and Taiwan could loom large as surprise flashpoint Issues 2019.

There are a number of potential geopolitical flashpoints. Without delving into detail, I would say generally that geopolitical risks will continue to rise rapidly in the post-Bubble backdrop. Issues easily disregarded during the Bubble expansion (i.e. the Middle East, Russia, Ukraine, Iran, etc.) may in total become more pressing Issues 2019. I can see a scenario where the U.S. is spending significantly more on national defense in the not too distant future.

“Chairman Powell ‘very worried’ about massive debt” was an early-2019 headline. I believe the U.S. Treasury market in 2018 hinted at a momentous change in Market Dynamics. And while a bout of “risk off” and a powerful short squeeze fueled a big year-end rally, there were times when the Treasury market's traditional safe haven appeal seemed to have lost some luster. The unfolding bursting Bubble predicament turns even more problematic if ever Treasury yields rise concurrently with faltering risk markets. Such a scenario seemed more realistic in 2018. With huge and expanding deficits as far as the eye can see, the suspect dollar and mounting geopolitical tensions, the potential for a disorderly rise in Treasury yields is a potential surprise Issue 2019.

Whether Treasury yields surprise on the upside or fall further in an unfolding crisis backdrop, U.S. corporate Credit is a pressing Issue 2019. Thursday (Jan. 10) ended a 40-day drought in junk bond issuance (longest stretch since at least 1995). Both high-yield and investment-grade funds suffered major redemptions in late-2018, exposing how abruptly financial conditions can tighten throughout corporate finance. Fueling liquidity abundance throughout the boom, ETF flows were exposed as a critical market risk.

Flows for years have been dominated by trend-following and performance-chasing strategies on the upside. The reversal of bullish speculative flows was joined in late-2018 by speculative shorting and hedging-related selling. Liquidity abundance abruptly transformed into unmanageable selling pressure and acute illiquidity. Pernicious Market Structure was revealed and, outside of short squeezes and fleeting bouts of optimism, I believe putting the ETF humpty dumpty back together will prove difficult. The misperception of ETF “moneyness” is being cracked wide open.

Enormous leverage has accumulated throughout corporate Credit over the past decade. This portends negative surprises and challenges in the unfolding backdrop. At this point, I’ll assume some type of trade agreement is cobbled together with the Chinese. This might provide near-term support for the markets and global economy. But I don’t believe a trade agreement would fundamentally change the backdrop of faltering global financial and economic Bubbles.

Expect ongoing global pressure on leveraged speculation. As an industry, the hedge funds did not experience huge redemptions in 2018. I expect redemptions and fund closures to be a significant issue following the next bout of serious de-risking/deleveraging. A similar dynamic should be expected for the ETF complex. Late-2018 outflows were likely just a warmup for the type of destabilizing flows possible in a panic environment.

In my view, an important interplay evolved during this protracted cycle between the ETF complex and a booming derivatives marketplace. Reliable inflows and abundant liquidity in the ETF universe created an advantageous backdrop for structuring and trading various derivatives strategies. This seemingly symbiotic relationship has run its course. The now highly uncertain ETF flow backdrop translates into a potentially problematic liquidity dynamic for derivative-related trading. ETF outflows pose risk to derivatives strategies, while a derivatives-induced market dislocation risks destroying investor faith in the liquidity and safety of ETF passive “investing.”

The possibility of a 1987-style “portfolio insurance” debacle except on a grander – global, multi-asset class - scale is an Issue 2019. The U.S. economy has vulnerabilities. Yet Unsound Finance is a predominant Issue 2019. Outside of possible dreadful geopolitical developments, I would argue that the key major risk for 2019 is the seizing up of global markets. Unprecedented amounts of risk have accumulated across markets around the globe. Consider a particularly problematic scenario: a major de-risking/deleveraging episode sparks upheaval and illiquidity across currencies, equities and fixed-income markets. Such a scenario might incite a crisis of confidence in major global financial institutions, including derivatives markets and counterparties. Central bankers better not disappoint.

Last week’s dovish turn by Chairman Powell broke the bearish spell and reversed markets higher, though this came weeks late in the eyes of most market participants. “We know that long periods of suppressed volatility can lead to the build-up of risks and to a disruptive ending, and the idea that monetary policy can ignore that and leave it to macroprudential tools just is not credible to me.” This prescient comment (released Friday) is extracted from 2013 Federal Reserve transcripts. Governor Powell at the time clearly had a firmer grasp of the risks associated with QE than chairman Bernanke and future chair Yellen.

It is my long-held view that the Fed (and the other major central banks) will see no alternative than to resort to QE when global markets “seize up.” Ten-year Treasury yields at 2.70%, German bund yields at 22 bps and JGBs at zero don’t seem inconsistent with this view. It’s been a decade (or three) of Monetary Disorder. Now come the consequences, commencing with acute market and price instability. I believe this instability will end in a serious and prolonged crisis. There will be policy interventions, of course. But it will become increasingly clear that flawed monetary doctrine and policies are more the problem than the solution. In an increasingly acrimonious world, how closely will policymakers coordinate crisis responses? Will central bankers stick with “whatever it takes”? How quickly will they react to the markets – and with how much firepower? Uncertainty associated with monetary policymaking in a global crisis environment is an Issue 2019.

For the Week:

The S&P500 jumped 2.5% (up 3.6% y-t-d), and the Dow rose 2.4% (up 2.9%). The Utilities increased 0.6% (up 0.3%). The Banks added 1.5% (up 5.5%), and the Broker/Dealers gained 2.2% (up 5.5%). The Transports surged 4.3% (up 5.0%). The S&P 400 Midcaps surged 4.7% (up 5.0%), and the small cap Russell 2000 jumped 4.8% (up 7.3%). The Nasdaq100 advanced 2.8% (up 4.3%). The Semiconductors rose 6.0% (up 5.0%). The Biotechs surged 8.1% (up 12.8%). While bullion added $2, the HUI gold index fell 1.8% (down 0.7%).

Three-month Treasury bill rates ended the week at 2.37%. Two-year government yields rose five bps to 2.54% (up 5bps y-t-d). Five-year T-note yields added three bps to 2.53% (up 2bps). Ten-year Treasury yields gained three bps to 2.70% (up 2bps). Long bond yields rose five bps to 3.03% (up 2bps). Benchmark Fannie Mae MBS yields increased two bps to 3.48% (down 2bps).

Greek 10-year yields dropped 11 bps to 4.28% (down 7bps y-t-d). Ten-year Portuguese yields fell 10 bps to 1.71% (down 1bp). Italian 10-year yields declined four bps to 2.85% (up 11bps). Spain's 10-year yields slipped three bps to 1.45% (up 3bps). German bund yields gained three bps to 0.24% (unchanged). French yields declined three bps to 0.66% (down 5bps). The French to German 10-year bond spread narrowed six to 42 bps. U.K. 10-year gilt yields added a basis point to 1.29% (up 1bp). U.K.'s FTSE equities index rose 1.2% (up 2.8% y-t-d).

Japan's Nikkei 225 equities index surged 4.1% (up 1.7% y-t-d). Japanese 10-year "JGB" yields jumped six bps to 0.02% (up 1bp y-t-d). France's CAC40 increased 0.9% (up 1.1% y-t-d). The German DAX equities index rose 1.1% (up 3.1%). Spain's IBEX 35 equities index jumped 1.6% (up 3.9%). Italy's FTSE MIB index rose 2.4% (up 5.3%). EM equities were mostly higher. Brazil's Bovespa index gained 2.0% (up 6.6%), and Mexico's Bolsa jumped 2.6% (up 4.6%). South Korea's Kospi index rallied 3.2% (up 1.7%). India's Sensex equities index increased 0.9% (down 0.2%). China's Shanghai Exchange rallied 1.5% (up 2.4%). Turkey's Borsa Istanbul National 100 index jumped 3.2% (up 0.5%). Russia's MICEX equities index rose 1.6% (up 3.6%).

Investment-grade bond funds saw outflows of $1.137 billion, while junk bond funds posted inflows of $1.048 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined six bps to a near nine-month low 4.45% (up 46bps y-o-y). Fifteen-year rates dropped 10 bps to 3.89% (up 45bps). Five-year hybrid ARM rates sank 15 bps to 3.83% (up 37bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 4.41% (up 8bps).

Federal Reserve Credit last week declined $12.2bn to $4.017 TN. Over the past year, Fed Credit contracted $388bn, or 8.8%. Fed Credit inflated $1.206 TN, or 43%, over the past 322 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt recovered $6.7bn last week to $3.396 TN. "Custody holdings" rose $44bn y-o-y, or 1.3%.

M2 (narrow) "money" supply rose $24.1bn last week to a record $14.523 TN. "Narrow money" gained $702bn, or 5.1%, over the past year. For the week, Currency slipped $0.5bn. Total Checkable Deposits dropped $48.6bn, while Savings Deposits jumped $44.5bn. Small Time Deposits added $4.5bn. Retail Money Funds surged $24.3bn.

Total money market fund assets jumped $19bn to a near nine-year high $3.067 TN. Money Funds gained $230bn y-o-y, or 8.1%.

Total Commercial Paper jumped $28.1bn to $1.073 TN. CP declined $38bn y-o-y, or 3.4%.

Currency Watch:

The U.S. dollar index declined 0.5% to 95.67 (down 0.5% y-t-d). For the week on the upside, the New Zealand dollar increased 1.5%, the Australian dollar 1.4%, the Mexican peso 1.4%, the British pound 1.0%, the Norwegian krone 0.9%, the South African rand 0.9%, the euro 0.7%, the Singapore dollar 0.4%, the Swiss franc 0.4%, the Swedish krona 0.4% and the Brazilian real 0.1%. The Japanese yen was little changed for the week. The Chinese renminbi increased 1.57% versus the dollar this week (up 1.71% y-t-d).

Commodities Watch:

January 7 – Bloomberg: “Goldman Sachs… chopped back its near-term metals forecasts as China’s economy has ‘decelerated notably,’ while balancing that outlook with a prediction mainland policy makers will respond by stoking expansion in the second half, aiding a revival in copper and aluminum. The bank -- which had been consistently bullish on raw materials heading into 2019 -- now sees copper at $6,100 a metric ton in three months and $6,400 in six, down from earlier forecasts of $6,500 and $7,000…”

The Goldman Sachs Commodities Index surged 4.2% (up 7.6% y-t-d). Spot Gold added $2 to $1,288 (up 0.4%). Silver slipped 0.8% to $15.656 (up 0.7%). Crude surged $3.63 to $51.59 (up 14%). Gasoline rose 3.9% (up 8%), and Natural Gas gained 1.8% (up 5%). Copper increased 0.5% (up 1%). Wheat added 0.5% (up 3%). Corn declined 1.2% (up 1%).

Market Dislocation Watch:

January 6 – Wall Street Journal (Ira Iosebashvili): “Uneven economic data and volatility in stocks have accelerated a surge into assets perceived as relatively safe…The Japanese yen is up nearly 5% against the dollar since markets began sliding at the end of last year’s third quarter. That move picked up speed after weaker-than-expected manufacturing data and a sales warning from Apple Inc. last week bolstered fears of a global slowdown. Other so-called haven assets are also rising. Gold prices have strengthened around 7% in that period and stand near their highest level in about half a year…”

January 10 – Wall Street Journal (Daniel Kruger and Sam Goldfarb): “No U.S. company rated below investment grade has issued bonds since November—the longest stretch without a high-yield sale in more than two decades… December was the first month since 2008 without a junk-bond sale, according to Dealogic. Thursday is on pace to mark 41 days without a deal, the longest stretch in data going back to 1995. Volatility in financial markets, uncertainty about the economy and the recent drop in oil prices are discouraging riskier companies from issuing debt and investors from buying it, analysts say. Slack investor demand recently lifted the premium, or spread, that companies with junk credit ratings have to pay over risk-free government debt to the highest level in more than two years.”

January 7 – Bloomberg (Tracy Alloway): “Underneath the surface of a burgeoning calm in credit markets lies a fat-tailed monster: Options traders preparing for a sell-off that would spark a surge in risk premiums to levels not seen in two years. Spreads in the cash market for U.S. corporate bonds have begun to reduce, tracking a relief rally in stocks after a tough year for the vast majority of asset classes. But fears linger in credit derivatives, with benchmark indexes implying a higher chance of a major surge in spreads… The distribution of probabilities implied by the options market is ‘becoming increasingly fat-tailed’ which "indicates an increase in market expectation of a tail event," JPMorgan analysts wrote…”

January 9 – Reuters (Trevor Hunnicutt): “Investors demanded cash back from U.S.-based funds for a 13th straight week… Investment Company Institute (ICI) data showed… People withdrew $30.4 billion from U.S.-based mutual funds and exchange-traded funds (ETFs) on a net basis during the week ended Jan. 2, including $14.2 billion from bonds and $11.3 billion from stocks…”

January 7 – CNBC (Yun Li): “Investors are dumping stocks and corporate bonds at the fastest pace ever. Mutual funds invested in equity and bonds lost a record $152 billion in December, while U.S. equity exchange-traded funds just had their first back-to-back weekly outflows since July 2018, shedding $7.1 billion in the last two weeks, according to TrimTabs Investment Research.”

January 9 – Reuters (Trevor Hunnicutt): “U.S. money market fund assets increased for a fifth straight week to their highest level since early 2010, as investors further raised their cash pile due to recent market volatility, a private report… showed. Assets of money market funds… jumped $35.62 billion to $3.029 trillion in the week ended Jan. 8.”

January 9 – Wall Street Journal (Stephanie Yang): “Investors have started to shake off last year’s steep losses, helping markets regain some ground in 2019. But the robots are still almost uniformly bearish. Trend-following investment strategies—a computer-based way of trading that has become a major force in some markets—have gone from bullish to bearish to a degree not seen in a decade, according to an analysis of algorithms that buy or sell based on asset-price momentum. Funds that use such strategies likely went from holding net long positions… in four major asset classes—stocks, bonds, currencies and commodities—in the third quarter of 2017, to being short, or wagering against, everything but bonds by 2019.”

Trump Administration Watch:

January 8 – Bloomberg (Jenny Leonard, Jennifer Jacobs, Saleha Mohsin, and Shawn Donnan): “President Donald Trump is increasingly eager to strike a deal with China soon in an effort to perk up financial markets that have slumped on concerns over the trade war, according to people familiar with internal White House deliberations. Talks between mid-level U.S. and Chinese officials in Beijing concluded on Wednesday, and a Chinese foreign ministry spokesman said a positive result from the meetings will be good for the global economy. The negotiations had been extended for a day, which added to optimism fueled by tweets from Trump that the two sides are making progress toward an agreement.”

January 10 – Wall Street Journal (Rebecca Ballhaus, Kristina Peterson and Natalie Andrews): “As negotiations to end a partial government shutdown broke down Wednesday, White House officials said an increasingly likely option is for President Trump to declare a national emergency over border security and try to use Pentagon funds to pay for construction of a wall or other barrier on the U.S.-Mexico border. If the White House goes that route, House Democrats, who now hold a majority in the chamber, have vowed to immediately challenge it in court. The stakes in the showdown over border-wall funding heightened Wednesday after discussions at the White House between the president and congressional leaders collapsed when Mr. Trump walked out.”

January 9 – CNBC (Emmie Martin): “The partial government shutdown, which began Dec. 22, has now stretched well into the new year. President Donald Trump said Friday that it would continue for ‘months or even years’ until he receives the requested $5 billion in funding for a border wall. The shutdown has left approximately 800,000 federal workers in financial limbo. Around 420,000 ‘essential’ employees are working without pay, while another 380,000 have been ordered to stay home… Government workers are far from alone in feeling stressed about not getting paid. Nearly 80% of American workers (78%) say they’re living paycheck to paycheck, according to a 2017 report by… CareerBuilder.”

January 7 – CNBC (Matthew J. Belvedere): “Commerce Secretary Wilbur Ross told CNBC… that U.S. tariffs are hurting China’s economy and Beijing’s ability to create jobs to stave off domestic disorder. The economic slowdown in China is a ‘big problem in their context of having a very big need to create millions of millions of jobs to hold down social unrest coming out of the little villages,’ Ross said… He argued that Chinese workers going to cities for jobs are finding none and returning home. ‘That creates a real social problem,’ he said. ‘That’s a very disgruntled group of people.’”

January 8 – Reuters (Lisa Lambert): “President Donald Trump… expressed longing for the lower interest rates that the Federal Reserve put in place during the 2007-09 recession, saying he could boost the economy if the central bank brought interest rates to zero. ‘Economic numbers looking REALLY good. Can you imagine if I had long term ZERO interest rates to play with like the past administration, rather than the rapidly raised normalized rates we have today. That would have been SO EASY! Still, markets up BIG since 2016 Election!’ Trump wrote in an early morning tweet.”

January 7 – Bloomberg (Felice Maranz): “Shares of Fannie Mae and Freddie Mac both gained the most intraday since November 2016 on Monday, as U.S. Comptroller of the Currency Joseph Otting takes over as acting director of GSEs’ regulator, the Federal Housing Finance Agency (FHFA). FNMA is up as much as 21% to the highest since Oct. 25; FMCC is up as much as 19% to the highest since Sept. 21…”

Federal Reserve Watch:

January 9 – Associated Press (Martin Crutsinger): “Federal Reserve officials expressed increasing worries when they met last month, as they grappled with volatile stock markets, trade tensions and uncertain global growth. The threats, they said, made the future path of interest rate hikes ‘less clear.’ According to minutes of the Fed’s December gathering…, officials believed that with inflation still muted, the central bank could afford to be ‘patient’ about future rate hikes. While the Fed did approve a fourth rate increase for the year, the minutes show that a ‘few’ Fed officials argued against hiking rates at the meeting.”

January 7 – Reuters (Howard Schneider): “The Federal Reserve may only need to raise interest rates once in 2019, Atlanta Fed President Raphael Bostic said…, focusing on business executives’ nervousness about the economy and a global slowdown as factors that may hold the U.S. central bank back. ‘I am at one move for 2019,’ Bostic said.”

January 7 – Bloomberg (Jeanna Smialek): “Former U.S. Treasury Secretary Lawrence Summers has jumped into the debate about negative interest rates, signing onto a paper that gives the policy -- adopted in Europe and Japan as an emergency tool during the financial crisis -- a damning review. Negative central bank rates have not been transmitted to overall deposit rates, and a model suggests that tiptoeing into negative territory in a world with such a disconnect is ‘at best irrelevant, but could potentially be contractionary due to a negative effect on bank profits,’ Summers writes…”

U.S. Bubble Watch:

January 8 – New York Times (Jim Tankersley): “The federal budget deficit continued to rise in the first quarter of fiscal 2019 and is on pace to top $1 trillion for the year, as President Trump’s signature tax cuts continue to reduce corporate tax revenue… The monthly numbers from the Congressional Budget Office also show an increase in spending on federal debt as rising interest rates drive up the cost of the government’s borrowing. The widening deficit comes despite a booming economy and a low unemployment rate… Federal spending outpaced revenue by $317 billion over the first three months of the fiscal year, which began in October… That was 41% higher than the same period a year ago, or 17% after factoring in payment shifts that made the fiscal 2018 first-quarter deficit appear smaller than it actually was… Corporate tax receipts fell by $9 billion for the quarter, or 15%. Individual receipts fell by $17 billion, or 4%. Interest costs on the debt rose by $16 billion for the quarter, or 19%. Interest costs for December were up 47% from the same month in 2017.”

January 9 – CNBC (Sam Meredith): “The U.S. is in danger of losing its triple-A sovereign credit rating later this year, Fitch said…, warning an ongoing government shutdown could soon start to impact its ability to pass a budget. A stalemate between President Donald Trump and congressional Democrats over a spending package to fund nine government agencies entered its 19th day on Wednesday. It comes at a time when lawmakers are deeply divided over the president’s demand for money for a border wall. ‘I think people are looking at the CBO (Congressional Budget Office) numbers. If people take the time to look at that you can see debt levels moving higher, you can see the interest burden in the U.S. government moving decidedly higher over the next decade,” James McCormack, Fitch’s global head of sovereign ratings told CNBC’s “Squawk Box Europe”… ‘There needs to be some kind of fiscal adjustment to offset that or the deficit itself moves higher and you’re essentially borrowing money to pay interest on the debt. So there is a meaningful fiscal deterioration there, going on the United States,’ he added.”

January 7 – Reuters (Richard Leong and Lucia Mutikani): “U.S. services sector activity slowed to a five-month low in December, but remained above a level consistent with solid economic growth in the fourth quarter. The Institute for Supply Management said… its non-manufacturing activity index fell to 57.6 last month, the lowest reading since July, from 60.7 in November.”

January 10 – Reuters (SinĂ©ad Carew): “U.S. companies’ shopping spree for their own shares helped put a floor on market declines in 2018. Don’t look for the same level of support in 2019. Wall Street’s recent volatility has optimists betting that buybacks could provide the market with an even better buffer in 2019. But many strategists see the lift from buybacks - a major factor behind the bull market - losing some force as earnings growth slows while tax policy bonanzas fizzle out. ‘Companies bought back around 2.8% of shares outstanding in 2018. That was a substantial support to the market and bigger than dividends,’ said Jack Ablin, chief investment officer at Cresset Wealth Advisors… ‘(In 2019) we expect the corporate firepower behind share buybacks to be diminished. The growth in cash flow will be slower.’”

January 7 – CNBC (Diana Olick): “More Americans think it is a bad time to buy a home, as fewer potential buyers can afford what is on the market. The share of Americans who think it is a good time to buy a home just dropped sharply, according to a December survey from… Fannie Mae. Higher mortgage rates and increased home prices are likely to blame. Homes are simply very expensive right now, in relation to income, and there are still very few entry-level homes for sale… ‘Consumer attitudes regarding whether it’s a good time to buy a home worsened significantly in the last month, as well as from a year ago, to a survey low,’ said Doug Duncan, senior vice president and chief economist at Fannie Mae.”

January 8 – Bloomberg (Prashant Gopal): “The U.S. housing market, already losing steam, is taking another hit from the government shutdown, delaying closings and damaging buyer confidence, according to a National Association of Realtors survey. About 20% of 2,211 agents surveyed by the group said they had clients who were impacted in some way by the shutdown that began on Dec. 22, the organization said today.”

January 9 – CNBC (Diana Olick): “The combination of lower mortgage rates and an unusually slow end to 2018 caused mortgage applications to surge to start this year. Overall volume jumped 23.5% last week from the previous week, according to the Mortgage Bankers Association... Mortgage applications to purchase a home also jumped 17% last week but were just 4% higher than a year ago.”

January 8 – Associated Press (Martin Crutsinger): “Americans slowed their pace of borrowing slightly in November, but it still grew by a robust $22.1 billion. Solid auto and student loans offset some of the decline in the category that covers credit cards. …November’s figure follows a $25 billion gain in October, which had been the biggest increase in 11 months.”

January 7 – Financial Times (Chris Flood): “Vanguard has kept its title as the world’s fastest-growing fund manager for a seventh successive year despite a sharp fall in new business in 2018. A preliminary estimate… showed that it attracted net inflows of $232bn, down 38% on the record $371.9bn it gathered in 2017… BlackRock, the world’s largest asset manager, registered net inflows of $73.8bn in the first nine months of 2018…”

January 8 – CNBC (Diana Olick): “Chinese consumers may have soured on some American products, like iPhones, but they have only sweetened on U.S. residential real estate. They have been the top foreign buyers in both units and dollar volume of residential housing for six years straight, according to the National Association of Realtors, and now they are expanding to new, lower price tiers. Chinese consumers appear to be less interested in trade wars and more interested in bidding wars, according to San Francisco-based real estate agent Michi Olson, who just returned from an international real estate property show in Shanghai.”

January 6 – Reuters (Heather Somerville): “New Trump administration policies aimed at curbing China’s access to American innovation have all but halted Chinese investment in U.S. technology startups, as both investors and startup founders abandon deals amid scrutiny from Washington. Chinese venture funding in U.S. startups crested to a record $3 billion last year, according to… Rhodium Group… Since then, Chinese venture funding in U.S. startups has slowed to a trickle, Reuters interviews with more than 35 industry players show.”

China Watch:

January 9 – Reuters: “China’s producer price index (PPI) in December rose 0.9% from a year earlier, marking the lowest rate since September 2016 and slowing sharply from the previous month’s 2.7% increase… Analysts… had expected producer inflation would cool to 1.6% last month. The consumer price index (CPI) rose 1.9% last month compared with a year earlier, also below market expectations for a 2.1% gain.”

January 9 – Bloomberg: “China’s Finance Ministry is set to propose a small increase in the targeted budget deficit for this year as officials seek to balance support for the economy with the need to keep control of debt levels. The ministry agreed the proposed deficit target of 2.8% of gross domestic product… The figure, which compares with 2018’s target of 2.6%, will be presented for approval at the National People’s Congress…”

January 7 – Wall Street Journal (Tom Wright and Bradley Hope): “Senior Chinese leaders offered in 2016 to help bail out a Malaysian government fund at the center of a swelling, multibillion-dollar graft scandal, according to minutes from a series of previously undisclosed meetings… Chinese officials told visiting Malaysians that China would use its influence to try to get the U.S. and other countries to drop their probes of allegations that allies of then-Prime Minister Najib Razak and others plundered the fund known as 1MDB… The Chinese also offered to bug the homes and offices of Journal reporters in Hong Kong who were investigating the fund, to learn who was leaking information to them… In return, Malaysia offered lucrative stakes in railway and pipeline projects for China’s One Belt, One Road program of building infrastructure abroad.”

Central Bank Watch:

January 9 – Wall Street Journal (Brian Blackstone): “One year after posting a record 54 billion franc ($55bn) profit, the Swiss National Bank swung to a 15 billion franc loss in 2018, as a double whammy of weaker global equity markets and a stronger Swiss franc eroded the value of its massive holdings of foreign stocks and bonds. The valuation loss… underscores the interplay between central banks and markets. Usually, it is central bank decisions, or hints of changes in interest rates and other policies that cause stock and bond markets to fluctuate. But this has worked in reverse for Switzerland’s central bank, whose finances are largely at the mercy of financial markets beyond its borders.”

Global Bubble Watch:

January 7 – Financial Times (Lena Komileva): “If 2018 was the first year that tested the resilience of global markets to a switch from quantitative easing to quantitative tightening, the results did not inspire confidence. Investors began the year unprepared for the renewed volatility that came as the Federal Reserve rolled back more of its insurance liquidity. The fact a strong US jobs market and historically low policy rates could not prevent US stocks having their worst December since 1931 confirmed that a decade of repressing volatility had left the market with a weak immune system. The central issue facing markets now is where the new clearing level for risk lies. Has recent turbulence reset market fundamentals to more sustainable levels, or does it portend greater pain to come?”

January 8 – Reuters (Katherine Greifeld): “The growth of the global economy is expected to slow to 2.9% in 2019 compared with 3% in 2018, the World Bank said…, citing elevated trade tensions and international trade moderation. ‘At the beginning of 2018 the global economy was firing on all cylinders, but it lost speed during the year and the ride could get even bumpier in the year ahead,’ World Bank Chief Executive Officer Kristalina Georgieva said…”

January 9 – Bloomberg: “The growth engine for the world’s car industry has been thrown into reverse, with China recording the first annual slump in auto sales in more than two decades -- though progress in trade talks with the U.S. and planned government incentives offer a ray of optimism. Sales in the world’s biggest market fell 6% to 22.7 million units last year…”

January 8 – Bloomberg (Sam Kim): “Samsung Electronics Co.’s quarterly profit and revenue missed estimates on sputtering demand for memory chips during the last three months of 2018, the same period when Apple Inc. saw anemic sales in China. The… company’s operating income fell to 10.8 trillion won ($9.6bn) in the quarter… falling short of the 13.8 trillion-won average of analysts’ estimates…”

January 8 – CNBC (Stephanie Landsman): “Earnings season may deliver a wake-up call to Wall Street. Stephen Roach, one of Wall Street’s leading authorities on Asia, believes multinational corporations are largely underestimating the impact of the U.S.-China trade war on their bottom lines. According to Roach, the first indication came last week… ‘Apple is probably the canary in the coal mine… There’s likely to be more to come.’ Roach, who was Morgan Stanley Asia chairman for five years, sees the trade conflict with China as the biggest threat to the U.S. economy and markets… ‘To think that what affects the Chinese has no bearing whatsoever on an otherwise resilient U.S. economy I think, is ludicrous,’ he said. ‘This is a two-way relationship. The U.S. depends heavily on China. It’s our third largest and most rapidly growing export market over the last 10 years.’”

January 9 – Financial Times (Jamie Smyth): “Free iPads, rental guarantees and an eye-watering A$100,000 ($72,000) off the price of an apartment are some of the sweeteners on offer from property developers amid the worst housing downturn in Australia for 35 years. National house prices fell 1.3% in December, the largest monthly fall since 1983, which resulted in an annual decline of 6.1% last year. Prices in Sydney… are down 11.1% from their peak, according to Morgan Stanley, which warned this week the slump could torpedo Australia’s run of 27 years without a recession… ‘We think the steep downturn in house prices exposes Australia to the risk of recession, particularly in the context of an exogenous shock such as slowdown in Chinese growth,’ said Daniel Blake, lead author of the Morgan Stanley report.”

Europe Watch:

January 9 – Financial Times (Miles Johnson and Monika Pronczuk): “Matteo Salvini has pledged a ‘new European spring’ alongside Poland’s rightwing government as Italy’s populist leader attempts to build a Eurosceptic alliance ahead of Brussels elections in May. On a trip to Warsaw to meet Jaroslaw Kaczynski, leader of Poland’s ruling Law and Justice party, Mr Salvini, Italy’s deputy prime minister and head of the country’s hard right League party, …promised a common action plan that would ‘fuel Europe with new strength and new energy’. ‘Poland and Italy will be the heroes of the new European spring and the renaissance of true European values,’ said Mr Salvini, who has already forged ties with other anti-migrant rightwing leaders across Europe, including France’s Marine Le Pen.”

January 7 – Financial Times (Kate Allen): “Italy must sell €226bn of medium- and long-dated debt this year to a market that remains fragile after investors were rattled by last year’s stand-off between the populist government and Brussels. The political turbulence drove Italian bond yields to their highest since the eurozone debt crisis more than half a decade ago, and while Rome last month reached agreement with Brussels on its budget deficit, investors are wary of assuming that the market will remain calm.”

January 8 – Reuters (Michael Nienaber): “German industrial output unexpectedly fell in November for the third consecutive month, adding to signs that companies in Europe’s largest economy are shifting into a lower gear… Industrial output fell by 1.9% on the month in November… coming in way below the 0.3% increase that had been forecast. The output figure for October was revised down to a fall of 0.8% from a previously reported drop of 0.5%.”

Brexit Watch:

January 6 – Reuters (William James): “Prime Minister Theresa May said… that Britain would be in uncharted territory if her Brexit deal is rejected by parliament later this month, despite little sign that she has won over skeptical lawmakers. Britain is due to leave the European Union on March 29 but May’s inability so far to get her deal for a managed exit through parliament has alarmed business leaders and investors who fear the country is heading for a damaging no-deal Brexit. May said the vote in parliament would be around Jan. 15…”

January 6 – Reuters (Richard Lough and Caroline Pailliez): “Emmanuel Macron intended to start the new year on the offensive against the ‘yellow vest’ protesters. Instead, the French president is reeling from more violent street demonstrations. What began as a grassroots rebellion against diesel taxes and the high cost of living has morphed into something more perilous for Macron - an assault on his presidency and French institutions.”

Fixed-Income Bubble Watch:

January 9 – Bloomberg (Katherine Greifeld): “As the U.S. government kicks off its debt sales this year, here’s one potentially worrisome sign for traders to keep in mind: the steep decline in demand at its bond auctions. Of the $2.4 trillion of notes and bonds the Treasury Department offered last year, investors submitted bids for just 2.6 times that amount… That’s less than any year since 2008. The bid-to-cover ratio, as it’s known, fell even as benchmark Treasury yields soared to multi-year highs in October, before falling back to their lows last month.”

January 7 – Reuters (Ismail Shakil and Arundhati Sarkar): “PG&E Corp’s shares fell 14% on Tuesday, after S&P Global stripped the California power company of its investment-grade credit rating in the face of massive claims stemming from deadly wildfires. The utility, whose roughly $18 billion in bonds fell on Monday due to bankruptcy fears, has come under severe pressure since a fatal Camp fire in November compounded its woes. It currently faces billions of dollars in liabilities related to wildfires in 2017 and 2018.”

Leveraged Speculation Watch:

January 8 – Bloomberg (Alan Mirabella): “Hedge funds posted a loss of 5.7% last year as managers struggled to capitalize on volatility and were roiled by political uncertainty. For December, funds lost 1.9%, according to preliminary figures from the Bloomberg Hedge Fund Database. The industry suffered through one of its worst years in 2018. Many managers not only failed to make money but did worse than the broader market. The return of volatility posed a challenge. The prospect of a trade war with China and the combative stance of President Donald Trump didn’t help.”

January 8 – Financial Times (Robin Wigglesworth): “Philippe Jabre was the quintessential swashbuckling trader, slicing his way through markets first at GLG Partners and then an eponymous hedge fund he founded in 2007 — at the time one of the industry’s biggest-ever launches. But in December he fell on his sword, closing Jabre Capital after racking up huge losses. The fault, he said, was machines. ‘The last few years have become particularly difficult for active managers,’ he said in his final letter to clients. ‘Financial markets have significantly evolved over the past decade, driven by new technologies, and the market itself is becoming more difficult to anticipate as traditional participants are imperceptibly replaced by computerised models.’ …Various quant strategies — ranging from simple ones packaged into passive funds to pricey, complex hedge funds — manage at least $1.5tn, according to Morgan Stanley. JPMorgan estimates that only about 10% of US equity trading is now done by traditional investors.”

Geopolitical Watch:

January 5 – South China Morning Post: “Chinese President Xi Jinping… ordered the People’s Liberation Army to be ready for battle as the country faces unprecedented risks and challenges. Xi’s speech was made at a meeting of top officials from the Central Military Commission (CMC), which he heads, and broadcast later on national television. ‘All military units must correctly understand major national security and development trends, and strengthen their sense of unexpected hardship, crisis and battle,’ he said… China’s armed forces must ‘prepare for a comprehensive military struggle from a new starting point’, he said. ‘Preparation for war and combat must be deepened to ensure an efficient response in times of emergency.’”

January 5 – Financial Times (Edward White): “Taiwan’s president Tsai Ing-wen has made a fresh call for international support in the face of aggressive signals from China. Ms Tsai, in a rare briefing with foreign media, said given the ‘worst-case scenario of China using force’, Taiwan was speeding up development of its military and signalled hope for more foreign assistance. ‘We are working hard to do everything to help ourselves to improve our defence capabilities but at the same time we still hope other countries that attach great importance to democracy and value Taiwan will be able to work together with us,’ Ms Tsai said.”

January 6 – Reuters (Philip Stewart, Christian Shepherd and Michael Martina): “A U.S. guided-missile destroyer sailed near disputed islands in the South China Sea in what China called a ‘provocation’ as U.S. officials joined talks in Beijing during a truce in a bitter trade war. The USS McCampbell carried out a ‘freedom of navigation’ operation, sailing within 12 nautical miles of the Paracel Island chain, ‘to challenge excessive maritime claims’, Pacific Fleet spokeswoman Rachel McMarr said…”

January 8 – Financial Times (Laura Pitel and Aime Williams): “Donald Trump’s top security aide was snubbed by Turkey’s president…, striking a blow to Washington’s efforts to contain the fallout from a plan to withdraw US troops from Syria. John Bolton, the White House national security adviser, had hoped to meet Recep Tayyip Erdogan on his two-day visit to Ankara as part of a rearguard effort to reassure US allies and secure the safety of Kurdish forces in Syria following last month’s abrupt announcement on the departure of the troops. Instead, he found himself on the receiving end of a blistering attack by Mr Erdogan, who accused him of making a ‘serious mistake’ in asking Turkey not to attack Kurdish militants…”

January 6 – Reuters: “Iran’s central bank has proposed slashing four zeros from the rial, state news agency IRNA reported…, after the currency plunged in a year marked by an economic crisis fuelled by U.S. sanctions. ‘A bill to remove four zeros from the national currency was presented to the government by the central bank yesterday and I hope this matter can be concluded as soon as possible,’ IRNA quoted central bank governor Abdolnaser Hemmati…”

Friday Evening Links

[AP] US stocks drift in a quiet close to another winning week

[Reuters] Powell sought fast end in 2013 to Fed's bond-buying program

[Reuters] If U.S. again risks default, Fed has 'loathsome' playbook

[Reuters] China banks' bad loan ratio climbs to 10-year high at end-2018

[WSJ] Default Fears Add Fresh Stress to Chinese Private Sector

[FT] Powell backed slowdown in Fed bond-buying in 2013