Friday, May 3, 2019

Weekly Commentary: Transitory Histrionics

May 3 – Financial Times (Sam Fleming): “Having lamented low inflation as one of the great challenges facing central bankers today in March, Jay Powell on Wednesday wrongfooted many investors with comments that seemed to play down the gravity of the problem. The new message from the Federal Reserve chairman — that ‘transitory’ drags may be slowing price growth, rather than more persistent problems — marked a rude awakening for investors who had been hoping that he would signal an ‘insurance’ interest rate cut this summer because of low inflation. To critics, Mr Powell’s sharp change in tone extends a pattern of unpredictable communications that have made Fed policy more difficult to read. While many accept that investors got ahead of themselves in treating a 2019 rate cut as a fait accompli, the risk is that in his effort to dial back expectations of easier policy Mr Powell undercut the central bank’s broader message: that it will do whatever is necessary to get stubbornly low inflation back on target.”

To many, Chairman Powell’s Wednesday news conference was one more bungled performance. It may not have been at the same level as December’s “tone deaf” “incompetence.” But his message on inflation was muddled and clumsily inconsistent. How on earth can Powell refer to below-target inflation as “Transitory”?

Chairman Powell should be applauded. Sure, he “caved” in January. And while he can be faulted (along with about everyone) for not appreciating the degree of market fragility back in December, markets had over years grown way too comfortable with the Fed “put”/backstop.

I don’t fault the Powell Fed for having attempted in December to let the markets begin standing on their own. It was about time – actually, way overdue. Fault instead unsound markets and decades of “activist” Fed policymaking. And when markets were on the cusp of dislocating, Chairman Powell did what he believed the Fed had to do: Dovish U-turn. From my point of view, the grave mistake was the unnecessary (“gas on a flame”) “exceed dovish expectations” March 20th meeting. I’ll assume the FOMC was prepared in March to err on the side of both caution and message consistency.

But it’s May now. Record stock prices, bubbling bond markets and a return to quite loose financial conditions – along with a marketplace having gone a little crazy with the rate cut narrative. It would have been unwise for the Fed to oblige. To further accommodate this highly speculative market environment would ensure an only greater price to pay down the line. Besides, does it really make sense to split hairs on the undershooting of the Fed’s 2% inflation target with the S&P500 returning 18% in about four months and the unemployment rate down to a 49-year low 3.6%? “Transitory” Histrionics.

We live in an era where unstable global financial markets dictate financial conditions and economic performance like never before. Moreover, the world is in the throes of history’s greatest financial and market Bubbles. So discard any fanciful notion of “equilibrium.” At this point, the Bubble either inflates or falters – and the longer it inflates the more acutely vulnerable everything becomes. The global Bubble was in jeopardy in December, with ill-prepared central bankers coming feverishly to the markets’ rescue. Their next rescue attempt will come with greater challenges.

It’s worth noting that monthly y-o-y gains in CPI averaged 2.5% in 2018 (up from 2017’s 2.1%). July’s 2.9% was the strongest reading since February 2012. Year-over-year CPI inflation was at 2.5% in October before dropping back to 1.5% by February.

Is it reasonable to contemplate that this recent pullback in inflation could prove Transitory? After Q4’s market instability and resulting tightening of financial conditions, major U.S. equities indices have since recovered back to record highs. Most indicators of credit conditions are now pointing to the loosest backdrop since early-October (some loosest since last summer). At $747 billion, year-to-date global corporate debt issuance is running at a record pace (Dealogic data courtesy of the FT). Synthetic CDOs are back. In China, the Credit slowdown from much of last year has reversed course, exemplified by a record expansion in Q1. And after the Q4 collapse from $75 to $43, the most important commodity for inflation (crude oil) has in 2019 rallied back to $62 (WTI).

Despite Powell’s “Transitory” coupled with a much stronger-than-expected (“goldilocks”) 263,000 April gain in Non-Farm Payrolls, markets still see a 50% probability of a rate cut by the December 11th FOMC meeting. While this is down from the previous week’s 66.4%, it remains above the 44.6% from two weeks ago and the 41.7% from April 12th. Ten-year Treasury yields ended the week at 2.53%, up a few bps for the week but still below the 2.56% close from two weeks ago. I’ll suggest it’s an appropriate juncture for analysts and pundits to contemplate factors beyond current Fed thinking for an explanation of why the markets expect rate cuts in the not too distant future.

It’s no coincidence that market probabilities for Fed rate cuts jumped as China indicated waning inclination to press ahead with aggressive stimulus. Curiously, the trading week ending April 26th saw a 5.6% drop in the Shanghai Composite along with a surge in Fed rate cut probabilities (by 12/11/19) to 66.4% from 44.6%. It’s worth adding that recent declines in crude, copper, aluminum, nickel and commodities more generally have been highly correlated with the reversal in Chinese equities. Furthermore, the dollar index jumped to two-year highs as China’s stocks reversed sharply lower.

Friday evening’s Drudge headlines are worthy of documenting for posterity: “Envy of the World. Unemployment 49-year Low. Wage Hits $27.77/hour. Stock Market Endless Rally. Trump Approval 50%.”

With Nasdaq up 23% so far this year, IPOs coming left and right and generally the most speculative market environment in two decades, it’s effortless these days to completely disregard China. Besides, Beijing has everything under control – don’t they? They always do.

My fascination with Bubbles goes back more than 30 years (Japan in 1986). There have been so many – seemingly an endless stream of Bubbles: Japan, U.S. equities, junk bonds and leveraged buyouts, the S&Ls, and coastal real estate Bubbles from the second-half of the eighties. Bonds, mortgage derivatives, Mexico from the early nineties. SE Asia, Russia and EM from the mid-nineties. A major U.S. Bubble in technology, telecommunications and corporate Credit more generally. Argentina. Iceland. The historic U.S. mortgage finance Bubble. Europe, especially Greece and the European periphery. Dubai and so on – to mention only the first that come to mind.

In my 30 years of studying Bubbles, a few things have become clear – I would argue indisputable: They always burst. During the Bubble, virtually everyone dismisses Bubble analysis, instead believing the boom is well-founded and sustainable. The pain on the downside is proportional to the excesses during the preceding boom. Tremendous damage is inflicted during the final “Terminal Phase” of excess.

There’s no sound reason to believe China has discovered some magic formula for escaping the downside. Rather, there’s every reason these days to contemplate what a bursting Chinese Bubble will mean to China and the rest of the world. And I find it very intriguing that there is absolutely no mention of China in all the discussion of inflation and Fed policy. I actually believe that acute Chinese fragilities go a long way towards explaining (the latest “conundrum” of) depressed global sovereign yields (especially Treasuries, bunds and JGBs) in the face of surging risk markets.

Sure, China’s boom has been inflating for so long that the naysayers (arguing the view of an unsustainable Bubble) have been long discredited. I would strongly argue that the historic Chinese Bubble has been the most perilous consequence of Bernanke’s zero rates/QE, Draghi’s “whatever it takes,” Kuroda’s “QE infinity,” and, more generally, the most aggressive and protracted synchronized global monetary stimulus imaginable. In many respects, China has become the epicenter of the now decadelong global government finance Bubble. Today, no market – sovereign debt, equities, corporate credit, commodities, currencies and derivatives – is immune to the Virulent China Syndrome.

The upshot to the most globally accommodated Bubble ever has been history’s greatest credit excesses; unprecedented domestic over/mal-investment; unparalleled inflations in bank Credit and apartment finance; a massive pool of Chinese global spending and investment; and the most dangerous distortions in global trade, financial flows, and structural imbalances the world has ever experienced.

The China Bubble has altered global inflation dynamics – it has fundamentally changed geopolitics and the world order. It has certainly played a prevailing role in a global backdrop promoting asset inflation at the expense of wages – in the process exacerbating inequality. And, increasingly, China’s ascendency on the world stage has spurred an extraordinary Arms Race in everything technology, industrial, military and geopolitical. In short, China has become the Global Poster Child for Unsound “Money” - with incredibly far-reaching consequences.

May 1 – Bloomberg (Susanne Barton): “Traders borrowing U.S. dollars to buy China’s yuan can count on Asia’s best risk-adjusted carry trade to perform well for another couple of months, according to Bank of America. The backdrop should remain favorable through June as the U.S. and China are unlikely to reach a trade deal before then and the Asian country won’t let its currency depreciate significantly in the meantime, said Claudio Piron, the bank’s co-head of Asian currency and rates strategy… The trade is being supported by a plunge in currency volatility, growing yield divergence between China and the U.S. and the prospect of bond and equity inflows into the world’s second-largest economy, Piron said. The drivers are allowing the yuan ‘to become increasingly stable and attract risk-on carry trades and CNY asset exposure,’ Piron wrote in a note to clients.”

How much speculative leverage has accumulated in Chinese Credit over the past decade? I have a difficult time believing it’s not History’s Greatest “Carry Trade”. Chinese banks and corporations are estimated to have borrowed more than $3.0 TN in dollar-denominated liabilities. In January, a Bloomberg article (Christopher Balding) pointed to $1.2 TN of Chinese dollar debt that would need to be rolled over during 2019.

Beijing’s huge horde of international reserve assets created the capacity for sustaining China's Bubble beyond that of all previous developing economies. While down from the $4.0 TN peak back in mid-2014, China’s $3.1 TN of reserves has been sufficient to maintain confidence in the Chinese currency and hold market crisis fears at bay. There was a scare in late 2015. Fears subsided when China pushed through aggressive stimulus while global central banks adopted only greater QE and monetary stimulus. And when currency weakness again posed risk to the Chinese Bubble late last year, Beijing pivots to yet another round of stimulus.

While conventional thinking holds that Beijing can stimulate Chinese Credit and economic output at its discretion indefinitely, such optimism is at this point misguided. A large and growing portion of the recent Credit expansion has flowed into non-productive purposes – including inflated apartment markets, hopelessly insolvent corporate borrowers and egregiously over-leveraged local government entities. Stimulus operations are losing the battle of diminishing marginal returns. Meanwhile, “Terminal” excess continues to ensure systemic risk rises exponentially – the apartment Bubble, the ballooning banking sector, resource misallocation and deep structural impairment. And let’s throw in unquantifiable “carry trade” speculative leveraging that has surely ballooned precariously.

It’s worth pondering that China’s international reserve holdings have not expanded in eight years. Over this period, Chinese banking system assets have inflated 165% (to $39TN). Chinese GDP has inflated 113% ($13.6TN). System Credit has easily more than doubled. And let’s not forget that there is little transparency as to the composition of China’s $3.1 TN of reserves. Much has been committed to China’s fledgling international lending programs.

While global risk markets have grown complacent with regard to China, the scope of myriad China-related latent risks should have alarm bells ringing. Yet I’ll be the first to admit that such risks can remain largely masked so long as Chinese Bubble inflation is uninterrupted. For this, Credit growth must accelerate.

Pedal to the metal in Beijing equates to pushing worries out to the future. But I don’t believe sustained aggressive stimulus is something China’s leadership is comfortable with. After a booming Q1, I expect Beijing to attempt to cautiously slow lending and somewhat tighten financial conditions. We’re at the precarious late-stage of Bubble excess where any slowdown in Credit and speculation poses acute systemic risk.

I believe markets are pricing in the high probability for some Chinese-related instability between now and year-end that will force the Fed and global central bankers into additional monetary stimulus. The Fed is fashioning a new “inflation targeting” regime that will be used to justify easing measures in the face of the lowest unemployment rate in five decades. Bond markets relish the prospect of rate cuts and the redeployment of QE.

Meanwhile, reminiscent of the second-half of 2007, collapsing market yields and anticipation of another round of Fed stimulus throw gas on the speculative mania burning white-hot in the risk markets. Why fret some potentially lurking Chinese developments months (or years) into the future with such easy “money” to be made in the risk markets in the here and now? If I were Chairman Powell, I certainly wouldn’t be interested in stoking that fire either.

For the Week:

The S&P500 added 0.2% (up 17.5% y-t-d), while the Dow was little changed (up 13.6%). The Utilities increased 0.3% (up 11.0%). The Banks jumped 1.5% (up 19.7%), and the Broker/Dealers rose 1.9% (up 17.5%). The Transports gained 0.7% (up 19.5%). The S&P 400 Midcaps increased 0.4% (up 19.1%), and the small cap Russell 2000 jumped 1.4% (up 19.7%). The Nasdaq100 added 0.2% (up 23.9%). The Semiconductors gained 1.5% (up 36.0%). The Biotechs increased 0.2% (up 13.1%). With bullion declining $7, the HUI gold index sank 4.7% (down 4.7%).

Three-month Treasury bill rates ended the week at 2.37%. Two-year government yields gained five bps to 2.33% (down 16bps y-t-d). Five-year T-note yields rose four bps to 2.32% (down 19bps). Ten-year Treasury yields gained three bps to 2.53% (down 16bps). Long bond yields were unchanged at 2.92% (down 10bps). Benchmark Fannie Mae MBS yields added two bps to 3.26% (down 24bps).

Greek 10-year yields rose four bps to 3.33% (down 106bps y-t-d). Ten-year Portuguese yields slipped a basis point to 1.12% (down 5bps). Italian 10-year yields declined two bps to 2.56% (down 18bps). Spain's 10-year yields fell four bps to 0.98% (down 43bps). German bund yields rose five bps to 0.03% (down 22bps). French yields added two bps to 0.37% (down 34bps). The French to German 10-year bond spread narrowed three to 34 bps. U.K. 10-year gilt yields jumped eight bps to 1.22% (down 6bps). U.K.'s FTSE equities index declined 0.6% (up 9.7% y-t-d).

Japan's Nikkei Equities Index did not trade because of holidays (up 11.2% y-t-d). Japanese 10-year "JGB" yields were unchanged at negative 0.04% (down 4bps y-t-d). France's CAC40 dipped 0.4% (up 17.3%). The German DAX equities index gained 0.8% (up 17.6%). Spain's IBEX 35 equities index fell 1.0% (up 10.2%). Italy's FTSE MIB index was little changed (up 18.8%). EM equities were mixed. Brazil's Bovespa index slipped 0.2% (up 5.5%), and Mexico's Bolsa dropped 1.6% (up 6.3%). South Korea's Kospi index rallied 0.8% (up 7.6%). India's Sensex equities index declined 0.3% (up 8.0%). China's Shanghai Exchange dipped 0.3% (up 23.4%). Turkey's Borsa Istanbul National 100 index fell 0.9% (up 2.9%). Russia's MICEX equities index gained 0.7% (up 8.9%).

Investment-grade bond funds saw inflows of $375 million, and junk bond funds posted inflows of $21 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined six bps to 4.14% (down 41bps y-o-y). Fifteen-year rates fell four bps to 3.60% (down 43bps). Five-year hybrid ARM rates sank nine bps to 3.68% (down 1bp). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down three bps to 4.22% (down 43bps).

Federal Reserve Credit last week declined $20.4bn to $3.872 TN. Over the past year, Fed Credit contracted $454bn, or 10.5%. Fed Credit inflated $1.061 TN, or 38%, over the past 339 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt recovered $8.9bn last week to $3.461 TN. "Custody holdings" rose $53.7bn y-o-y, or 1.6%.

M2 (narrow) "money" supply declined $22.9bn last week to $14.489 TN. "Narrow money" rose $520bn, or 3.7%, over the past year. For the week, Currency increased $0.4bn. Total Checkable Deposits dropped $11.2bn, and Savings Deposits slipped $4.6bn. Small Time Deposits declined $1.7bn. Retail Money Funds fell $5.7bn.

Total money market fund assets jumped $21.7bn to $3.072 TN. Money Funds gained $244bn y-o-y, or 8.7%.

Total Commercial Paper declined $1.4bn to $1.065 TN. CP gained $11.9bn y-o-y, or 1.1%.

Currency Watch:

The U.S. dollar index declined 0.5% to 97.52 (up 1.4% y-t-d). For the week on the upside, the British pound increased 2.0%, the Japanese yen 0.4%, the euro 0.4%, the Swiss franc 0.3%, the South African rand 0.3%, the Canadian dollar 0.3%, the Singapore dollar 0.1% and the Mexican peso 0.1%. For the week on the downside, the South Korean won declined 0.8%, the Swedish krona 0.5%, the Australian dollar 0.3%, the Norwegian krone 0.2%, the New Zealand dollar 0.2% and the Brazilian real 0.2%. The Chinese renminbi declined 0.09% versus the dollar this week (up 2.13% y-t-d).

Commodities Watch:

May 2 – Financial Times (Henry Sanderson): “The central banks of Russia and China helped drive a 7% increase in global gold demand in the first quarter from a year earlier, according to the World Gold Council, as they continued efforts to trim their exposure to US dollars. Central banks purchased a total of 145.5 tonnes of gold worth about $6bn, an increase of 68% compared with last year and the strongest first quarter since 2013… Russia was the biggest buyer during the period, adding 55.3 tonnes… China added 33 tonnes to its holdings and Ecuador bought gold for the first time since 2014…”

April 28 – Reuters (Noah Browning and Julia Payne): “Tighter U.S. sanctions on Iranian oil planned for May are adding to a wealth of factors curbing global supply of heavy-medium crude, driving up prices for scarcer barrels and setting up a stand-off between buyers and sellers. The new curbs on Iranian exports come on top of Washington’s earlier ban on Venezuelan crude and output snags in Angola, another big producer of the dense crude grades that best yield lucrative refined products like jet fuel. U.S. officials say overall global oil supply will remain plentiful despite its sanctions… But much of the profusion in supply, led by the United States, Saudi Arabia and Russia, is in lighter grades.”

The Bloomberg Commodities Index declined 1.1% this week (up 3.7% y-t-d). Spot Gold slipped 0.6% to $1,279 (down 0.3%). Silver declined 0.7% to $14.978 (down 3.6%). WTI crude dropped $1.36 to $61.94 (up 36%). Gasoline sank 3.5% (up 53%), and Natural Gas declined 0.5% (down 13%). Copper dropped 2.6% (up 7%). Wheat declined 1.0% (down 13%). Corn jumped 2.6% (down 1%).

Market Instability Watch:

April 30 – Financial Times (Joe Rennison): “Investors are making record bets on stock market calm after a U-turn in monetary policy helped erase losses from a sharp sell-off in the fourth quarter of last year. There has been a rush to sell derivatives tied to the Vix index, Wall Street’s ‘fear gauge’, expecting it to stay low. Large speculators, mostly thought to be hedge funds, were net short 178,000 Vix futures contracts last week, the biggest bet on record… It marks a stark shift in sentiment from the end of the year, when the data showed that the same group of investors had bought a net 30,000 contracts, suggesting an expectation that the market decline in the final months of the year would continue.”

May 1 – Reuters (Jason Lange): “The U.S. government will have to stop borrowing money between July and December if Washington doesn’t agree to raise a legal restriction on public debt, the Treasury Department said… Hitting that so-called ‘debt ceiling’ could trigger a U.S. default on its debt and an immediate recession, a risk that has become a regular facet of U.S. politics over the last decade. The current debt limit was set in March. Treasury has been able to continue borrowing from investors by using accounting measures such as limiting government payments to public sector retirement funds.”

Trump Administration Watch:

May 3 – Wall Street Journal (David Harrison): “Top White House and Federal Reserve officials squared off over interest rates Friday in a public clash over how to manage the economy at a time of strong growth and historically low unemployment. Vice President Mike Pence and White House National Economic Council Director Lawrence Kudlow—echoing President Trump’s comments Tuesday—called on the Fed to lower interest rates, saying the economy’s engine could handle more fuel. ‘The economy is roaring,’ Mr. Pence said Friday in a CNBC interview, shortly after the Labor Department reported the jobless rate had fallen to 3.6% in April, the lowest level in 50 years. ‘This is exactly the time not only to not raise interest rates, but we ought to consider cutting them.’”

May 1 – CNBC (Kayla Tausche): “The announcement of a U.S. trade deal with China is ‘possible’ by next Friday, sources told CNBC on Wednesday. A U.S. delegation met with Chinese negotiators in Beijing on Wednesday as the world’s two largest economies try to hammer out details of an agreement. Chinese Vice Premier Liu He will travel to Washington for talks next week.”

April 30 – Bloomberg (Saleha Mohsin and Andrew Mayeda): “The White House is ramping up pressure to reach a trade deal with China in the next two weeks, warning that the U.S. is prepared to walk away from the negotiations. ‘It won’t go on forever,’ Mick Mulvaney, President Donald Trump’s acting chief of staff, said… ‘At some point in any negotiation you go, ‘we’re close to getting something done so we’re going to keep going.’ On the other hand, at some point you throw up your hands and say ‘this is never going anywhere.’’”

April 30 – CNBC (Jeff Cox): “President Donald Trump, in his most brazen attack yet on the Federal Reserve, called for the central bank on Tuesday to cut interest rates by 1 percentage point and to implement more money-printing quantitative easing. In a two-part tweet, the president unfavorably compared the Fed to its China counterpart and said if monetary policy in the U.S. was looser, the economy would ‘go up like a rocket.’”

April 30 – Associated Press (Martin Crutsinger): “President Donald Trump said Tuesday the economy would ‘go up like a rocket’ with better policies from the Federal Reserve while the close political ally he hopes to put on its board faced more questions about his candidacy from female GOP senators based on his past writing about women. In a tweet, the president said that the economy, while doing well, would do even better if the Fed started cutting rates and provided ‘some quantitative easing,’ referring to the process the Fed used following the financial crisis to purchase bonds to lower long-term interest rates.”

May 1 – Associated Press (Christopher Rugaber): “Stephen Moore, a conservative commentator whom President Donald Trump had tapped for the Federal Reserve board, withdrew from consideration Thursday after losing Republican support in the Senate, largely over his past inflammatory writings about women… ‘Steve won the battle of ideas including Tax Cuts and deregulation which have produced non-inflationary prosperity for all Americans,’ Trump said. ‘I’ve asked Steve to work with me toward future economic growth in our Country.’”

April 30 – Wall Street Journal (Editorial Board): “Who says there’s no bipartisanship in Washington? Democrats in Congress visited the White House on Tuesday, and they emerged to say that they and President Trump had agreed to spend $2 trillion on public works. When it comes to spending more money, Washington can always find common ground. ‘We agreed on a number, which was very, very good—$2 trillion,’ said Senate Minority Leader Chuck Schumer. ‘Originally we had started a little lower. Even the President was eager to push it up to $2 trillion.’ Given Mr. Trump’s fondness for big, round numbers, who can doubt it? The question is who is going to pay for all this? The annual federal budget deficit is already nearing $1 trillion.”

April 30 – CNBC (Richard Cowan and Susan Heavey): “Doubts mounted… over U.S. President Donald Trump’s pick to fill a vacant seat at the Federal Reserve, with one Republican senator saying she was ‘very unlikely’ to back economic commentator Stephen Moore and another calling his nomination ‘very problematic.’ The remarks, from U.S. Republican Senators Joni Ernst and Lindsey Graham, respectively, signaled growing resistance to Trump’s bid to put a loyalist on the Fed’s policy-setting panel…”

April 28 – Wall Street Journal (William Mauldin): “President Trump’s push to revamp North America’s trade rules is hitting a roadblock in Washington as Democrats and labor groups demand changes, dimming its chances of passage before next year’s presidential election. As Congress returns from recess this week with a full plate of priorities, House Speaker Nancy Pelosi (D., Calif.) and other prominent Democrats have signaled they won’t allow a vote on the administration’s new agreement with Canada and Mexico without certain changes.”

Federal Reserve Watch:

May 1 – Bloomberg (Craig Torres, Christopher Condon, and Steve Matthews): “Federal Reserve Chairman Jerome Powell pushed back against pressure for interest-rate cuts from traders and President Donald Trump, saying inflation will rebound and the economy will stay healthy without fresh help from the central bank. ‘We don’t see a strong case for moving in either direction,’ Powell told a press conference… ‘The economy continues on a healthy path, and the Committee believes that the current stance of policy is appropriate.’”

May 2 – Wall Street Journal (James Mackintosh): “Two words in Federal Reserve Chairman Jerome Powell’s opening comments on Wednesday mattered: ‘transient’ and ‘symmetric.’ The markets focused only on the first, with stocks and gold falling and bond yields rising as Mr. Powell described this year’s drop in inflation as transitory, implying less chance of interest-rate cuts. The second might matter more in the long run, as the Fed embarks on its first review of its 2% inflation target set seven years ago. Mr. Powell and Vice Chairman Richard Clarida have already made clear that the target itself isn’t up for debate but the way it is implemented could change, with big implications for markets. This is where ‘symmetric’ comes into play. In itself, it just says that inflation above 2% is as acceptable as inflation below 2%, but it has gained symbolic importance because of the Fed review.”

April 29 – CNBC (Jeff Cox): “Federal Reserve officials are considering a new program that would allow banks to exchange Treasurys for reserves, a move aimed at ensuring liquidity during difficult times that also would help the central bank decrease the size of its nearly $4 trillion balance sheet. The so-called standing repo facility is in its early discussion phases. Respected St. Louis Fed economists David Andolfatto and Jane Ihrig have authored two papers on the plan, which they say would ease the regulatory burden for banks that feel pressured into holding ultra-safe assets. In some quarters, the idea is viewed as a natural extension of current Fed policy. Others, though, think it in essence could be a repackaged form of quantitative easing and thus yet another iteration of the Fed’s decadelong tinkering in financial markets.”

April 29 – New York Times (Neil Irwin): “When a recession threatens, the Federal Reserve has a trusty method for either preventing it or minimizing its damage: Cut interest rates — by a lot, if necessary. But what happens when interest rates stay near record lows even in good times? With the economic expansion on track to become the longest on record, one of the most important beneath-the-radar policy conversations in Washington will take place in the coming months. Fed officials are undertaking the most extensive rethinking of how they set monetary policy since they set a formal target for inflation seven years ago. The results will help determine how long it can keep the good times going and how effectively it will be able to fight the next downturn. In the near term, any changes are likely to tilt policy in the direction of having lower interest rates for longer periods, with the aim of getting inflation to more consistently average 2%.”

May 3 – Wall Street Journal (Nick Timiraos): “At first blush, the decision by a second Trump-selected candidate for the Federal Reserve Board to withdraw in as many weeks marks a win for the central bank’s defenders, who had warned that former campaign adviser Stephen Moore and former Republican presidential candidate Herman Cain were too partisan for the technocratic Fed. The episode shows ‘Republicans still wish to see the Fed as a place where serious work is done by credible Republicans,’ said Peter Conti-Brown, a financial historian and legal scholar at the University of Pennsylvania.”

April 28 – CNBC (Jeff Cox): “The Federal Reserve’s preferred inflation gauge showed no change in March and remained well below the central bank’s target… At the same time, consumer spending surged amid a jump in expenditures on motor vehicles and health care. The core personal consumption expenditures index… was flat for the month and up 1.6% year over year. The headline number rose 0.2% for a 1.5% increase over the year.”

U.S. Bubble Watch:

May 3 – Associated Press (Christopher Rugaber): “U.S. employers added a robust 263,000 jobs in April, suggesting that businesses have shrugged off earlier concerns that the economy might slow this year and now anticipate strong customer demand. The unemployment rate fell to a five-decade low of 3.6% from 3.8%, though that drop reflected a rise in the number of people who stopped looking for work. Average hourly pay rose 3.2% from 12 months earlier, a healthy increase that matched the increase in March.”

April 29 – Reuters (Lucia Mutikani): “U.S. consumer spending increased by the most in more than 9-1/2 years in March as households stepped up purchases of motor vehicles, but price pressures remained muted, with a key inflation measure posting its smallest annual gain in 14 months. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, surged 0.9%. That was the biggest rise since August 2009 and was also driven by increased healthcare expenditures. Spending rose 0.1% in February.”

May 3 – Bloomberg (Katia Dmitrieva): “America’s merchandise-trade deficit widened in March for the first time in three months as an increase in imports exceeded the rise in exports. The goods-trade gap grew to $71.4 billion from $70.9 billion in February… Goods imports increased by $2 billion to $211.7 billion in March from the previous month, while exports climbed by $1.4 billion to $140.3 billion…”

May 1 – Reuters (Lucia Mutikani): “U.S. manufacturing activity slowed to a 2-1/2-year low in April amid a sharp drop in new orders while construction spending unexpectedly fell in March, suggesting economic growth was moderating after surging in the first quarter… The ISM said its index of national factory activity fell to 52.8 in April, the lowest reading since October 2016, from 55.3 in March.”

May 1 – CNBC (Fred Imbert): “The U.S. economy added far more jobs than expected in April as payrolls in the services sector grew by the most in more than two years, according to… ADP and Moody’s Analytics. Private payrolls grew by 275,000 last month, the biggest increase since July, when they expanded by 284,000… Services-providing jobs increased by 223,000 in April…”

April 30 – CNBC (Diana Olick): “National home prices rose 4% in February from a year earlier, according to… the S&P CoreLogic Case-Shiller home price index. That is down from a 4.2% annual gain in January. The 10-City Composite rose 2.6% annually, down from 3.1% in the previous month. The 20-City Composite posted a 3% year-over-year gain, down from 3.5% in January. Markets still gaining big: Las Vegas, Phoenix and Tampa, Florida, saw the highest year-over-year gains among the 20 cities. Las Vegas prices were up 9.7%, followed by Phoenix with a 6.7% increase, and Tampa with a 5.4% increase.”

April 30 – Reuters: “Contracts to buy previously owned homes rose to an eight-month high in March, the National Association of Realtors said… The NAR’s pending home sales index increased to a reading of 105.8, up 3.8% from the prior month and the highest since July. February’s index was unrevised at 101.9.”

May 2 – Wall Street Journal (David Harrison): “The U.S. continues to be on a path to an expanding national debt, the Congressional Budget Office said… The federal debt will grow to 92% of gross domestic product in 2029 from 78% in 2019, the largest projected share since 1947… CBO estimates that the average interest rate on the government’s debt will go from 2.3% last year to 3.5% in 2029. Annual deficits will average around 4.3% of the economy between 2020 and 2029…, well above the 2.9% average that prevailed between 1969 and 2018.”

May 1 – CNBC (Diana Olick): “The nation’s priciest properties are in far less demand this year, and that is taking a toll on their values. Sales of homes listed at $2 million and above fell 16% in the first quarter, the sharpest annual decline since 2010, according to Redfin… This as the supply of those homes rose 14%, marking four straight quarters of annual increases in inventory. The average price of a ‘luxury’ home, which Redfin defines as the top 5% in each of the 1,000 cities it tracks, fell 1.6% to $1.55 million. Nonluxury homes saw their average price rise 2.7% annually to $300,000.”

April 29 – CNBC (Diana Olick): “The median price of a San Francisco Bay Area home sold last month fell slightly compared with the prior-year period, marking the first annual drop since the bottom of the last housing crash, seven years ago, according to CoreLogic. In March, the median price was $830,000, down 0.1% compared with March 2018. The decline came as price gains had been shrinking for several months. Before last month, the median sale price had risen annually for 83 consecutive months since April 2012. Both May and June 2018 had the highest ever median sale price: $875,000.”

May 2 – Reuters (Lucia Mutikani): “U.S. worker productivity increased at its fastest pace in more than four years in the first quarter, depressing labor costs and suggesting inflation could remain benign for a while. …Nonfarm productivity, which measures hourly output per worker, increased at a 3.6% annualized rate in the last quarter. That was the strongest pace since the third quarter of 2014.”

China Watch:

April 30 – Bloomberg: “A huge tumble in government bonds, the worst rout in months for stocks and a weakening yuan -- April was a month of selling in China’s markets. There was no place to hide as the risk-on rally that had added some $2.5 trillion to the world’s top-performing equities started to lose steam. The Shanghai Composite Index is down for the month amid record foreign selling and small caps just entered a correction. China’s sovereign debt is heading for its worst monthly drop in more than eight years, while the yuan slid the most since October.”

April 29 – Bloomberg: “Investors are running out of reasons to chase the bull market in Chinese stocks. After adding as much as $2.5 trillion to share values and outpacing gains everywhere else in the world, the rally in China is starting to look tired. Headwinds include an uninspiring earnings season, as well as the likelihood that Beijing will pursue a less aggressive stimulus policy than anticipated. Talks with the U.S. on trade also resume this week. Some of the hottest trades have already started to unravel in the past two weeks, including brokers, small caps and stocks with links to next-generation telecom networks.”

April 29 – Reuters: “Growth in China’s services industry slowed in April…, adding to uncertainty over demand in the world’s second-largest economy. The official non-manufacturing Purchasing Managers’ Index (PMI) fell to 54.3 in April from 54.8 in March, but stayed well above the 50-point mark that separates growth from contraction. Services account for more than half of China’s economy, and rising wages have increased Chinese consumers’ spending power.”

April 30 – Reuters (Stella Qiu and Ryan Woo): “Factory activity in China expanded for a second straight month in April but at a much slower pace than expected…, suggesting the economy is still struggling for traction despite a flurry of support measures… The official Purchasing Managers’ Index (PMI) for manufacturing fell to 50.1 in April from March’s reading of 50.5, which was the first expansion in four months…”

April 28 – Financial Times (Hudson Lockett): “Bond investors beware: the Middle Kingdom is splitting down the middle. Increasingly, international investors are being drawn to China’s debt markets, the third biggest in the world behind the US and Japan, as issuance soars and as central-government bonds start to be included in global benchmarks. But any fund manager venturing beyond these safest assets should consult a map before taking a plunge into provincial government debt. It is not unusual for local governments to run big deficits in China. The latest official figures show that only the wealthy urban municipalities of Beijing and Shanghai posted a funding surplus in 2017. Revenues collected by the other 29 provincial governments fell short of spending. But Moody’s… has found that the regional differences between provincial funding gaps are widening. Where eastern provincial governments faced an average revenue shortfall of 27% compared with spending, those in central and western China saw gaps averaging 50 and 77%, respectively.”

May 1 – Financial Times (Lucia Mutikani): “For ‘the Netflix of China’, an initial public offering in New York was just a curtainraiser. In the 12 months following the $2.4bn IPO of iQiyi, the Chinese video-streaming platform sold equity-linked financial instruments known as convertible bonds for more than three quarters of that amount. And it is not the only one. Cash-hungry Chinese technology companies have turned to the convertible bond markets with gusto in 2019, raising $4.6bn in the year to date…”

April 27 – Reuters (Ben Blanchard): “President Xi Jinping… hailed deals worth more than $64 billion signed during China’s Belt and Road Initiative (BRI) this week as he sought to reassure skeptics the project will deliver sustainable growth for all involved. Xi said market principles will apply in all Belt and Road cooperation projects and that his signature initiative to recreate the old Silk Road joining China with Asia and Europe will deliver green and high-quality development. ‘More and more friends and partners will join in Belt and Road cooperation,’ he said in his closing remarks. ‘The cooperation will enjoy higher quality and brighter prospects.’”

April 29 – Reuters (Ben Blanchard): “President Xi Jinping appealed to China’s youth… to love the country and dedicate themselves to the Communist Party, warning on the centenary of student-led protests there was no place for those who ignored the country’s needs… Speaking to officials and youth delegates at the Great Hall of the People, Xi said China’s young should be grateful to the party, the country, the society and the people. ‘Tell every Chinese person that patriotism is one’s duty, is an obligation,’ Xi said…‘For Chinese youth of the new era, ardently loving the motherland is the foundation of building the body and of talent,’ he added.”

Central Bank Watch:

May 3 – Financial Times (Sam Fleming): “Jean-Claude Juncker, the European Commission president, has said he ‘would not mind’ a German such as Bundesbank chief Jens Weidmann becoming head of the European Central Bank. ‘Weidmann is a convinced European and an experienced central banker and therefore suitable,’ Mr Juncker said in an interview with Handelsblatt, the German business newspaper. ‘I do not explicitly plead for him, but I am not against him either. I strongly disagree with the opinion held in parts of southern Europe that a German cannot become ECB president.’ Mr Juncker said a German could take on the top job at either the commission or the ECB, the most influential economic job in the EU.”

Europe Watch:

April 29 – Reuters (Paul Day): “Spain’s ruling Socialists were considering possible partners for a new government for the politically polarized country on Monday after they won a national election but failed to secure a majority. Prime Minister Pedro Sanchez faces a choice between a complex alliance with fellow leftists Podemos or joining forces across the political divide with the center-right Ciudadanos.”

April 29 – Bloomberg (William Horobin): “Economic confidence in the euro area dropped for a 10th month in April to the lowest in more than two years… The European Commission’s monthly survey showed an industrial morass is increasingly entrenched as companies continue to struggle with the global slowdown and homegrown difficulties, notably the upheaval in Germany’s car industry.”

April 30 – Reuters (Michelle Martin): “German annual inflation accelerated to 2.1% in April, exceeding the European Central Bank’s target for the first time since November… Consumer prices, harmonized to make them comparable with inflation data from other European Union countries, rose by 2.1% year-on-year after an increase of 1.4% in the previous month…”

EM Watch:

April 29 – Financial Times (Jonathan Wheatley): “The Turkish lira has an unenviable record this year, down more than 11%, ranking 145th of 146 world currencies tracked by Bloomberg. Only the Argentine peso, heavily sold on fears of a return to power for Cristina Fernández de Kirchner, the former leftist president, has done worse. In part, says Robin Brooks, chief economist at the Institute of International Finance, the trajectory of the lira reflects worries over the nature of growth in Europe’s seventh biggest economy, which is heavily dependent on borrowed money. The IIF tracks what it calls the ‘credit impulse’ — defined as the quarterly change in new credit issued — and compares that with subsequent growth in gross domestic product. By that measure… Turkey is among the most credit-reliant among emerging economies, along with Colombia, Russia, Indonesia and Brazil.”

Brexit Watch:

April 28 – Financial Times (Claire Jones): “Brexit is likely to threaten the pound’s status as a global reserve currency according to a survey of central bank money managers who say Britain’s departure from the EU will alter their views on sterling. The pound’s history as one of the most important global currencies has meant central banks have long held assets denominated in pounds that can be sold quickly to help curb swings in their own currency’s exchange rates. But a poll by Central Banking Publications, a trade journal, suggests its status will be endangered by Brexit, with three-quarters of reserve managers predicting that central banks will collectively alter — and in all likelihood cut — their sterling holdings.”

Global Bubble Watch:

April 29 – Wall Street Journal (Daniel Kruger): “A growing number of investors are paying governments in Europe for the privilege of holding their bonds. The amount of negative-yielding government bonds outstanding through 2049 has risen 20% this year to about $10 trillion, the highest level since 2016… The expanding pool of such bonds—which guarantee that a buyer will receive less in repayment and periodic interest than the buyer paid—highlights how expectations for growth in much of the developed world have deteriorated. Government debt sold by countries including Germany, Ireland and Sweden are among those with negative yields.”

May 2 – Bloomberg (Tasos Vossos): “Central banks hellbent on cheap money are strong-arming investors into riskier bond bets, and there’s little reason to fight it for now, says Bob Michele. The chief investment officer at JPMorgan Asset Management is touting Spanish government bonds and European bank capital notes, as negative yields engulf the region’s bonds. ‘The ECB has bullied us and the rest of the market into it,’ Michele said… ‘They’re not going to raise rates so that leaves us scrambling for yield. They’re going to maintain the balance sheet so it ends up backstopping countries like Spain.’”

April 30 – Reuters (David Ljunggren): “The Canadian economy unexpectedly shrank by 0.1% in February, pulled down in part by weakness in the mining sector and bad weather that hurt rail transport… Analysts in a Reuters poll had expected no change from January, when the economy grew by 0.3%.”

Japan Watch:

April 28 – Bloomberg (Paul Panckhurst): “A record 8.46 million Japanese homes are sitting vacant as builders keep adding stock in a country where the population is shrinking. The number jumped by 260,000 in a twice-a-decade survey released by the government on Friday, reaching 13.6% of housing, the Nikkei Asian Review reported.”

Fixed-Income Bubble Watch:

May 2 – Financial Times (Robin Wigglesworth): “Mark Twain once said that the key to good health was to ‘eat what you don’t want, drink what you don’t like, and do what you’d rather not’. After a long post-crisis debt binge, some US companies are now reluctantly eyeing a stricter diet. All-time highs in stock prices suggest investors are relaxed about the new regime. But for how much longer? Companies in the S&P 500 handed shareholders a record-breaking $1.25tn through dividends and stock buybacks in 2018, lifting the post-crisis handout to almost $8tn… That is nearly equal to the current value of all the gold ever mined. Much of the largesse has been financed by roaring earnings. But US companies have also increased their debt — by $2.5tn over the past five years alone — lifting their net debt to earnings ratio to its highest since 2002, according to Bank of America.”

May 3 – Bloomberg (Davide Scigliuzzo): “These are boom times for investment firms that make direct loans to small and mid-sized companies. The promise of higher returns and better underwriting standards than those available in the public markets have helped drive hundreds of billions of dollars into private debt funds. It made for a hot topic this week as the titans of finance gathered in Beverly Hills… for the annual Milken Institute Global Conference. Executives at firms from Oak Hill Advisors to Barings still see plenty more opportunities. But some flagged concern that the market -- on pace to reach $1 trillion next year -- will overheat.”

May 3 – Bloomberg (Molly Smith and Dana Hull): “Tesla Inc. raised $2.35 billion through debt and stock offerings that expanded from the company’s initial plans, helping to put some near-term liquidity fears to rest. The electric-car maker raised $750 million selling common stock and $1.6 billion from convertible bonds, up from originally offering $650 million and $1.35 billion. The capital raise sparked a relief rally in both Tesla’s stock and bonds, which had reflected investor worry over whether the company can be sustainably profitable.”

May 3 – Financial Times (Joe Rennison): “Investors are flocking back to a complex debt derivatives product blamed for amplifying losses in the financial crisis, reckoning that the securities are safer now that they are no longer backed by subprime mortgages. The vehicles, known as ‘synthetic’ CDOs, short for collateralised debt obligations, bundle together derivatives whose returns depend on the performance of bonds, loans and other debts — providing hedge funds and other investors another way to bet on the creditworthiness of corporate America. In contrast to standard CDOs, which bundle the bonds and loans themselves, synthetic CDOs proved especially destabilising during the crisis because they allowed multiple bets on the same subprime mortgages.”

May 3 – Wall Street Journal (Ben Eisen): “Ginnie Mae is taking steps to curb repeated mortgage refinancings that it says are hurting both borrowers and investors. The government-backed firm, which promotes homeownership by guaranteeing government mortgage bonds, is considering barring some loans backed by the Department of Veterans Affairs from inclusion in its flagship bonds. Its proposal… is aimed at stopping so-called ‘churning,’ a practice in which lenders push borrowers to refinance their home loans over and over in a bid to boost fees to the lenders. Ginnie Mae has made churning a priority in recent years. It started taking action against individual lenders last year when their activity suggested they were pushing refis on borrowers, even when the borrowers wouldn’t benefit from it.”

Leveraged Speculator Watch:

May 2 – Bloomberg (Claire Boston): “Hedge funds and other investors are reviving a type of securitized product that blew up during the financial crisis. This time around they’re convinced that the structures will not only weather the next downturn, but might even profit from it. Money managers are resurrecting collateralized debt obligations that bundle risky bonds and loans into new, higher-rated securities. Issuers… are betting tweaks to the products will allow them to keep enough cash on the sidelines that, when the next slowdown hits, they’ll be able to swoop in and buy the most beaten-down debt on the cheap.”

Geopolitical Watch:

April 29 – Reuters (Niklas Pollard): “Global military expenditure reached its highest level last year since the end of the Cold War, fueled by increased spending in the United States and China, the world’s two biggest economies, a leading defense think-tank said… In its annual report, the Stockholm International Peace Research Institute (SIPRI) said overall global military spending in 2018 hit $1.82 trillion, up 2.6% on the previous year. That is the highest figure since 1988, when such data first became available…”

April 30 – Bloomberg (Saleha Mohsin and Andrew Mayeda): “It was a ploy that from its outset felt like a long shot. Before dawn Tuesday, Juan Guaido, flanked by his political mentor Leopoldo Lopez and a handful of soldiers who had broken ranks, issued a message to Venezuela and the world: The time to topple Nicolas Maduro’s authoritarian regime was right now. By Wednesday morning, with Maduro still firmly in control of the military command, Lopez had sought refuge at the Spanish embassy and the streets of the capital were quiet, long empty of the protesters who had heeded Guaido’s call to join what he called Operation Liberty.”

May 2 – Financial Times (Mex Seddon): “The Kremlin’s position on the Venezuela crisis, where US-backed opposition leader Juan Guaidó launched a stalled effort to overthrow Russian ally Nicolás Maduro, is ‘incompatible’ with the US stance, Russian foreign minister Sergei Lavrov said… ‘I don’t see how you can combine two positions where one — ours — is based on the UN charter and the principles and norms of international law, and the other has the US appointing an acting president of a different country from Washington,’ Mr Lavrov told reporters. Mr Lavrov said that Mike Pompeo, the US secretary of state, had told Russia to stay out of Venezuela in a ‘surreal’ phone call on Wednesday, to which he replied: ‘We never interfere in the affairs of others and urge everyone else to do the same.’”

April 28 – Reuters (Idrees Ali): “The U.S. military said it sent two Navy warships through the Taiwan Strait on Sunday as the Pentagon increases the frequency of movement through the strategic waterway despite opposition from China. The voyage risks further raising tensions with China but will likely be viewed by self-ruled Taiwan as a sign of support from the Trump administration amid growing friction between Taipei and Beijing. Taiwan is one of a growing number of flashpoints in the U.S.-China relationship, which also include a trade war, U.S. sanctions and China’s increasingly muscular military posture in the South China Sea, where the United States also conducts freedom-of-navigation patrols.”

April 28 – Bloomberg (Linly Lin): “The head of the U.S. Navy warned China that its coast guard and maritime militia will be treated in the same way as the nation’s navy in the South China Sea, the Financial Times reported… China is increasingly relying on non-naval ships to assert its claims in the region, blurring the line between its military and coast guard, which has complicated U.S. efforts in the past few years, according to the report. China considers at least 80% of the South China Sea to be its sovereign territory, a claim disputed by other regional powers. Admiral John Richardson told the FT that he has ‘made it very clear that the U.S. Navy will not be coerced and will continue to conduct routine and lawful operations around the world.’”

April 27 – Reuters (Hesham Hajali and Stanley Carvalho): “U.S. Central Command chief General Kenneth McKenzie said… the United States would deploy the necessary resources to counter any dangerous actions by Iran, Sky News Arabia reported. ‘We’re going to continue to reach out to our partners and friends in the region to ensure that we make common cause against the threat of Iran… I believe we’ll have the resources necessary to deter Iran from taking actions that will be dangerous… We will be able to respond effectively.’”

April 29 – Reuters (Ulf Laessing and Ahmed Elumami): “An armed group attacked Libya’s largest oilfield on Monday, but was repelled after clashes with its protection force, while fighting escalated in eastern commander Khalifa Haftar’s effort to capture the capital Tripoli.”

May 2 – Wall Street Journal (Ben Kesling): “The U.S. Navy and Marine Corps are deepening their commitments to Arctic security and to operations in Alaska, top Pentagon officials told Congress… Navy Secretary Richard Spencer said the service would undertake extensive Arctic operations this summer and fall, while the Marine Corps commandant said that Marines are committed to training in Alaska to an extent not seen in decades. The actions are part of a broader U.S. commitment to step up its presence in a region taking on expanded strategic importance…”

Friday Afternoon Links

[Reuters] Wall St. climbs as jobs data supports upbeat economic outlook

[Reuters] Oil edges up after strong economic data, but ends week lower

[Reuters] Fed 'insurance' rate cut not likely soon as economy hums along

[CNBC] Trump and Putin talked about Mueller report, Venezuela and North Korea during phone call

[Bloomberg] Fed Voters Split With Powell Over Case for a Possible Rate Cut

[WSJ] White House Escalates Feud With Fed

[FT] Federal Reserve officials crack open door to rate cut

[FT] Investors dive into high-quality US corporate debt once more