Friday, May 10, 2019

Weekly Commentary: Deal or No Deal

What went wrong? Clearly, all the positive talk from both the U.S. and China painted a much too rosy picture of trade negotiation progress. From the Wall Street Journal (Lingling Wei and Bob Davis): “The new hard line taken by China in trade talks—surprising the White House and threatening to derail negotiations—came after Beijing interpreted recent statements and actions by President Trump as a sign the U.S. was ready to make concessions, said people familiar with the thinking of the Chinese side.”

“…The U.S. thought China agreed to detail the laws it would change to implement the trade deal under negotiation. Beijing said it had no intention of doing so… The hardened battle lines were prompted by Beijing’s decision to take a more aggressive stance in negotiations… They said Beijing was emboldened by the perception that the U.S. was ready to compromise. In particular…, Mr. Trump’s hectoring of… Chairman Jerome Powell to cut interest rates was seen in Beijing as evidence that the president thought the U.S. economy was more fragile than he claimed.”

In the most comprehensive and insightful article on the subject I’ve read so far, a Reuters team (David Lawder, Jeff Masson, Michael Martin, Chris Prentice, Dan Burns, Jing Xu and Ben Blanchard) presented compelling analysis:

“The diplomatic cable from Beijing arrived in Washington late on Friday night, with systematic edits to a nearly 150-page draft trade agreement that would blow up months of negotiations between the world’s two largest economies, according to three U.S. government sources and three private sector sources briefed on the talks. The document was riddled with reversals by China that undermined core U.S. demands, the sources told Reuters. In each of the seven chapters of the draft trade deal, China had deleted its commitments to change laws to resolve core complaints that caused the United States to launch a trade war: Theft of U.S. intellectual property and trade secrets; forced technology transfers; competition policy; access to financial services; and currency manipulation.”

Why would Beijing return a 150-page draft with “systematic edits” that they surely understood would risk blowing up months of negotiations? “Liu last week told Lighthizer and Mnuchin that they needed to trust China to fulfill its pledges through administrative and regulatory changes… Both Mnuchin and Lighthizer considered that unacceptable, given China’s history of failing to fulfill reform pledges.”

The U.S. was demanding that China change existing laws to incorporate trade concessions along with agreeing to “an enforcement regime more like those used for punitive economic sanctions – such as those imposed on North Korea or Iran – than a typical trade deal.”

China views U.S. demands to change laws as an infringement of national sovereignty. And I can imagine Chinese officials have utter disdain for a U.S.-dictated “enforcement regime.” Xi and Putin’s private talks - and close personal relationship - surely coalesce around their mutual revulsion to U.S. hegemony including its aggressive command of international organizations and authority over punitive economic sanctions. The U.S. was pushing vehemently for concessions the Chinese likely considered red line issues. Beijing made the calculated decision to push back. Have increasingly contentious U.S. military excursions in the Taiwan Strait and South China Sea been a factor? Less than a trust-building exercise. Huawei? How much is Venezuela's Maduro on the hook to the Chinese? Kim Jong Un (aka “Rocketman”) up to his old tricks mere coincidence?

That so many things are coming to head is no coincidence: Late-stage historic global Bubble. The rise of insecurity, populism in the U.S., President Trump and the Chinese as a popular (can’t lose) political target. The rise of Chinese economic might, financial power, technological prowess, global influence and rapidly expanding military capabilities. The multi-decade global Bubble has caused unprecedented wealth inequality, uncertainty and fragility – within and between nations. And an increasingly disenchanted U.S. middle-class has manifested into a country deeply divided economically, socially and politically – more distrustful of its institutions and seeking scapegoats.

In China, a meaningful segment of society has attained wealth beyond what was previously imaginable. A historic Bubble has inflated economic output, perceived wealth and expectations. With their Bubble faltering, the Communist Party has tightened its grip. Beijing can use the long history of foreign interference to deflect blame for its mismanagement of Chinese finance and resulting deep financial and economic structural maladjustment.

The odds of a trade negotiation blowup have rather obviously escalated. Yet both sides are viewed as in almost desperate need of a deal. Ramifications for a breakdown in the Chinese/U.S. trading relationship are so awful markets are convinced it can’t happen. Besides, there’s the Trifecta of Market “Puts” – Trump, the Fed and Xi. Market support is regarded as more dependable than ever after the January Powell U-turn, this week’s cut in Chinese bank reserve requirements, and a U.S. election that gets closer by the day.

With Chinese Bubble fragility so acute, few believe Beijing will risk a blowup. For the U.S. administration, a favorable trade deal with China will be a crowning achievement heading into 2020 elections. For Making America Great Again, it certainly doesn’t hurt politically to appear to have beaten the Chinese into submission.

Assuming a trade deal is eventually consummated, I don’t see the U.S. and China coming out of talks as cordial trading partners (i.e. NAFTA, South Korea and Japan). Instead, these two adversaries will have even less trust, along with a clearer appreciation for the intensity of their ongoing competitive rivalry, irreconcilable differences and likely future clashes. It’s reasonable to view trade negotiations as the first salvo of confronting global superpowers.

Back in the late-eighties Bubble when the Japanese were to “take over the world,” it was in the context of their superior manufacturing capabilities and rapidly expanding financial might. There was no concurrent military buildup or global ambitions outside of expanding trade and investment. Sometimes competitor perhaps, but the Japanese remained very much in the U.S.’s back pocket. That Toyota and Honda were offering U.S. consumers higher quality products was a big problem for Detroit. But there was no fear of the Japanese becoming a threatening geopolitical adversary. No Arms Race.

The bursting of the Japanese Bubble had only secondary geopolitical ramifications. Facing an increasingly destabilizing Bubble, policymakers were primarily focused on the wellbeing of Japanese society and the soundness of domestic finance, the asset markets, and overall economic structure. The potential for waning global influence and heightened geopolitical risk wasn’t an issue. While the Japanese would have had some justification, there was no proclivity to blame the U.S. “hegemon” or “foreigners” more generally. Post-Bubble dissatisfaction was, repeatedly, discharged at the ballot box.

I tend to look at the Chinese Bubble, with its 1.4 billion citizens and unprecedented Communist government control over finance, the economy and society, as the climax of a multi-decade global Bubble that, in important respects, gathered initial critical momentum in Japan. China, however, has used the Bubble to incredibly expand its global economic, financial, technological and military ambitions. One cannot overstate the global ramifications for a faltering Chinese Bubble. There is a multidimensional Arms Race aspect – economic, financial, technology, military and geopolitical power.

Despite Friday’s “national team”-supported 3.1% rally, the Shanghai Composite sank 4.5% this week. China’s CSI 500 Index was down 7.8% in the first four sessions of the week, the CSI 300 Financials 8.6%, the CSI Small Caps 7.8% and the growth/tech ChiNext index 9.5%. Hong Kong’s Hang Seng China Financials Index fell 7.8% this week. The Chinese Renminbi declined 1.3% (to a 4-month low), with the Offshore Renminbi sinking 1.6%. This week revealed that the U.S. and China are not close to a deal as was widely believed. It also offered important confirmation of the China Fragility Thesis – markets and currency.

As goes China, so goes the emerging markets. Asian equities were under pressure. Major indices were down 4.0% in South Korea, 3.9% in India and 3.5% in Taiwan. At the “Periphery of the Periphery,” Turkish stocks were slammed 5.8%. Indices were down 4.7% in Poland, 3.2% in Czech Republic and 2.6% in Russia. EM currencies were under modest pressure for the week, with around 1% declines for the Chilean peso, Colombian peso, Indian rupee and Mexican peso. Friday’s 3.5% surge in the Turkish lira almost fully erased losses from earlier in the week.

European shares were weak, led to the downside by the banks and financials. Germany’s DAX fell 2.8%, France’s CAC40 4.0% and Italy’s MIB 4.1%. Europe’s STOXX 600 Banks Index dropped 5.9%, with Italian banks hit 7.6%. Japan’s TOPIX Bank index fell 4.4%, underperforming the Nikkei’s 4.1% decline. The vulnerable European “Periphery” saw 10-year sovereign spreads (to bunds) widen 19 bps in Italy and 24 bps in Greece.

For U.S. risk markets, it’s in the eye of the beholder: resilient or complacent. The S&P500 dropped 2.1%, with the Nasdaq100 down 3.3%. Investment-grade corporate CDS rose only modestly, while junk bond spreads increased to the widest in a month. The gains in Bank CDS were mostly small. Ten-year Treasury yields declined six bps (to 2.47%) – as an auction drew the weakest demand (bid-to-cover) in a decade. The fireworks were in the VIX. After ending last week at 12.87, the VIX traded up to 18.80 Monday morning before closing the session at 15.44. The VIX then spiked to as high as 23.38 in Thursday afternoon trading before closing out the week at 16.04. Writing/selling put options has been free “money” since the Powell U-turn. Crowded Trade.

Deal or No Deal, this week had me pondering the next crisis. It will, after all, be the first international market crisis in an era of competing global powers. Do the rivals come together or seek advantage at the other’s expense? I grimaced some months back when President Trump began using his Twitter account to troll the struggling Chinese markets and economy. And in this age of the strongman head of state, where will this leave central bankers when things turn dicey? Has the era of putting a select group of like-minded global central bankers in a room and empowering them to orchestrate a strategy to reliquefy the world run its course?

May 10 – Bloomberg (Shawn Donnan, Saleha Mohsin and Ye Xie): “President Donald Trump’s administration told China it has a month to seal a trade deal or face tariffs on all its exports to the U.S., even as both sides sought to avoid a public breakdown in negotiations despite a developing stalemate. The threat was made during talks in Washington on Friday, hours after Trump upped the ante by imposing a second round of punitive duties on $200 billion in Chinese goods. The talks are under close scrutiny across global financial markets, and U.S. stocks turned positive after negotiators on both sides said the session had gone fairly well. In a series of tweets that cheered markets further, Trump… declared that the talks with China had been ‘candid and constructive.’ ‘The relationship between President Xi and myself remains a very strong one, and conversations into the future will continue,’ he said. Further talks are possible, but there’s no immediate plan for the next round, according to a person familiar with the negotiations.”

Should be an interesting month. The Chinese appear content for now to walk softly while carrying a big stick. What is that stick?

May 8 – Reuters (Yawen Chen and Kevin Yao): “Chinese banks throttled back new lending in April after a record first quarter that sparked fears of more bad loans… Chinese banks extended 1.02 trillion yuan ($150.16bn) in net new yuan loans in April…, well below analysts’ expectations of 1.2 trillion yuan in a Reuters poll and March’s surprisingly strong 1.69 trillion yuan… Outstanding yuan loans grew 13.5% from a year earlier, slightly lower than expectations and March’s 13.7%. Growth of outstanding total social financing (TSF), a broad measure of credit and liquidity in the economy, slowed to 10.4% from a year earlier from 10.7% in March… Total TSF in April fell much more than expected, to 1.36 trillion yuan from 2.86 trillion yuan in March.”

China’s Aggregate Financing increased $199 billion (1.36 TN yuan) during April, about 18% below estimates and down 23% from April ’18. In addition to weaker-than-expected bank loans, there was continued weakness in various “shadow lending” components along with local government bonds. Aggregate Financing expanded $721 billion the first four months of 2019, about 8% ahead of comparable 2018 growth.

And while April was below expectations, year-to-date Bank Loan growth of $1.0 TN was 13% ahead of comparable 2018. Bank Loans were up $2.482 TN, or 19.0% over the past year. The expansion in Consumer Loans slowed markedly from March’s $133 billion to April’s $79 billion. Year-to-date Consumer Loan growth of $349 billion ran about 2% ahead of comparable 2018. Consumer Loans expanded 17.3% over the past year, 40% in two years, 75% in three years and 138% in five.

April’s Credit slowdown is likely a reflection of Beijing’s decision to somewhat tighten lending. It will be interesting to see if policymakers now quickly shift back to looser conditions.

For the Week:

The S&P500 dropped 2.1% (up 14.9% y-t-d), and the Dow fell 2.1% (up 11.2%). The Utilities declined 0.9% (up 10.0%). The Banks lost 3.0% (up 16.1%), and the Broker/Dealers dropped 2.7% (up 14.3%). The Transports sank 3.3% (up 15.6%). The S&P 400 Midcaps fell 2.4% (up 16.3%), and the small cap Russell 2000 dropped 2.5% (up 16.6%). The Nasdaq100 slumped 3.3% (up 19.9%). The Semiconductors sank 5.8% (up 28.0%). The Biotechs slid 4.5% (up 8.0%). Though bullion rallied $7, the HUI gold index dropped 3.4% (down 8.0%).

Three-month Treasury bill rates ended the week at 2.37%. Two-year government yields dropped seven bps to 2.27% (down 22bps y-t-d). Five-year T-note yields fell six bps to 2.26% (down 25bps). Ten-year Treasury yields declined six bps to 2.47% (down 22bps). Long bond yields dipped three bps to 2.89% (down 13bps). Benchmark Fannie Mae MBS yields declined three bps to 3.23% (down 27bps).

Greek 10-year yields surged 17 bps to 3.50% (down 90bps y-t-d). Ten-year Portuguese yields were unchanged at 1.12% (down 44bps). Italian 10-year yields jumped 12 bps to 2.68% (down 6bps). Spain's 10-year yields slipped a basis point to 0.98% (down 44bps). German bund yields dropped seven bps to negative 0.045% (down 29bps). French yields declined three bps to 0.35% (down 36bps). The French to German 10-year bond spread widened about four to 39 bps. U.K. 10-year gilt yields fell eight bps to 1.14% (down 14bps). U.K.'s FTSE equities index dropped 2.4% (up 7.1% y-t-d).

Japan's Nikkei Equities Index sank 4.1% (up 6.6% y-t-d). Japanese 10-year "JGB" yields declined a basis point to negative 0.05% (down 5bps y-t-d). France's CAC40 lost 4.0% (up 12.6%). The German DAX equities index slumped 2.8% (up 14.2%). Spain's IBEX 35 equities index dropped 3.1% (up 6.8%). Italy's FTSE MIB index sank 4.1% (up 13.9%). EM equities were under pressure. Brazil's Bovespa index declined 1.8% (up 3.6%), and Mexico's Bolsa fell 2.0% (up 4.2%). South Korea's Kospi index sank 4.0% (up 3.3%). India's Sensex equities index fell 3.9% (up 3.9%). China's Shanghai Exchange tumbled 4.5% (up 17.9%). Turkey's Borsa Istanbul National 100 index slid 5.8% (down 3.0%). Russia's MICEX equities index fell 2.6% (up 6.1%).

Investment-grade bond funds saw inflows of $3.333 billion, while junk bond funds posted outflows of $212 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell four bps to 4.10% (down 45bps y-o-y). Fifteen-year rates declined three bps to 3.57% (down 44bps). Five-year hybrid ARM rates dropped five bps to 3.63% (down 14bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up a basis point to 4.23% (down 44bps).

Federal Reserve Credit last week dropped $19.3bn to $3.852 TN. Over the past year, Fed Credit contracted $465bn, or 10.8%. Fed Credit inflated $1.041 TN, or 37%, over the past 340 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt added $0.3bn last week to $3.462 TN. "Custody holdings" rose $65bn y-o-y, or 1.9%.

M2 (narrow) "money" supply surged $51.6bn last week to a record $14.541 TN. "Narrow money" rose $580bn, or 4.2%, over the past year. For the week, Currency increased $2.7bn. Total Checkable Deposits jumped $28.4bn, and Savings Deposits rose $19.2bn. Small Time Deposits slipped $1.3bn. Retail Money Funds added $2.7bn.

Total money market fund assets rose $12.3bn to $3.084 TN. Money Funds gained $290bn y-o-y, or 10.4%.

Total Commercial Paper jumped $17.1bn to $1.081 TN. CP gained $21.8bn y-o-y, or 2.1%.

Currency Watch:

May 7 – Reuters (Kevin Yao): “China’s foreign exchange reserves unexpectedly fell for the first time in six months in April, despite recent data that suggested the world’s second-largest economy is starting to steady in response to stimulus measures. The decline in China’s reserves, the world’s largest, was modest, however, falling $3.81 billion last month to $3.095 trillion… Economists polled by Reuters had expected reserves would rise $1.24 billion to $3.1 trillion.”

The U.S. dollar index slipped 0.2% to 97.33 (up 1.2% y-t-d). For the week on the upside, the South African rand increased 1.4%, the Japanese yen 1.1%, the Swiss franc 0.5%, and the euro 0.3%. For the week on the downside, the British pound declined 1.3%, the Mexican peso 1.0%, the New Zealand dollar 0.8%, the Swedish krona 0.7%, the South Korean won 0.6%, the Brazilian real 0.4%, the Australian dollar 0.2%, the Singapore dollar 0.2%, and the Norwegian krone 0.1%. The Chinese renminbi declined 1.28% versus the dollar this week (up 0.82% y-t-d).

Commodities Watch:

May 8 – Financial Times (Adam Samson): “China’s central bank added gold to its reserves for the fifth month in a row in April, the latest emerging market central bank to stock up on the yellow metal. The People’s Bank of China said its gold reserves rose to 61.1m ounces last month, an increase of 480,000 ounces from March, and bringing its total gold holdings to about $78.3bn. Emerging market central banks have become some of the largest buyers in the gold market as they look to diversify their reserves away from the dollar. Last year central banks, led by Russia, bought more gold last year than at any time since America decided to move off the gold standard in 1971, with around $27bn worth of purchases.”

The Bloomberg Commodities Index fell 1.5% this week (up 2.2% y-t-d). Spot Gold increased 0.5% to $1,286 (up 0.3%). Silver lost 1.3% to $14.79 (down 4.8%). WTI crude slipped 28 cents to $61.66 (up 36%). Gasoline declined 1.8% (up 50%), while Natural Gas gained 2.0% (down 11%). Copper fell 1.6% (up 6%). Wheat dropped 3.0% (down 16%). Corn sank 5.1% (down 6%).

Market Instability Watch:

May 8 – Reuters (Jeff Mason and David Alexander): “President Donald Trump said… that China ‘broke the deal’ in trade talks with Washington and would face stiff tariffs if no agreement is reached. ‘You see the tariffs we’re doing?’ Trump told a rally with supporters in Florida. ‘Because they broke the deal. ... They broke the deal. So they’re flying in. The vice premier tomorrow is flying in, but they broke the deal. They can’t do that. So they’ll be paying. If we don’t make the deal, nothing wrong with taking in more than $100 billion a year.’”

May 7 – Financial Times (Adam Samson): “While Turkish authorities blame the weakness of the lira on sinister foreign influences, a large part of the damage comes from a more local source: the growing fondness among the country’s companies and savers for foreign-currency deposits. The share of Turkish bank deposits held in currencies such as US dollars and euros hit the equivalent of TL1tn at the end of March, according to data from Turkey’s Banking Regulation and Supervision Agency.”

May 8 – Bloomberg (Elizabeth Stanton and Chris Anstey): “The U.S. Treasury… saw the weakest demand for its benchmark 10-year note in a decade, illustrating the diminishing appetite among some investors to accept current yields. Bids for the $27 billion of notes exceeded the offering by 2.17 times, the lowest since 2009… Foreign investors, led by China and Japan, have accounted for a smaller and smaller share of American government debt outstanding.”

Trump Administration Watch:

May 5 – Bloomberg (Joanna Ossinger and Michael Patterson): “In the end, all it took was two tweets from Donald Trump. After weeks of warnings from many on Wall Street that price swings across global markets were too subdued, the American president’s threat to boost tariffs on China sent volatility soaring Monday. The VIX Index jumped as much as 46%, the most since the February 2018 volatility meltdown. S&P 500 Index futures slid 1.5% and the Shanghai Composite fell 5.6%, the most since February 2016… ‘For 10 months, China has been paying Tariffs to the USA of 25% on 50 Billion Dollars of High Tech, and 10% on 200 Billion Dollars of other goods. These payments are partially responsible for our great economic results. The 10% will go up to 25% on Friday. 325 Billions Dollars...’ ‘...of additional goods sent to us by China remain untaxed, but will be shortly, at a rate of 25%. The Tariffs paid to the USA have had little impact on product cost, mostly borne by China. The Trade Deal with China continues, but too slowly, as they attempt to renegotiate. No!’”

May 9 – Wall Street Journal (Lingling Wei in Beijing and Bob Davis): “The new hard line taken by China in trade talks—surprising the White House and threatening to derail negotiations—came after Beijing interpreted recent statements and actions by President Trump as a sign the U.S. was ready to make concessions, said people familiar with the thinking of the Chinese side. High-level negotiations are scheduled to resume Thursday in Washington, but the expectations and the stakes have changed significantly. A week ago, the assumption was that negotiators would be closing the deal. Now, they are trying to keep it from collapsing. In the current negotiations, the U.S. thought China agreed to detail the laws it would change to implement the trade deal under negotiation. Beijing said it had no intention of doing so, triggering Mr. Trump’s threat Sunday to escalate tariffs and bringing the dispute into the open. The hardened battle lines were prompted by Beijing’s decision to take a more aggressive stance in negotiations, according to the people following the talks. They said Beijing was emboldened by the perception that the U.S. was ready to compromise.”

May 6 – Wall Street Journal (Gordon Lubold and Michael R. Gordon): “U.S. intelligence showed that Iran has made plans to target U.S. forces in Iraq and elsewhere in the Middle East, triggering a decision to reinforce the American military presence in the region in an effort to deter any possible moves by Tehran, U.S. officials said… The escalation in tensions came as European diplomats said… that Iran appeared poised to breach portions of the 2015 international nuclear pact that restricted Tehran’s nuclear program in exchange for relief from economic sanctions. That followed a rocket barrage fired into Israel by an Iranian-backed militia in Gaza over the weekend.”

May 7 – Reuters (Idrees Ali): “The U.S. military said… that B-52 bombers will be part of additional forces being sent to the Middle East to counter what the Trump administration says are ‘clear indications’ of threats from Iran to U.S. forces there.”

May 9 – National Post: “The Trump administration says it has seized a North Korean cargo ship that U.S. officials say was used to transport coal in violation of international sanctions… The announcement was made at a time of tension between the two countries. It came hours after North Korea fired two suspected short-range missiles, its second weapons launch in five days.”

May 5 – Reuters (Tuvan Gumrukcu): “Turkey will never bow to U.S. sanctions over its agreement to purchase Russian S-400 surface-to-air missile defense systems, Vice President Fuat Oktay said… regarding a deal that has strained ties between the NATO allies. Washington says the systems are not compatible with NATO equipment and may compromise its Lockheed Martin F-35 fighter jets. It has warned of possible U.S. sanctions if Ankara pushes on with the Russian deal.”

May 5 – Reuters (David Ljunggren): “Canada is leaning on the United States to help settle a dispute with China, which has started to block imports of vital Canadian commodities amid a dispute over a detained Huawei executive. In a sign of increasing frustration at what it sees as a lackluster U.S. response, Prime Minister Justin Trudeau’s government is signaling it could withhold cooperation on major issues. China has upped the pressure on Canada in recent weeks over the arrest of Huawei Technologies Co Ltd Chief Financial Officer Meng Wanzhou…”

Federal Reserve Watch:

May 7 – Bloomberg (Craig Torres): “Federal Reserve Governor Randal Quarles said inflation is tough to measure and a price index running just under the Fed’s 2% target is good enough for him. ‘Inflation is difficult to measure precisely. I don’t share the concern that some have that if we are at 1.8% inflation for a significant period of time, that this is a problem that needs to be fixed. From my point of view, 1.8 is two’ percent’, Quarles said. ‘I would not undergo heroic efforts -- including rethinking our monetary policy framework, or significant monetary policy stimulus -- in order to edge 1.8 up to two. I just don’t think that level of heroism is necessary. If we were at 1 forever you would have a different issue.’”

May 7 – Reuters (Jason Lange): “The U.S. Federal Reserve does not see a good case for raising or lowering interest rates and its current policy stance could help inflation move toward the central bank’s 2% target, Fed Vice Chair Richard Clarida said… ‘We don’t see a strong case to move rates in either direction,” Clarida told Bloomberg television… ‘Monetary policy is in a good place right now.’”

May 6 – Bloomberg (Rich Miller): “A posse of Federal Reserve policy makers met with skepticism last week when they described ways to potentially improve their management of the economy. Participants at a Hoover Institution monetary conference questioned whether the central bankers have the will or the way to implement the fresh strategies they outlined, including average inflation targeting. The experts also voiced concern that the U.S. may be left vulnerable to a potentially deep and prolonged economic downturn. ‘It seems very fragile,’ former Fed adviser Andrew Levin said… of proposals made during a panel discussion by Fed regional bank presidents from Cleveland, Dallas, St. Louis and San Francisco. ‘I lose sleep worrying’ that the economy is dependent on such shaky strategies’…”

May 5 – Reuters (Ann Saphir and Howard Schneider): “Federal Reserve policymakers fear they are ill-equipped to battle the next recession under their current inflation-targeting approach, and this year are well into an effort to vet new strategies for managing interest rates in a world of muted inflation and low borrowing costs. But for the U.S. central bankers and monetary policy experts who converged in Palo Alto Friday to discuss available options, the challenge was clear: not only will it be difficult to settle on a better framework before the next recession hits, figuring out how to explain it to the public so that it actually works will be a major challenge.”

May 8 – Reuters (Howard Schneider): “A top Federal Reserve official said… she wants to explore whether the central bank, in a future downturn, should begin targeting explicit levels for longer-term interest rates as a way to add more stimulus to the economy… ‘Once the short-term interest rates we traditionally target have hit zero, we might turn to targeting slightly longer-term interest rates — initially one-year interest rates, for example, and if more stimulus is needed, perhaps moving out the curve to two-year rates,’ Brainard said… ‘Under this policy, the Federal Reserve would stand ready to use its balance sheet to hit the targeted interest rate.’”

U.S. Bubble Watch:

May 10 – Wall Street Journal (Kate Davidson): “The U.S. budget gap widened 38% in the first seven months of the fiscal year as federal spending outpaced tax collections. The government ran a $531 billion deficit from October through April, the Treasury Department said Friday, compared with $385 billion during the same period a year earlier, a 38% increase. Federal outlays rose 8%, to nearly $2.6 trillion, while revenues increased 2%, to $2.04 trillion—a record for the seven-month period.”

May 9 – CNBC (Thomas Franck): “The U.S. goods and services deficit with its global trading partners widened slightly in March as demand for foreign goods buoyed imports… The trade deficit rose 1.5% from February to a seasonally adjusted $50 billion in March… Though the trade deficit widened in March, it remains below the recent December high. The trade gap ballooned to $59.9 billion at the end of 2018, which was the largest gap in 10 years. On a year-to-date basis, the goods and services deficit decreased $5.8 billion, or 3.7%, from a year earlier…”

May 6 – New York Times (Jeanna Smialek): “Companies with large amounts of debt are borrowing more money at a breakneck pace, prompting the Federal Reserve to flag the trend as one potential risk in the financial system. Loans to companies with large amounts of outstanding debt — known as leveraged lending — grew by 20% in 2018 to $1.1 trillion, according to the Fed’s twice-annual Financial Stability Report. The share of new, large loans going to the comparatively risky borrowers now exceeds peak levels reached previously in 2007 and 2014… Risks associated with leveraged loans have ‘intensified, as a greater proportion are to borrowers with lower credit ratings and already high levels of debt… Any weakening of economic activity could boost default rates and lead to credit-related contractions to employment and investment among these businesses.’”

May 7 – CNBC (Diana Olick): “Home prices are less heated this spring, but the largest metropolitan markets are still overpriced. About 40% of the nation's top 50 markets… were overvalued in March, according to… CoreLogic, which defines an overvalued market as one in which prices are at least 10% higher than the long-term, sustainable level. In those markets, 16% were undervalued and 44% were at value... On a national level, home prices rose 3.7% annually in March…, less than the 4% annual increase in February.”

May 8 – CNBC (Diana Ollick): “After pulling back for several weeks, homebuyers stepped back into the mortgage market last week. Total mortgage application volume increased 2.7% compared with the previous week, according to the Mortgage Bankers Association... Volume was 8% higher compared with the same week one year ago… Purchase applications drove the gains, rising 4% for the week and 5% annually.”

May 7 – Associated Press (Christopher Rugaber): “U.S. employers advertised almost 7.5 million jobs at the end of March, a solid figure that signals hiring will likely remain strong in the months ahead. …Job openings rose 4.8% from the previous month, while the number of people quitting their jobs slipped. There are now 1.2 million more open jobs than there are unemployed Americans, a dynamic that suggests businesses will have to keep raising pay to attract and retain the workers they need. The figures underscore the ongoing strong demand for labor that exists among U.S. companies, as the recovery nears the end of its 10th year.”

May 9 – Reuters (Lucia Mutikani): “U.S. producer prices rose moderately in April, but underlying inflation pressures at the factory gate appeared to be picking up. The Labor Department said… its producer price index for final demand increased 0.2% last month after jumping 0.6% in March. In the 12 months through April, the PPI increased 2.2%, matching March’s rise.”

May 7 – Reuters (Jason Lange): “U.S. banks tightened standards on commercial real estate loans and on credit card borrowing during the first quarter, according to a survey of bank officers… The U.S. Federal Reserve’s quarterly survey of senior loan officers also showed banks were taking steps to curb potential losses from loans to firms that are exposed to the risks of economic trouble in Asia and Europe, the Fed said… ‘A moderate net fraction of banks reported that they expect the quality of loans to exposed firms to deteriorate,’ the Fed said.”

May 7 – Reuters (Joe Rennison): “Interest-only mortgages are surging in popularity with commercial landlords across the US, fuelling fears of a return to crisis-era loose lending and a spike in defaults if the economy takes a dip. Interest-only mortgages accounted for 77% of the loans backing $16.5bn of new commercial mortgage-backed securities in the US during the first quarter, according to… Trepp, up from 68% a year earlier. Combined with partial interest-only loans, which allow borrowers to pay just the interest for an initial period, the total reached 89% of the loans backing all new CMBS in the first three months of the year. It is the highest level since 2009, and in line with levels seen in the build-up to the 2008 financial crisis, when banks such as Washington Mutual and Wachovia… made aggressive but ill-fated moves into the commercial property market.”

May 7 – Bloomberg (Emily Wilkins): “Student loans, already a hardship for many young borrowers, now are projected to be a burden for another class of people: U.S. taxpayers. The federal student loan program will cost the federal government $31 billion over the next decade, according to recent estimates from the nonpartisan Congressional Budget Office. That’s a shift from past CBO forecasts that the government would profit from the program.”

China Watch:

May 8 – Bloomberg: “An unexpected fall in China’s exports and an equally unforeseen rise in imports show that the world’s second-largest economy continues a tentative recovery while global demand weakens and trade tensions re-escalate. Exports dropped 2.7% in April versus a forecast 3% increase, while imports expanded by 4% compared to a projected slip… Those misses highlight that the global slowdown is weighing down on China’s growth, instead of the other way around, at least for now. Months of policy stimulus has fueled a pickup in the Asian economy, although the re-escalating trade threats may throttle those green shoots.”

May 8 – CNBC (Huileng Tan): “China's April consumer inflation was in line with expectations, but a spike in pork prices contributed to higher food prices… Overall consumer price index (CPI) in April rose 2.5% from a year ago, …slightly higher that the 2.3% year-on-year in March. However, food consumer price inflation rose 6.1% from a year ago in April compared to a 4.1% rise a month earlier… Pork prices, in particular, soared 14.4% on-year and 1.6% on-month. Producer price inflation (PPI) — a gauge of industrial profitability — rose 0.9% from a year ago in April, the fastest pace since December 2018.”

May 7 – Bloomberg: “This year is shaping up to be the biggest by far for defaults in China’s $13 trillion bond market, highlighting the widening fallout from the government’s campaign to rein in leverage. Companies defaulted on 39.2 billion yuan ($5.8bn) of domestic bonds in the first four months of the year, some 3.4 times the total for the same period of 2018… The pace is also more than triple that of 2016, when defaults were more concentrated in the first half of the year, unlike 2018. The trend is clear: unless something changes, 2019 will be the new high. China continues to press banks to extend credit to the private sector, and small and medium-sized companies especially… But President Xi Jinping’s team has also focused on shrinking the shadow-banking system, where credit decisions were made with less regulatory oversight and where it was easier to build up unsustainable leverage.”

May 5 – Bloomberg: “China decided to cut the amount of cash some banks must hold as reserves, and timed its announcement of the decision to help shore up domestic markets as uncertainties in the trade talks with the U.S. re-emerged. The required reserve ratio for rural commercial lenders serving companies in the county where the bank operates or with less than 10 billion yuan ($1.5bn) of assets will be lowered to 8%, taking effect on May 15… The unusual timing of the announcement, as markets were opening, appeared to be in response to an escalation of the trade war by U.S. President Donald Trump.”

May 5 – Reuters (Ryan Woo): “Activity in China’s services sector further improved in April, with export sales rising at a record pace, a private business survey showed on Monday, although the longer-term outlook for new orders stayed subdued due to global economic uncertainties. The Caixin/Markit services purchasing managers’ index (PMI) climbed to 54.5, the highest since January 2018 and slightly up from 54.4 in March… Export orders increased the most since the survey began measuring this in September 2014.”

May 5 – Bloomberg: “China’s banking regulator has told the nation’s major lenders to accelerate recognition of nonperforming loans, as officials seek to bolster the quality of lending, according to people familiar with the matter. The China Banking and Insurance Regulatory Commission in recent weeks used so-called window guidance to inform banks with nationwide operations that they must classify corporate loans overdue for more than 60 days as nonperforming, down from 90 days previously…”

May 7 – Bloomberg: “Can China’s peer-to-peer lending industry be saved? The prospect seemed far-fetched just a few months ago, when P2P platforms were failing by the dozens and angry investors were protesting in major cities across the country. But after a nearly two-year government campaign to root out fraud and improve lending standards, a potential path to recovery for the world’s biggest P2P market is becoming clearer. Industry insiders are betting that a handful of closely regulated players will emerge from the cull. They envision a revamped model… in which P2P platforms match small borrowers with institutional money managers and banks, instead of individual savers. That would allow China to keep funneling much-needed credit to small companies, while at the same time containing exposure to investors who can bear the risk.”

Central Bank Watch:

May 8 – Reuters (Charlotte Greenfield and Praveen Menon): “New Zealand’s central bank cut its benchmark interest rate for the first time in two-and-a-half years…, and signaled a 50-50 chance of another easing, sending the local dollar sharply lower. The Reserve Bank of New Zealand (RBNZ) lowered the official cash rate (OCR) by 25 bps to an all-time trough of 1.50%, as expected, after switching in March to an explicitly dovish footing on weaker domestic activity and employment headwinds.”

May 7 – Bloomberg (Birgit Jennen and Piotr Skolimowski): “The appointment of the next European Central Bank head could potentially be delayed until just weeks before President Mario Draghi’s term expires amid a swathe of top European Union vacancies. That’s one of the scenarios being discussed among EU diplomats, according to a person familiar with the matter who asked not to be identified. The complexity of upcoming negotiations could see the ECB post decided together with the head of the European Council in the autumn. The bloc’s politicians face filling an unprecedented number of high-level posts this year that also include the presidency of the EU Commission -- the hottest potato of the lot -- and there’s currently no consensus on who should get the positions.”

Europe Watch:

May 7 – CNBC (Silvia Amaro): “The EU has cut growth forecasts for Germany for the second time this year, as trade tensions and a Chinese slowdown weigh on the traditional economic powerhouse of the region. Germany is only expected to grow at a rate of 0.5% this year... It will be the second-worst economy across the EU in terms of growth, with only Italy looking more downbeat. It comes after the institution lowered Germany's growth expectations from 1.8% to 1.1% in February.”

May 7 – Financial Times (Mehreen Khan and Jim Brunsden): “Italy’s budget deficit is set to breach EU rules by a wide margin next year, according to forecasts from the European Commission that raise the prospect of a renewed clash over economic policies between Brussels and Rome’s anti-establishment government. The Italian deficit is expected to balloon to 3.5% of gross domestic product in 2020, up from an already higher than expected 2.5% this year. The deterioration is set to be driven by a slowing Italian economy, Rome’s plans to implement expensive policies including a citizens’ income and its intention to repeal a landmark pension reform.”

May 7 – Reuters (Francesco Guarascio): “Italy’s huge debt is expected to grow further this year and next as the country’s growth remains sluggish, the European Commission said… in quarterly economic forecasts that could reignite a dispute over Rome’s budget. Brussels cut its already gloomy outlook of Italy’s economy, which it now says is set to grow by 0.1% this year instead of the 0.2% it predicted in February. The country grew by 0.9% last year… With no policy changes by the eurosceptic Italian administration, Italy’s debt would grow to 133.7% of gross domestic product (GDP) this year, and peak at 135.2% in 2020…”

EM Watch:

May 9 – Financial Times (Laura Pitel): “Turkey’s central bank announced a backdoor rate rise on Thursday after the embattled lira came under renewed pressure this week. The central bank said it was suspending funding at its benchmark one-week repo rate, which is set at 24%. The measure will force banks to borrow money at the higher overnight rate of 25.5%. The move came after the lira lost 4% of its value this week, as investors balked at the fresh political uncertainty triggered by an announcement that the mayoral election in Istanbul would be rerun in June.”

Global Bubble Watch:

May 8 – Financial Times (Delphine Strauss): “Growth in global commerce has slowed sharply since the US-China trade dispute escalated in mid-2018, and an array of economic indicators suggest that the year-long row is having an increasing effect on the global economy. Negotiators from the world’s two largest economies are preparing to meet in Washington on Thursday in an effort to resolve an eleventh-hour impasse in their trade deal talks. Evidence is accumulating that the tariffs which now affect more than 50% of bilateral trade between the US and China are curbing global commerce, driving up prices for American consumers and holding back business investment as companies seek to restructure their supply chains.”

May 7 – Bloomberg (Michelle Jamrisko): “As growth worries and trade war jitters threaten to spoil any rebound for emerging markets in 2019, property markets are shaping up as a critical element to monitor for further signs of gloom. Some developing economies from Thailand to Dubai and Brazil are facing double-digit real estate sales declines on the back of weakening domestic growth. Developed countries already have shown some of the pain -- including Australia, the U.K., Switzerland and Singapore -- and made all the more worrisome as borrowing costs remain relatively low. ‘There are different factors driving the various markets; real estate tends to be to a large extent a localized market’ said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd. ‘However, the one over-riding theme is decelerating economic growth momentum, which is continuing to be a headwind for all markets and preventing a recovery in markets, such as Dubai, which have faced multi-year downturns.’”

Fixed-Income Bubble Watch:

May 7 – CNBC (Kate Rooney): “U.S. debt has climbed to an alarming level, according to DoubleLine CEO Jeffrey Gundlach. ‘People are starting to realize that the deficit and debt are totally out of control,’ Gundlach said… Gundlach said the ‘main reason’ the yield curve between 3-year and 5-year Treasury notes is steepening is the ballooning deficit. Last year, U.S. national debt increased by more than 6% of GDP, he said… Gundlach… also flagged trouble in the corporate bond market, which got ‘dragged down’ in the ‘economic mess that we're in.’ ‘The corporate bond market is so much worse today than it was in 2006,’ he said.”

Leveraged Speculator Watch:

May 7 – Bloomberg (Alan Mirabella): “Hedge funds gained for the fourth straight month led by managers who trade on economic trends. In April, funds advanced 1.5% with all seven strategies posting positive returns, according to… the Bloomberg Hedge Fund Database. For the year, funds are up 6.6%. Macro funds rose 2.6% for the best performing strategy for the month. Commodity trading advisers, which trade futures and options, were the second-best with an increase of 2.2%.”

May 5 – Financial Times (Siobhan Riding): “Quantitative equity funds have bled almost $25bn in assets since October as poor performance prompts investors to question the effectiveness of the previously top-selling strategies. Quant funds, which exploit factors such as value and momentum, enjoyed soaring popularity in the past decade as investors abandoned active equity funds in search of superior returns at a lower cost. But investor sentiment has shifted after quant funds delivered disappointing returns in 2018.”

May 6 – Bloomberg (Michael McDonald): “Harvard University’s N.P. ‘Narv’ Narvekar is doubling down on an investment that has fallen out of fashion: hedge funds. Narvekar’s bet on the sophisticated, high-cost brand of money manager marks the biggest since the university hired him in 2016 to turn around the lagging performance of its $39 billion endowment. Over the two years ended in June, the largest fund in higher education almost doubled its investment in hedge funds, which now total $13 billion…”

Geopolitical Watch:

May 8 – Financial Times (David Gardner): “The US decision to send a military task force to the Middle East was described… by John Bolton, national security adviser to President Donald Trump, as a ‘clear and unmistakable warning to the Iranian regime’ that any attack on the US or its allies would be met with ‘unrelenting force’… The USS Abraham Lincoln aircraft carrier strike group, to which Mr Bolton referred, set out for the Mediterranean and the Gulf more than a month ago, as part of a scheduled rotation. Mr Bolton is a warmonger. Nevertheless, the bellicose tone towards Iran of Trump administration hawks such as Mr Bolton and Mike Pompeo, secretary of state, are part of a pushback against the Islamic Republic that probably increases the risk of war.”

May 8 – Financial Times (Andrew England and Najmeh Bozorgmehr): “Flanked by generals on both sides, President Hassan Rouhani watched as Iranian soldiers carrying huge portraits of fallen ‘martyrs’ paraded in Tehran, war planes swooped overhead and military trucks rumbled past hauling massive missiles. Yet Army Day, an annual show of military strength and resilience in the face of years of sanctions and arms embargoes, has rarely been marked with the theocratic regime under such intense pressure. One year after President Donald Trump unilaterally withdrew the US from the 2015 nuclear accord Tehran signed with world powers, the stakes are again being raised in a dispute some fear could trigger the Middle East’s next conflict. Those concerns intensified this week with the deployment of a US aircraft carrier strike group to the region, and the unscheduled visit of Mike Pompeo, US secretary of state, to neighbouring Iraq. Mr Pompeo warned that the regime in Tehran was ‘escalating their activity’, without providing any detail. Within hours, Mr Rouhani said Iran would no longer comply with some of its commitments to the nuclear deal, while insisting that the Islamic republic would continue diplomatic efforts but ‘with a new language and logic’.”

May 8 – CNN (James Griffiths, Joshua Berlinger and Sheena McKenzie): “Iran announced… it was partially withdrawing from a landmark nuclear deal, marking a serious escalation in Tehran's faceoff with the United States. President Hassan Rouhani said in a televised speech that Iran would reduce its ‘commitments’ to the Joint Comprehensive Plan of Action, or JCPOA, but would not fully withdraw, amid heightened pressure from the US in recent weeks.”

May 7 – Reuters (Idrees Ali): “The U.S. military said two of its warships sailed near islands claimed by China in the South China Sea…, a move that angered Beijing at a time of tense ties between the world’s two biggest economies. The busy waterway is one of a growing number of flashpoints in the U.S.-China relationship, which also include a trade war, U.S. sanctions and Taiwan.”

May 9 – Reuters (Tim Kelly): “In fresh show of naval force in the contested South China Sea, a U.S. guided missile destroyer conducted drills with a Japanese aircraft carrier, two Indian naval ships and a Philippine patrol vessel in the waterway claimed by China, the U.S. Navy said… While similar exercises have been held in the South China Sea in the past, the combined display by four countries represents a fresh challenge to Beijing as U.S. President Donald Trump threatens to hike tariffs on $200 billion worth of Chinese goods. ‘Professional engagements with our allies, partners and friends in the region are opportunities to build upon our existing, strong relationships,’ Commander Andrew J. Klug, the captain of the U.S. destroyer, the USS William P. Lawrence, said…”

May 8 – Reuters (Angus Berwick and Mayela Armas): “Venezuelan intelligence agents detained opposition leader Juan Guaido’s congressional deputy…, using a tow truck to drag his vehicle away with him inside, prompting the U.S. government to warn of ‘consequences’ if he was not released.”

May 7 – Reuters (Ece Toksabay and Jonathan Spicer): “Turkish authorities… scrapped the result of a vote for Istanbul mayor lost by President Tayyip Erdogan’s candidate, responding to calls by his AK Party for a re-run, in a move that hit the lira and drew opposition accusations of ‘dictatorship’… Turkey’s main opposition Republican People’s Party (CHP), which narrowly won the mayor’s office in the country’s largest city, called the ruling a ‘plain dictatorship.’”

Friday Evening Links

[Reuters] Wall St. snaps losing streak after Trump's upbeat trade comments

[CNBC] Trump says China tariffs 'may or may not be removed' while trade talks continue

[Reuters] Fed's Williams says U.S. economy strong despite trade tensions

[Reuters] U.S. government posts $160 billion surplus in April

[Reuters] Iran Guards reject U.S. talks, cleric threatens carrier

[Reuters] U.S. warns merchant ships of possible Iranian attacks in Middle East

[Bloomberg] Wall Street Picks the Next Domino to Fall in Trade-War Rout

[WSJ] U.S., China Remain at Impasse on Trade

[WSJ] U.S. Budget Deficit Grew 38% in First Seven Months of Fiscal 2019