Friday, August 30, 2019

Weekly Commentary: Dudley Sticks His Neck Out

What a fascinating environment; each week bringing something extraordinary. Yet there is this dreadful feeling that things are advancing toward some type of cataclysm.

“U.S. President Donald Trump’s trade war with China keeps undermining the confidence of businesses and consumers, worsening the economic outlook. This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along? If the ultimate goal is a healthy economy, the Fed should seriously consider the latter approach… There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.” Bill Dudley, Bloomberg op-ed, August 27, 2019

The former president of the Federal Reserve Bank of New York’s piece galvanized an overwhelmingly negative response. Virtually everyone agrees it would be an outrage for the Fed to take such a plunge into the political maelstrom.

A Federal Reserve spokeswoman responded: “The Federal Reserve's policy decisions are guided solely by its congressional mandate to maintain price stability and maximum employment. Political considerations play absolutely no role.”

Former Treasury official Larry Summers weighed in (from CNBC interview): “The Fed’s job is to stay out of politics. The Fed’s job is to respond to the best assessment they can make of economic conditions and adjust the economy – interest rates - appropriately… But for a trusted former official of the Fed, whose thinking is inevitably going to be tied to the Fed, to recommend that they raise interest rates so as to subvert the economy and influence a presidential election is grossly irresponsible – is an abuse of the privilege of being a former Fed official… It is not the job of non-elected appointed officials to a technocratic role to decide how they’re going to act so as to constrain and influence the behavior the President of the United States – and the behavior of the remainder of the government of the United States. That is to misunderstand entirely the role of appointed officials in a democracy.”

Summers’ view is certainly well-founded, at least in theory. But it’s an especially complex world in which we live. Is it the job of non-elected appointed officials to a technocratic role to decide the performance of securities markets, hence the distribution of wealth throughout society? Asking for trouble…

Dudley’s bold op-ed requires context. It followed the previous Friday’s disturbing presidential tweets and the S&P500’s resulting 2.6% drop. “…Who is our bigger enemy, Jay Powell or Chairman Xi?” “Our great American companies are hereby ordered to immediately start looking for an alternative to China…” And contrary to Larry Summers’ comments, Bill Dudley made no suggestion to “raise interest rates so as subvert the economy.”

The critical issue is instead whether the Fed should respond with additional monetary stimulus to ill-advised tweets and policy dictum that risks deflating market confidence. This outrage at the thought of the Fed becoming “political” is illusory. The Fed began its insidious venture into the murky political realm under Greenspan’s reign in the nineties.

It has been long accepted that the Federal Reserve should refrain from policies that amount to Credit allocation. Picking winners and losers within the economy should be outside the Fed’s purview and risks political backlash and a loss of institutional credibility.

The notion that the Federal Reserve would not respond to declining stock prices – under any circumstance – has become heresy. There was no outrage when the Greenspan Fed manipulated the yield curve and adopted an asymmetrical policy approach to underpin the securities markets. Where was the outrage when Bill Dudley (while at Goldman Sachs) and others specifically called for the Fed to adopt policies to spur mortgage Credit expansion for the purpose of systemic reflation after the collapse of the “tech” Bubble? There was even minimal debate when the Bernanke Fed employed unprecedented post-mortgage finance Bubble Credit allocation and reflationary measures. And it was as if I was the only analyst that had an issue when Bernanke later stated the Fed would “push back” against a tightening of financial conditions, essentially signaling the Federal Reserve would not tolerate a market correction.

I am again reminded of the late Dr. Richebacher's important insight that asset inflation is the most dangerous type of inflation, certainly riskier than consumer price inflation. There is (was) general agreement that more than a modest increase in consumer prices is undesirable and would provoke tightening measures from responsible central bankers. But with rising asset prices almost universally viewed constructively (while confirming the soundness of policies), there is no constituency motivated to rise up and demand measures to contain inflating asset prices and Bubbles.

It is now a consensus view that the Federal Reserve (and global central bankers) should backstop financial markets to promote economic growth and wealth creation. The Fed, market participants and most pundits prefer to ignore that such a doctrine places the central bankers at the epicenter of Credit, resource and wealth allocation. Such a position ensures the Fed now wades chest deep in the political muck. It’s been a slippery slope I’ve been chronicling now for over 20 years.

The Fed’s market-centric and interventionist approach has essentially supported incumbent Presidents and Washington politicians. From this perspective, it is clearly “establishment” and susceptible to “deep state” innuendo. This regime is today challenged by President Trump, with his penchant for tariffs, confrontation, and scathing attacks on the Fed and its Chairman. The President is essentially blackmailing the Fed: Play ball or you’ll be blamed, ridiculed and targeted, with clear risk of losing your jobs along with the institution’s coveted independence.

What Dudley is really questioning is whether the Fed needs to make a departure from its regime in response to the market, economic, institutional and geopolitical risks posed by an unorthodox President increasingly considered unstable and pursuing a dangerously ill-advised policy course. Should the Fed continue to backstop the financial markets when the marketplace is responding rationally to increasingly high-risk financial, economic and geopolitical backdrops? With the administration clearly pursuing a risky strategy while placing a gun to Powell’s head, should the Federal Reserve continue to enable such a policy course when it is deemed to put so many things at great risk?

Crazy like a fox. A clear flaw in the Fed’s interventionist regime is now being exploited, while Dudley’s “outrageous” op-ed is only making public what must be an area of intense discussion within the Marriner S. Eccles Federal Reserve Board Building.

Politico (Victoria Guida): “Peter Conti-Brown, a professor at the University of Pennsylvania's Wharton School who specializes in Fed history, noted that Fed watchers have long debated whether the central bank should be used as an insurance policy against bad economic policy decisions. But ‘in today’s climate, an op-ed from the former vice chairman of the [Federal Open Market Committee] arguing that the Fed should be transparently reactive to Donald Trump is a little bit dangerous,’ he said. ‘Where Dudley completely jumps the shark is by saying we should have a republic with central bankers who pick winners and losers… ‘If Powell follows Dudley’s advice … then we’ll mark that as the end of independent central banking,’ he said.”

A central bank beholden to securities market Bubbles has already forsaken independence. After accommodating the mortgage finance Bubble with years of loose monetary policy, the Fed has been completely hamstrung for the past decade. Our central bank waited too long to commence the process of normalizing policy. In the end, it was unwilling to impose any semblance of a tightening of financial conditions, despite securities markets signaling dangerous monetary excess. Still, the Fed is now condemned for excessive tightening that has put U.S. markets and economic prospects at risk. This is the narrative the President is using as he fashions a scapegoat while aiming to hammer the Fed into submission.

And from Slate (Jordan Weissmann): “It is hard to overstate what a tremendously dangerous concept this is. Dudley is not talking about a conflict between two equal branches of government. If the economy crashes and Democrats don’t want to pass a stimulus because it might help Trump, that would be crappy and inhumane, but it’d also fundamentally be politics. Voters could decide who to hold accountable. Here, Dudley is effectively talking about an economic coup staged by a group of unelected technocrats. He doesn’t seem to be worried about the implications of this idea, because he feels the president has already politicized the central bank… The best way for the Fed to show it is not a political institution is to not act like a political institution, and intervene to help the economy when circumstances obviously dictate it.”

The problem: circumstances don’t obviously dictate that the Fed should be intervening. The unemployment rate is 3.7%, near a 50-year low. Stock prices are within 3% of all-time highs, while all varieties of bonds are priced at unprecedented lofty levels. And after declining to near zero in March, the Atlanta Fed’s GDPNow Forecast has current growth maintaining a reasonable late-cycle 2% pace.

August 28 – Bloomberg (Rich Miller and Christopher Condon): “A Republican member of the Senate Banking Committee called for the panel to hold a hearing on what he termed the danger that the Federal Reserve will meddle in the 2020 presidential election, a day after a former top central bank official suggested that the Fed resist interest-rate cuts that would aid Donald Trump. Senator Thom Tillis… said… he was ‘very disappointed’ that… Bill Dudley appeared to be ‘lobbying the Fed to use its authority as a political weapon against President Trump,’… ‘The president is standing up for America against China after 30 years of our country and our workers being ripped off and there is now an effort to get the Fed to try to sabotage the president’s efforts,’ Tillis said.”

The Fed’s political problem will not end with Donald Trump or Chinese trade negotiations. Going forward, our central bank will be under unrelenting pressure to support the markets and boost the economy - and will be a target for the party on the losing side of election outcomes.

As the Fed policy regime evolved, it failed to articulate a sound framework for explaining the factors driving monetary policy decisions. A view took hold that there is little risk of aggressive stimulus so long as consumer price inflation stays within its 2% target. As things turn increasingly dicey, the Fed will struggle to push back against calls for aggressive rate cuts and the restart of QE. For years now, loose monetary policy has accommodated egregious financial excess, including fiscal deficits approaching 5% of GDP during peacetime economic expansion. Deficits don’t matter; speculative excess and asset Bubbles don’t matter.

I expect Trump's attacks are the first salvo in what will be only more intense political pressure directed at the Fed to employ aggressive stimulus measures.

August 30 – Wall Street Journal (David Harrison and Maureen Linke): “The decadelong economic expansion has showered the U.S. with staggering new wealth driven by a booming stock market and rising house prices. But that windfall has passed by many Americans. The bottom half of all U.S. households, as measured by wealth, have only recently regained the wealth lost in the 2007-2009 recession and still have 32% less wealth, adjusted for inflation, than in 2003… The top 1% of households have more than twice as much as they did in 2003. This points to a potentially worrisome side of the expansion, now the longest on record. If another recession comes, it could be devastating for people who have only just recovered from the last one.”

The rise of populism is in its initial stage. The situation turns much more serious when the current Bubble deflates. There are major costs associated with the Fed’s loss of independence – independence from politics as well as from market pressure. For now, however, markets are trading on the prospect of aggressive global monetary stimulus (rate cuts and QE).

Risk markets this week rallied on a more conciliatory tone from President Trump reciprocated by Beijing. The S&P500 rose 2.8%, and the Nasdaq100 jumped 3.0%. The German DAX gained 2.8%, with France’s CAC40 up 2.9%. Mexican stocks surged 6.9% and Brazilian equities rose 3.5%.

And, once again, the safe havens completely dismissed the risk market rally. Ten-year Treasury yields fell four bps to 1.50%, with the 30-year long bond yield down six bps to a record low 1.96%. German bund yields were down another two bps to negative 0.70%, and Swiss yields dropped eight bps to negative 1.09%.

But perhaps the more amazing market moves were at Europe’s periphery. Italian yields sank 32 bps this week, trading below 1.0% for the first time while taking the 2019 yield collapse to 174 bps. Led by a 5.1% rally in bank shares, Italian stocks recovered 4.1% this week. Meanwhile, Greek 10-year yields dropped 33 bps to a record low 1.61% (down 279bps y-t-d). Portuguese yields ended the week at 0.13%, with Spanish yields down to 0.11%.

What a difference a currency makes. Argentina these days must wish it was a member of the euro zone. Argentine 30-year yields surged another 365 bps to 18.38%, while Argentina’s 100-year dollar-denominated bond traded down to 40 cents on the dollar. The Argentine peso sank another 7.3% this week, pushing y-t-d losses versus the dollar to 37%.

August 29 – Reuters (Cassandra Garrison and Walter Bianchi): “Standard & Poors announced… that it was slashing Argentina’s long-term credit rating another three notches into the deepest area of junk debt, saying the government’s plan to ‘unilaterally’ extend maturities had triggered a brief default. The ratings agency said it would consider Argentina’s long-term foreign and local currency issue ratings as CCC- ‘vulnerable to nonpayment’ - starting on Friday following the government’s Wednesday announcement that it wants to ‘re-profile’ some $100 billion in debt.”

What a month! After beginning the month at $14.115 TN, negative-yielding global bonds ended August at $16.838 TN (from Bloomberg). The safe haven Japanese yen gained 2.4% and the Swiss franc increased 0.4%. Gold bullion surged $107 to a six-year high. On the downside, the Argentine peso collapsed 26.25%, with the Brazilian real down 8.0%, the South African rand 5.6%, the Colombian peso 4.7%, the Russian ruble 4.7%, the Mexican peso 4.6% and the Turkish lira 4.3%. China’s renminbi dropped 3.80% for the month, slicing through the 7.0 level to the low versus the dollar going back to early 2008. With ominous developments in global bonds and currencies, global equities bent but didn’t break. After a summer of discontent, expect a tumultuous autumn.

For the Week:

The S&P 500 rallied 2.8% (up 16.7% y-t-d), and the Dow rose 3.0% (up 13.2%). The Utilities gained 1.7% (up 18.1%). The Banks rallied 3.9% (up 8.5%), and the Broker/Dealers jumped 3.8% (up 6.3%). The Transports surged 4.0% (up 10.4%). The S&P 400 Midcaps gained 2.4% (up 13.1%), and the small cap Russell 2000 rose 2.4% (up 10.8%). The Nasdaq100 advanced 3.0% (up 21.5%). The Semiconductors surged 4.0% (up 30.3%). The Biotechs were little changed (up 3.9%). Though bullion slipped $7, the HUI gold index increased 0.9% (up 42.1%).

Three-month Treasury bill rates ended the week at 1.935%. Two-year government yields slipped three bps to 1.51% (down 98bps y-t-d). Five-year T-note yields declined three bps 1.39% (down 113bps). Ten-year Treasury yields fell four bps to 1.50% (down 119bps). Long bond yields dropped six bps to 1.96% (down 105bps). Benchmark Fannie Mae MBS yields fell eight bps to 2.39% (down 111bps).

Greek 10-year yields sank 33 bps to 1.61% (down 279bps y-t-d). Ten-year Portuguese yields fell four bps to 0.13% (down 160bps). Italian 10-year yields sank 32 bps to 1.00% (down 174bps). Spain's 10-year yields declined three bps to 0.11% (down 131bps). German bund yields declined two bps to negative 0.70% (down 94bps). French yields fell three bps to negative 0.40% (down 111bps). The French to German 10-year bond spread narrowed one to 30 bps. U.K. 10-year gilt yields were unchanged at 0.48% (down 80bps). U.K.'s FTSE equities index recovered 1.6% (up 7.1% y-t-d).

Japan's Nikkei Equities Index was little changed (up 3.4% y-t-d). Japanese 10-year "JGB" yields dropped four bps to negative 0.27% (down 27bps y-t-d). France's CAC40 jumped 2.9% (up 15.8%). The German DAX equities index rose 2.8% (up 13.1%). Spain's IBEX 35 equities index gained 1.9% (up 3.2%). Italy's FTSE MIB index surged 4.1% (up 16.4%). EM equities were mostly higher. Brazil's Bovespa index rallied 3.5% (up 11.1%), and Mexico's Bolsa surged 6.9% (up 2.4%). South Korea's Kospi index gained 1.0% (down 3.6%). India's Sensex equities index rose 1.7% (up 3.5%). China's Shanghai Exchange slipped 0.4% (up 15.7%). Turkey's Borsa Istanbul National 100 index dipped 0.4% (up 6.0%). Russia's MICEX equities index jumped 3.0% (up 15.6%).

Investment-grade bond funds saw inflows of $3.475 billion, and junk bond funds posted inflows of $689 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose three bps to 3.58% (down 94bps y-o-y). Fifteen-year rates gained three bps to 3.06% (down 91bps). Five-year hybrid ARM rates dipped one basis point to 3.31% (down 54bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-year fixed rates jumping 15 bps to 4.20% (down 36bps).

Federal Reserve Credit last week declined $3.3bn to $3.724 TN. Over the past year, Fed Credit contracted $462bn, or 11.0%. Fed Credit inflated $913 billion, or 32%, over the past 355 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $4.0bn last week to $3.475 TN. "Custody holdings" rose $46.3bn y-o-y, or 1.4%.

M2 (narrow) "money" supply declined $5.0bn last week to $14.937 TN. "Narrow money" gained $728bn, or 5.1%, over the past year. For the week, Currency increased $2.7bn. Total Checkable Deposits dropped $51.3bn, while Savings Deposits jumped $42.8bn. Small Time Deposits slipped $2.2bn. Retail Money Funds gained $3.6bn.

Total money market fund assets fell $14.1bn to $3.364 TN. Money Funds gained $503bn y-o-y, or 17.6%.

Total Commercial Paper dropped $9.7bn to $1.120 TN. CP was up $56bn y-o-y, or 5.3%.

Currency Watch:

The U.S. dollar index jumped 1.7% to 98.807 (up 2.7% y-t-d). For the week on the upside, the South African rand increased 0.4%. On the downside, the Swedish krona declined 2.5%, the Norwegian krone 2.1%, the Swiss franc 1.6%, the euro 1.5%, the New Zealand dollar 1.2%, the British pound 0.9%, the Japanese yen 0.8%, the Mexican peso 0.7%, the Brazilian real 0.6%, the Australian dollar 0.3%, the Canadian dollar 0.2% and the South Korean won 0.1%. The Chinese renminbi declined 0.85% versus the dollar this week (down 3.88% y-t-d).

Commodities Watch:

August 27 – Bloomberg: “A major gold-buying spree by central banks is likely to persist in the coming years, according to Australia & New Zealand Banking Group Ltd., which flagged the potential for further purchases by nations including China. ‘In the current environment, where uncertainty in emerging-market currencies is high, we see good reason for countries like Russia, Turkey, Kazakhstan and China to continue to diversify their portfolios,’ ANZ said… Net buying by the sector is likely to stay above 650 tons, it said. Central-bank accumulation of bullion has emerged as a increasingly important trend in the global market… Authorities have been adding to reserves as growth slows, trade and geopolitical tensions rise, and some nations seek to diversify away from the dollar. Official purchases now account for about 10% of worldwide consumption, according to ANZ. ‘The People’s Bank of China holds nearly 1,936 tons of gold, which equates to only 3% of its total foreign reserve holdings, giving the country plenty of room to increase its allocation,’ ANZ said.”

The Bloomberg Commodities Index rallied 1.2% this week (unchanged y-t-d). Spot Gold dipped 0.4% to $1,520 (up 18.5%). Silver surged 4.5% to $18.342 (up 18%). WTI crude recovered 93 cents to $55.10 (up 21%). Gasoline added 0.2% (up 16%), and Natural Gas rallied 6.2% (down 22%). Copper increased 0.6% (down 3%). Wheat dropped 3.2% (down 8%). Corn gained 0.5% (down 1%).

Market Instability Watch:

August 29 – Reuters (Dhara Ranasinghe, Ritvik Carvalho, Tom Arnold): “August has turned out to be another month of milestones for bond markets as an escalating trade conflict fans recession fears, pushing borrowing costs deeper and deeper into negative territory. Some $16 trillion of global debt, including corporate and sovereign bonds, now yield less than 0%, up from almost $13 trillion in early July. Investors, desperate to grab any yield, have rushed into longer-dated bonds: U.S. 30-year borrowing costs are down 60 bps in August, set for their biggest monthly decline since the 2011 euro debt crisis. Long-dated Japanese bond yields have also hit three-year lows and are set for their biggest monthly declines in more than three years.”

August 25 – Bloomberg (Sarah Ponczek and Vildana Hajric): “Donald Trump’s trying to win a trade war, so don’t talk to him about 600 points in the Dow Jones Industrial Average. But for traders coping with the price impact of his tirades, it’s all they want to talk about. Days like Friday are creating stress in the trenches. A decade ago, Max Gokhman was a 24-year-old at the center of the storm, buying and selling toxifying credit contracts at a hedge fund he founded. Now head of asset allocation at Pacific Life Fund Advisors, he says those days barely compare when it comes to the unpredictability he’s facing daily. ‘I used to tell people trading credit derivatives through 2008 was crazy, but this is way weirder,’ said Gokhman. Back then, ‘the liquidity is what made it challenging to put on or take off your positions. Now every part of the market has its own idiosyncrasy, and at the top you have Trump, who can wreak havoc in really creative ways nobody’s thought of before.’”

August 28 – Reuters (Eliana Raszewski and Hugh Bronstein): “Argentina will negotiate with holders of its sovereign bonds and the International Monetary Fund to extend the maturities of its debt obligations as a way of ensuring the country’s ability to pay, Treasury Minister Hernan Lacunza said… …Lacunza said the government would ‘re-profile’ the maturities of debt owed to the IMF under a $57 billion standby agreement. Interest and principal payments on bonds issued under international and local law will not be altered in the re-profiling. The changes in maturities would be aimed at obligations held by institutional, rather than individual investors, he said.”

August 27 – New York Times (Matt Phillips): “China’s currency weakened by 0.15% against the dollar on Tuesday. It was a decline that — on its own — seems unremarkable. But as the trade war between Washington and Beijing drags on, the value of the renminbi is increasingly at the heart of the global fight over trade, technology and economic dominance between the world’s two largest economies. Lately, even the minuscule moves are starting to add up. Tuesday’s dip pushed the currency to its weakest level against the dollar since early 2008… Since the Trump administration began to talk of imposing tariffs on Chinese exports in early 2018, the currency is down roughly 10%. The drop has picked up speed in August, with the renminbi down about 4%.”

August 29 – Reuters (Noah Sin and Tom Westbrook): “Three months of anti-government protests have thrown Hong Kong into its deepest crisis in decades… The Hong Kong dollar is pegged in a narrow band around HK$7.8 per U.S. dollar, but has for weeks languished at the weak end as unrest has deepened, shedding 0.8% since early July. Bets in the market suggest some think the peg could falter… The forwards market suggests speculative bets on the peg breaking are building. Twelve-month forwards recently traded outside the currency’s range. Spreads in option markets have spiked to their widest in three years this month, in favor of dollar calls, suggesting investors are paying a high premium to bet on the Hong Kong dollar’s drop.”

Trump Administration Watch:

August 26 – Bloomberg (Shawn Donnan, Jennifer Jacobs, and Josh Wingrove): “President Donald Trump left the G-7 summit… taking a softer tone toward China, just days after spooking financial markets with another escalation in their trade war. Yet amid all the soothing words, Trump made it clear that he wasn’t abandoning his rough and tumble tactics to force a trade deal on China. After spending a weekend listening to fellow Group of Seven leaders urging him to ease tensions with China, Trump pointed to recent calls and an amiable speech by China’s top negotiator as signs Beijing wanted a deal. He shrugged off, however, the uncertainty his trade war has caused and showed no signs of backing down in an increasingly bitter trade dispute that’s chipping away at global economic growth and sending world markets tumbling.”

August 25 – Wall Street Journal (Rebecca Ballhaus, Noemie Bisserbe and Max Colchester): “President Trump clashed with world leaders over the U.S. trade war with China and a host of foreign-policy issues at a Group of Seven summit that showed his isolation on the world stage. A weekend of meetings at this sea resort included an unexpected visit by Iranian Foreign Minister Javad Zarif at France’s invitation that caught some U.S. officials off guard. Mr. Zarif, who was sanctioned by the U.S. last month, met with French President Emmanuel Macron and other French officials and briefed the U.K. and German delegations… Throughout the summit, attempts at bonhomie… gave way to tensions. G-7 leaders tried to squeeze concessions from Mr. Trump on Iran and other issues over closed-door meals, beyond the reach of White House advisers and TV cameras. But Mr. Trump responded by doubling down on his policies and offering accounts of group meetings that conflicted with other countries’ descriptions.”

August 25 – CNBC (Amanda Macias): “President Donald Trump said Sunday he could declare the escalating U.S.-China trade war as a national emergency if he wanted to. ‘In many ways this is an emergency,’ Trump said at the G-7 leaders meeting… ‘I could declare a national emergency, I think when they steal and take out and intellectual property theft anywhere from $300 billion to $500 billion a year and when we have a total lost of almost a trillion dollars a year for many years,’ Trump said, adding that he had no plan right now to call for a national emergency.”

August 28 – Reuters (David Lawder and Rajesh Kumar Singh): “The Trump administration… made official its extra 5% tariff on $300 billion in Chinese imports and set collection dates of Sept. 1 and Dec. 15, prompting hundreds of U.S. retail, footwear, toy and technology companies to warn of price hikes. The U.S. Trade Representative’s office said in an official notice that collections of a 15% tariff will begin… Sunday on a portion of the list covering over $125 billion of targeted goods from China. This initial tranche includes smartwatches, Bluetooth headphones, flat panel televisions and many types of footwear.”

August 28 – Reuters (Saleha Mohsin): “Treasury Secretary Steven Mnuchin said issuing ultra-long U.S. bonds is ‘under very serious consideration’ in the Trump administration, possibly setting up a move that would mark a historic revamp of the $16 trillion Treasuries market. ‘If the conditions are right, then I would anticipate we’ll take advantage of long-term borrowing and execute on that,’ Mnuchin said… He said officials held a meeting earlier in the day to review the possibility.”

August 25 – Reuters (Jeff Mason): “The United States and Japan agreed in principle on Sunday to core elements of a trade deal that U.S. President Donald Trump and Prime Minister Shinzo Abe said they hoped to sign in New York next month. The agreement, if finalized, would cool a trade dispute between the two allies just as a trade war between the United States and China escalates.”

Federal Reserve Watch:

August 27 – Associated Press (Martin Crutsinger): “A former top Federal Reserve official suggested… the Fed should avoid responding to the effects of President Donald Trump’s trade war with China and even consider how its actions might affect Trump’s re-election prospects… William Dudley, former president of the Fed’s New York regional bank, argued in a Bloomberg Opinion piece that if the Fed were to accommodate the president — by further cutting interest rates, for example — it could lead him to escalate his trade war and elevate the risk of a recession. ‘This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?’ Dudley wrote. His most dramatic suggestion was for the politically independent Fed to consider Trump’s re-election prospects in formulating its policies.”

August 27 – Reuters (Ann Saphir and Trevor Hunnicutt): “The U.S. central bank… rejected a call from a former Federal Reserve policymaker to counter President Donald Trump’s trade agenda by refusing to ‘play along’ and denying the president the interest rate cuts he has demanded. ‘The Federal Reserve’s policy decisions are guided solely by its congressional mandate to maintain price stability and maximum employment,’ a Fed spokeswoman said. ‘Political considerations play absolutely no role.’”

August 26 – Reuters (Ann Saphir): “Central bankers in Europe and Japan have used negative interest rates to try to boost their economies and lift sagging inflation expectations, but Federal Reserve policymakers have been generally skeptical of doing so in the United States. New research from the San Francisco Federal Reserve Bank… is likely to increase their doubts. When the Bank of Japan announced its plan to move to negative policy rates in 2016, inflation expectations actually fell rather than rose as policymakers had hoped, researchers at the San Francisco Fed wrote in the bank’s latest Economic Letter.”

U.S. Bubble Watch:

August 29 – Bloomberg (Reade Pickert): “The U.S. merchandise-trade deficit unexpectedly narrowed in July to a three-month low as exports picked up and imports declined. The gap shrank to $72.3 billion in July from $74.2 billion the month prior…”

August 30 – Reuters (Lucia Mutikani): “U.S. consumer spending increased solidly in July as households bought a range of goods and services, which could further allay financial market fears of a recession, but the strong pace of consumption is unlikely to be sustained amid tepid income gains… Consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose 0.6% last month after an unrevised 0.3% gain in June. Economists… had forecast consumer spending advancing 0.5% last month.”

August 27 – CNN (Matt Egan): “The leaders of Corporate America are cashing in their chips as doubts grow about the sustainability of the longest bull market in American history. Corporate insiders have sold an average of $600 million of stock per day in August, according to TrimTabs… August is on track to be the fifth month of the year in which insider selling tops $10 billion. The only other times that has happened was 2006 and 2007… Investors often view insider buying and selling… as a signal of confidence. Even though the stock market is much larger than it was in 2007, so the $10 billion mark may not mean as much now as it did then, the acceleration of insiders heading for the exits could indicate concern about the challenges ahead, especially as the US-China trade war threatens to set off a recession.”

August 27 – CNBC (Diana Olick): “Home prices are still gaining nationally, but not nearly as much as they have been over the past few years. Prices in June rose 3.1% annually, according to the S&P CoreLogic Case-Shiller national home price index. That’s down from 3.3% annual gain in May. The 10-City Composite annual increase came in at 1.8%, down from 2.2% in May. The 20-City Composite rose 2.1% annually, down from 2.4% in the previous month. ‘Home price gains continue to trend down, but may be leveling off to a sustainable level,’ S&P Dow Jones Indices’ Philip Murphy said… Fewer cities (12) experienced lower YOY price gains than in May (13). Phoenix, Las Vegas and Tampa reported the highest annual gains among the 20 cities.”

August 28 – Bloomberg (Danielle Moran): “U.S. state and local governments are selling bonds at the fastest pace since December 2017, seizing on interest rates that are tumbling toward a more than half-century low… Governments have sold $36.9 billion of long-term debt in August, the most since late 2017 and up 22% from a year earlier.”

August 28 – Bloomberg (Prashant Gopal): “Homebuilders are pulling back from U.S. manufacturing areas as shots fired in President Donald Trump’s trade war begin to ricochet across the economic landscape. In major manufacturing counties, permits to build single-family houses declined 3.8% in the second quarter from a year earlier, compared with 10% annual growth in the same period of 2017… Non-manufacturing areas also cooled, but not as sharply. The permit slowdown in factory towns began in early 2018 as the Trump administration’s tough talk about China and other trading partners intensified…”

August 30 – Wall Street Journal (Rebecca Elliott and Christopher M. Matthews): “Bankruptcies are rising in the U.S. oil patch as Wall Street’s disaffection with shale companies reverberates through the industry. Twenty-six U.S. oil-and-gas producers… have filed for bankruptcy this year, according to an August report by the law firm Haynes & Boone LLP. That nearly matches the 28 producer bankruptcies in all of 2018, and the number is expected to rise as companies face mounting debt maturities. Energy companies with junk-rated bonds were defaulting at a rate of 5.7% as of August, according to Fitch Ratings, the highest level since 2017.”

August 28 – Bloomberg (Isis Almeida): “Crazy weather that disrupted U.S. Midwest plantings is adding to farmer stress, with growers ranking 2019 as their hardest year ever. A survey conducted by Farm Futures showed that 53% of respondents said 2019 is the most difficult year they’ve faced as farmers -- that includes 49% of baby boomers and mature growers, who lived through the 1980s farm crisis, according to the poll of 711 growers…”

August 27 – CNBC (Lauren Hirsch): “Peloton, best known for at-home fitness equipment and accompanying streaming fitness services, revealed… growing sales but widening losses ahead of its IPO, in documents filed with regulators. In the fiscal year ended June 30, Peloton reported sales grew 110% to $915 million from $435 million in fiscal 2018. Meanwhile, its 2019 net loss widened to $245.7 million, from a net loss of $47.9 million in the prior year.”

China Watch:

August 24 – Reuters (Winni Zhou and Se Young Lee): “China said on Saturday it strongly opposes Washington’s decision to levy additional tariffs on $550 billion worth of Chinese goods and warned the United States of consequences if it does not end its ‘wrong actions’. The comments made by China’s Ministry of Commerce came after the U.S. President Donald Trump announced on Friday that Washington will impose an additional 5% duty the Chinese goods, hours after Beijing announced its latest retaliatory tariffs on about $75 billion worth of U.S. goods... ‘Such unilateral and bullying trade protectionism and maximum pressure violates the consensus reached by head of China and United States, violates the principle of mutual respect and mutual benefit, and seriously damages the multilateral trade system and the normal international trade order,’ China’s commerce ministry said…”

August 27 – South China Morning Post (Sarah Zheng): “Beijing has cast doubt on whether trade talks are set to resume, with its foreign ministry contradicting US President Donald Trump’s claim that China had sought a return to the negotiating table and state media saying the countries were in touch only at a ‘technical level’. Markets jumped when Trump said on Monday that China called ‘our top people’ – the US Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin – on Sunday evening to ‘get back to the table’… The countries had been due to speak on Tuesday, according to a previous statement from China’s Ministry of Commerce… But there has since been no sign of progress on that front and the Chinese foreign ministry again said… it was not aware of the phone calls over the weekend.”

August 27 – Financial Times (Thomas Hale): “The Global Times is a Chinese government-run tabloid that often attracts headlines for its controversial, well, headlines. So it was only a matter of time before it got around to the topic of the gold standard – which… the paper said could be revived. The article in question, though, was attributed to research firm Anbound, a Beijing-based think tank… Its line of argument was roughly that the US no longer wants to be burdened with the dollar’s status as the global reserve currency: When the US decoupled the value of the dollar from gold, it actually committed to take on the responsibility of world finance, based on which a new financial order was formed. It is this financial order that has allowed the US to enjoy huge development dividends. Now, the US is unwilling to continue assuming and fulfilling such responsibilities for the current world financial order, and Trump has continuously intervened in the operation of the Fed and global financial market order. This development points to the necessity of seeking and building a new financial order, which is the fundamental basis for the re-emergence of the gold standard in the world financial market.”

August 28 – Reuters (Pete Sweeney): “China’s Big Four lenders are feeling the pressure. Beijing, trying to slash a $310 billion pile of officially recognised bad debt, is pushing giants like China Construction Bank to help troubled smaller rivals, or rescue them outright. First-half earnings look healthy enough, but softer credit figures suggest they are already moving to shield their balance sheets. CCB, the country’s second-largest lender with 24 trillion yuan in assets, is a leader in efforts to rescue troubled state-owned borrowers through debt-for-equity swaps. In May, it was brought in to help the government’s takeover of Baoshang Bank, by handling its day-to-day business. That move was quickly followed by similar interventions at the Bank of Jinzhou and Hengfeng Bank involving other central institutions. There are almost certainly more to come.”

August 29 – Reuters (Cheng Leng): “China’s banking and insurance regulator said… a series of small and medium-sized bank inspections has uncovered a number of rule violations and misdemeanors. The China Banking and Insurance Regulatory Commission (CBIRC) said lenders were found to have contravened rules by lending to undercapitalised real estate projects, to over-indebted local government platforms, and to firms found to have seriously violated environmental laws.”

August 25 – Financial Times (Don Weinland and Sherry Fei Ju): “A big source of easy financing for Chinese companies is coming under pressure, leaving in its wake a string of corporate defaults. Starting in 2015, China’s asset management industry became a booming centre for ‘shadow finance’, lending outside the formal banking sector. Banks, securities houses and trust companies were able to raise cash from wealthy investors and structure lending products through accounts at asset management companies. Loans linked to asset management companies, and structured finance products called asset management plans became hugely popular. By the end of March, securities companies had Rmb1.99tn ($280bn) in funds linked to asset managers that had been lent out through such arrangements… Meanwhile, global asset managers have been allocating more money than ever to Chinese stocks and fixed-income products.”

August 25 – Bloomberg: “The foreign debt built up by Chinese companies is about a third bigger than official data show, adding to the pressure on the country’s currency reserves as a wave of repayment obligations approaches in 2020. On top of the $2 trillion in liabilities to foreigners captured in official data, mainland Chinese firms have around another $650 billion in debts built up by subsidiaries overseas… About 70% of that debt is guaranteed by entities such as onshore parent companies and their subsidiaries… The amount of maturing debt will rise in coming quarters, with $63 billion due in the first half of 2020 alone.”

August 26 – Reuters (Twinnie Siu): “Illegal violence is pushing Hong Kong to the brink of great danger, the city government said…, after a weekend of clashes that included the first gun-shot and the arrest of 86 people, the youngest just 12. Police fired water cannon and volleys of tear gas in running battles with protesters who threw bricks and petrol bombs on Sunday, the second day of weekend clashes in the Chinese-ruled city.”

August 27 – Financial Times (Tom Mitchell, Nicolle Liu and Alice Woodhouse): “On July 28, Hong Kong police arrested 17 people for their alleged participation in a riot in the territory’s premier business district. The accused included students, chefs, clerks, a teacher, a nurse and, fatefully for Hong Kong’s corporate sector, a young pilot for Cathay Pacific Airways. Within two weeks the chance arrest of Liu Chung-yin, 30… had plunged his employer into the biggest political crisis since its establishment in 1946 and shaken relations between Hong Kong’s business community and China’s ruling Communist party in Beijing. On August 9, China’s aviation regulator accused management at Hong Kong’s de facto flag carrier and its controlling shareholder, Swire Pacific, of not acting quickly enough to discipline Mr Liu and other employees alleged to have participated in illegal or violent protests…”

August 26 – Wall Street Journal (Joanne Chiu): “Hong Kong’s formidable property market is straining, as protest pressures add to those created by an escalating U.S.-China trade spat and slowing global growth. In the past two months, shares in big real-estate companies have dropped and a marquee land sale in a much-hyped redevelopment area has fallen through. Home values have edged lower, and some analysts now expect prices, after marching upward for many years, to be flat for 2019. Trade tensions and signs of slowing growth weigh on commercial-property prices in other world cities as well. But property plays an outsize role in the Hong Kong economy, and real estate is one of the most important sectors in the local stock market.”

August 28 – Bloomberg: “Chinese President Xi Jinping will deliver a major speech to mark 70 years since the official founding of the People’s Republic of China… The speech on Oct. 1 will be accompanied by a national day parade showcasing China’s advances in military technology, Wang Xiaohui, executive vice minister for the Communist Party’s Publicity Department, said... ‘The purpose is to motivate and mobilize the whole party, the whole military, and all of the people to unite closely around the CCP Central Committee with Xi at the core,’ Wang said.”

August 27 – Wall Street Journal (Yoko Kubota): “After five years, China is putting the finishing touches on a sweeping new system to punish and reward companies for their corporate behavior. But foreigners worry that, amid the continuing U.S.-China trade dispute, Beijing will use its new corporate ‘social credit’ system as a weapon against international businesses. While Beijing’s better-known plans for a social-credit system for individuals have stirred privacy concerns, a parallel effort to monitor corporate behavior would similarly consolidate data on credit ratings and other characteristics… into one central database… The system is set to fully start next year. An algorithm would then determine to what degree companies are complying with the country’s various laws and regulations. In some cases, companies could be punished by losing access to preferential policies or facing stricter levels of administrative punishment…”

August 27 – Bloomberg: “Chinese companies are dialing back dollar-denominated junk bond sales just as demand for the riskier assets weakens. Firms have raised just $1.3 billion issuing high-yield securities in August, the least in two years and down from $7.8 billion for all of July…”

Central Banking Watch:

August 25 – Financial Times (Brendan Greeley): “For the world’s central bankers gathered in Jackson Hole, there was a sense that things would never be the same again. The developed world had experienced a ‘regime shift’ in economic conditions, James Bullard, president of the St Louis Federal Reserve, told the Financial Times. ‘Something is going on, and that’s causing I think a total rethink of central banking and all our cherished notions about what we think we’re doing,’ he said. ‘We just have to stop thinking that next year things are going to be normal.’ Interest rates are not going back up anytime soon, the role of the dollar is under scrutiny both as a haven asset and as a medium of exchange, and trade uncertainty has become a permanent feature of policymaking. Policymakers acknowledged they had reached a turning point in the way they viewed the global system. They cannot rely on the tools they used before the financial crisis to shape the economic environment, and the US can no longer be considered a predictable actor in economic or trade policy…”

August 26 – Bloomberg (Jana Randow): “Germany’s top central banker is back in the role he’s best known for -- arguing against European Central Bank stimulus. Despite gathering clouds over the economy, Bundesbank President Jens Weidmann told the Frankfurter Allgemeine… that it would be ‘wrong for us to act for action’s sake.’ He also said speculation over interest-rate cuts or more quantitative easing ‘doesn’t do justice to the euro area’s latest economic data.’ Those remarks suggest Weidmann is back to a more hardline stance after months of portraying himself as a pragmatist who could succeed Mario Draghi as ECB president. It’s a foretaste for Draghi’s successor Christine Lagarde, and could complicate the Sept. 12 policy meeting when investors are looking for an interest-rate cut and possible resumption of asset purchases…”

August 28 – Bloomberg (Catherine Bosley): “Swiss National Bank Governing Board Member Andrea Maechler said the franc’s value means the central bank’s ultra-loose monetary policy is vital… Asked about intervention limits, Maechler said it’s ‘very much a question of context,’ and action always requires a cost-benefit analysis. She also said the ‘expansive monetary policy of the SNB remains necessary.’ Inflationary pressures are very weak, and it wouldn’t take much to make consumer prices fall…”

Brexit Watch:

August 26 – Reuters (William James): “Prime Minister Boris Johnson said he was prepared to take Brexit talks with the European Union down to the very last minute before the Oct. 31 exit deadline, and if necessary to take a decision to leave without a deal on that day. Johnson has 68 days to convince the EU to give him a new Brexit deal, with neither side so far willing to compromise on the most contentious issues. If he can’t get a deal, he says Britain will leave the bloc anyway. That leaves Britain, with the world’s fifth largest economy, heading for a messy divorce with the EU that critics fear could lead to food shortages and major border disruption in the short term and undermine the country’s prosperity in the long term.”

Asia Watch:

August 27 – Financial Times (Song Jung-a and Kana Inagaki): “Japan’s trade and diplomatic dispute with South Korea has escalated sharply. Seoul terminated its intelligence-sharing pact with Tokyo last week and on Sunday went ahead with its postponed two-day military drills around the Dokdo islands, known in Japan as Takeshima, that are controlled by Seoul but claimed by Japan. Analysts remain sceptical that the stand-off can be resolved quickly and a further escalation could disrupt global supply chains as the world wrestles with the intensifying US-China trade war. The dispute originally stems from a ruling by South Korea’s supreme court last autumn that awarded damages against Japanese companies for forced labour during the second world war. According to Tokyo, all such claims were ‘settled completely and finally’ by a 1965 treaty under which it paid compensation to the South Korean government. Seoul, however, maintains the deal does not preclude individual victims from suing for damages. The row flared up in July after Japan imposed controls on three chemicals crucial to South Korea’s semiconductor industry.”

EM Watch:

August 29 – Financial Times (Editorial Board): “Argentina is hurtling towards another disorderly debt default. It would be the ninth in the country’s history. The timing is highly unusual, coming two months before a presidential election and less than a year into an IMF bailout that had already been increased. But it is also a recognition of reality. IMF assumptions on Argentina’s ability to roll over its short-term debt proved wildly optimistic in the face of political uncertainty. A recent central-bank auction that covered only a fraction of the debt falling due highlighted how much Argentina is struggling to refinance its vast and largely US dollar-denominated debt pile.”

August 29 – Bloomberg (Sydney Maki and Ben Bartenstein): “To Carmen Reinhart, an Argentine default is all but inevitable -- and will likely come sooner rather than later. The Harvard University economist says the government’s re-profiling plan is already a default on domestic debt, which rating companies will likely promptly respond to. While asking bondholders for more time doesn’t configure a default on its foreign obligations, it would be ‘a miracle if they get to six months.’”

August 27 – Reuters (Jamie McGeever and Jose Gomes Neto): “The Brazilian central bank waded into the foreign exchange market on Tuesday in a rare sale of dollars on the spot market after the real slumped to its weakest level against the greenback in almost a year and within sight of its all-time low. The intervention marked the first time in 10 years that the bank had sold dollars on the spot market without using additional instruments or a commitment to repurchase. It later announced plans to sell up to $1.5 billion in the spot market on Wednesday but with repurchase commitments, on top of a planned $550 million spot market sale linked to regular swap contracts auctions.”

August 30 – Bloomberg (Suvashree Ghosh, Siddhartha Singh, and Shruti Srivastava): “India announced its most sweeping bank overhaul in decades, minutes before data showed economic growth in Asia’s No. 3 economy slumped to a six-year low. Four new lenders that result from a series of state-bank mergers will hold business worth 55.8 trillion rupees ($781bn), or about 56% of the Indian banking industry… The government will inject a combined 552.5 billion rupees of capital into these entities, she said.”

August 28 – Bloomberg (Ameya Karve and Divya Patil): “Credit analysts are keeping a watchful eye on signs of stress in Indian household debt after unemployment rose to a 45-year high and as lenders grapple with the worst soured debt levels of any major economy. India’s bad debt malaise has centered on corporate debt, and loans to individuals have been seen as safer and a growth opportunity for banks. Given the slowdown in the economy and a drying-up of credit from shadow banks, analysts are signaling potential risks…”

Global Bubble Watch:

August 27 – Bloomberg (Enda Curran): “Manufacturing engines around the world are turning gloomier by the day. A collapse in exports pushed Germany to the brink of a recession in the second quarter with total economic output contracting. At the same time, business confidence in Europe’s largest economy is at its weakest in almost seven years. On the other side of the globe, South Koreans are at their most pessimistic since January 2017… There was a warning for Singapore, too, with debt restructuring experts predicting a tide of bad corporate debt in the city-state that serves as a large hub of international shipping. Those three bellwethers of global trade are all taking hits tied to the U.S.-China tariff battle that shows few signs of cooling off.”

August 27 – Bloomberg (Anchalee Worrachate): “A once-unthinkable collapse in global bond yields is forcing pension funds to buy bonds that offer negative returns -- putting the financial security of future retirees in jeopardy. U.S. institutions managing trillions of dollars in retirement savings… have been ratcheting down return expectations. Japan’s Government Pension Investment Fund, the world’s largest, has warned that money managers risk losses across asset classes. In Europe, pension funds may be forced to cut benefits in part thanks to the decline in rates. Investors were already taking on more credit risk to make up for dwindling income elsewhere, with some chasing less liquid markets like private debt. Now, negative yields on over a quarter of investment-grade bonds… are increasing the urgency for portfolio managers to find new sources of returns.”

Fixed-Income Bubble Watch:

August 28 – Bloomberg (David Caleb Mutua): “Investors in debt from blue-chip U.S. companies are on track for the best August in 37 years as corporate bonds benefit from the rally in Treasuries. High-grade bonds returns stand at 3.3% so far this month, heading for the best August since 1982… This year, the bonds have gained the most of all major fixed-income assets with 14.1%. That’s the best return at this point of any year since 2009.”

August 28 – Bloomberg (Claire Boston): “As borrowing costs plunge for the highest-quality companies, there’s a growing incentive for riskier businesses like fast-food chains to mortgage virtually all their assets. Franchised companies like burger restaurant Jack in the Box Inc. and massage provider Massage Envy are increasingly selling unusual bonds backed by most of their business. By pledging key assets like royalties, fees, and intellectual property to bondholders, companies can win investment-grade credit ratings on their debt and slash their financing costs, making their bonds higher quality even if their overall companies are still relatively risky. This year borrowers have sold more than $6.9 billion of these securities, known as whole-business securitizations, approaching the most on record... Fast-food restaurants used to be the main issuers of this debt, but a wider array of companies are jumping in.”

Leveraged Speculation Watch:

August 28 – Bloomberg (Nathan Crooks): “Ray Dalio thinks the ability of central banks to reverse an economic downturn is coming to an end as the global economy enters what he says are the late stages of the long-term debt cycle. ‘Interest rates get so low that lowering them enough to stimulate growth doesn’t work well,’ the billionaire founder of investment management firm Bridgewater Associates wrote… Money printing and buying financial assets won’t work either, Dalio said, as it doesn’t produce adequate credit in the real economy and creates the need for large budget deficits and then their monetization.”

Geopolitical Watch:

August 28 – Reuters (Ben Blanchard, Huizhong Wu and Gao Liangping): “China’s military will make even greater ‘new’ contributions to maintaining Hong Kong’s prosperity and stability, state news agency Xinhua… cited the People’s Liberation Army garrison in the territory as saying. The military has now completed a routine troop rotation in Hong Kong, with air, land and maritime forces entering the territory, the report added.”

August 28 – Bloomberg: “China warned a U.S. warship sailing near disputed islands in the South China Sea that it was violating the country’s sovereignty and urged Washington to halt its ‘provocative’ naval operations… ‘Facts have proven that the so-called ‘freedom of navigation’ of the United States is essentially a hegemony that ignores the rules of international law, seriously undermines China’s sovereignty and security interests, and seriously undermines the stability of the South China Sea region,’ said Senior Colonel Li Huamin…”

August 27 – Reuters (Idrees Ali): “China has denied a request for a U.S. Navy warship to visit the Chinese port city of Qingdao in recent days, a U.S. defense official told Reuters on Tuesday, at a time of tense ties between the world’s two largest economies. This marks at least the second time China has denied a request by the United States this month, having earlier rejected a request for two U.S. Navy ships to visit Hong Kong, as the political crisis in the former British colony deepened.”

August 25 – Reuters (Jeffrey Heller, Maayan Lubell, Stephen Farrell, Lisa Barrington, Ellen Francis and Laila Bassam): “Israel said on Sunday an air strike against an arm of Iran’s Revolutionary Guards in Syria that it accused of planning ‘killer drone attacks’ showed Tehran that its forces were vulnerable anywhere.”