Friday, September 20, 2019

Weekly Commentary: No Coincidences

September 20 – Wall Street Journal (Daniel Kruger): “The Federal Reserve Bank of New York will offer to add at least $75 billion daily to the financial system through Oct. 10, prolonging its efforts to relieve funding pressure in money markets. In addition to at least $75 billion in overnight loans, the New York Fed… will also offer three separate 14-day repo contracts of at least $30 billion each next week… On Friday banks asked for $75.55 billion in reserves, $550 million more than the amount offered by the Fed, offering collateral in the form of Treasury and mortgage securities. The Fed’s operation was the fourth time this week it has intervened to calm roiled money markets. Rates on short-term repos briefly spiked to nearly 10% earlier this week as financial firms looked for overnight funding. The actions marked the first time since the financial crisis that the Fed had taken such measures.”

With the Lehman collapse setting off the “worst financial crisis since the Great Depression”, instability in the multi-trillion repurchase agreement marketplace generates intense interest. This market for funding levered securities holdings is critical to the financial system’s “plumbing.” It's a market in perceived “money” – highly liquid and virtually risk free-instruments. If risk suddenly becomes an issue for this shadowy network, the cost and availability of Credit for highly leveraged players is suddenly in question. And any de-risking/deleveraging at the nucleus of the global financial system would pose a clear and present danger for sparking “risk off” throughout Credit markets and financial markets more generally.

I’ll usually begin contemplating the CBB on Thursdays. This week’s alarming dislocation in the “repo” market was clearly a major development worthy of focus. But I was planning on highlighting the lack of initial contagion effects in corporate Credit, a not surprising development considering the New York Fed’s aggressive liquidity injections.

Investment-grade Credit default swaps (CDS), for example, closed Thursday trading near their lowest levels since February 2018. Junk bond spreads (to Treasuries) went out Thursday near the narrowest since early-November. Bank CDS, another important indicator, also continued to signal “all’s clear” throughout Thursday trading. As of Thursday’s close, Goldman Sachs’ (5yr) CDS was up a modest three points for the week to 58, after closing the previous Friday near the low going back to January 2018.

But Friday’s trading session came with additional intrigue. Investment-grade CDS jumped 15% to 59.7, the highest close in about a month. Goldman Sachs CDS rose 9.4% to 63.1, an almost four-week high. JPMorgan CDS rose 8.9% (to 42.7), BofA 11.0% (to 47.5) and Citigroup 5.7% (to 61.1). And as key financial CDS prices moved sharply higher, safe haven bond yields dropped. Treasury yields fell six bps in Friday trading to 1.72%, and Bund yields declined two bps to negative 0.525%. Even more curious, Gold popped almost $18 Friday to $1,517, boosting the week’s gain to $28.

The Fed’s return to system liquidity injections after a decade hiatus received abundant media coverage. For the most part, analysts were pointing to a confluence of unusual factors: $35 billion money market outflows to fund September 15th quarterly corporate tax payments; settlements for outsized Treasury auctions; and the approaching end to the quarter (where money center banks generally reduce balance sheet leverage for financial reporting and regulatory purposes).

Missing from the discussion was that this week’s money market tumult followed on the heels of instability in other markets. Is it coincidence that Monday’s spike in repo rates followed last week’s extraordinary bond market reversal – where 10-year Treasury yields surged 34 bps and benchmark MBS yields spiked an incredible 46 bps (2.37% to 2.83%)?

What a nightmare it’s been over recent months for those attempting to hedge interest-rate risk. After trading to 4.10% in November, benchmark MBS yields were down to 3.02% near the end of March. MBS yields then rose to 3.34% in April, before reversing lower to trade all the way down to 2.51% by late June. Yields were back up to 2.91% in mid-July – only to then reverse to a three-year low of 2.30% on September 4th. Collapsing MBS yields spur waves of refinancings, shortening the lives (“duration”) of existing MBS securities trading in the marketplace (as old MBS are replaced with new lower-yielding securities).

The marketplace for hedging MBS and other interest-rate risk is enormous. Derivatives really do rule the world. When market yields are declining, players that had sold various types of protection against lower rates are forced into the marketplace to acquire instruments for hedging their escalating rate exposure. Much of this levered buying would typically be financed in the repurchase agreement (“repo”) marketplace. This type of hedging activity can prove strongly self-reinforcing. Intense buying forces Treasury and bond market prices higher, “squeezing” those short the market while spurring additional hedging-related purchases. At the same time, the expansion of “repo” securities Credit boosts overall system liquidity, supporting the upside inflationary bias in bond and securities prices.

The recent downside dislocation in market yields included tell-tale signs of manic blow-off speculative excess. At 1.46% lows (September 3rd), an exuberant marketplace was calling for sub-1% Treasury yields – as if the unending supply from massive deficit spending would remain permanently divorced from market price dynamics. Meanwhile, booming corporate issuance was gobbled up at near record low yields - and at the lowest spreads to Treasuries in two years. Inflows were inundating the fixed-income ETF complex. Excesses in U.S. fixed-income were unfolding as $18 TN of global investment-grade bonds traded at negative yields, including European corporate debt.

Things got conspicuously out of hand. With global central bankers in aggressive easing mode – including an ECB restarting the QE machine while pushing rates further into negative territory – market participants were in the mood to believe central banks had abolished market cycles. Like deficits and Current Account Deficits, speculative excess and leverage don’t matter.

While everyone was relishing the mania, trouble was building under the market's surface – in the “plumbing.” As yields collapsed, speculative leverage mounted. Surging prices incited a buyers’ panic in Treasuries, MBS, corporate bonds, CDOs and structured finance – a chunk of it financed in the “repo” and money markets. Derivative player hedging activities also significantly boosted system leverage. All the speculative leveraging worked to expand system liquidity, crystallizing the market perception of endless liquidity abundance. While a deficient indicator of system liquidity, it’s still worth noting M2 “money” supply has expanded $560 billion over the past six months. Money market fund assets (retail funds included in M2) are up $350 billion since the end of April. Where’s all this “money” been coming from?

Market “melt-up” upside dislocations sow the seeds for abrupt market reversals and attendant upheaval. One day’s panic buying (on leverage) can be the following session’s frantic selling (unwind of leverage). Especially in the derivatives arena, self-reinforcing derivative-related dynamic (“delta”) hedging during an upside speculative blow-off is susceptible to abrupt reversals. Hedging programs necessitate buying into rapidly rising markets, only to immediately shift to aggressive selling in the event of market weakness. The associated leverage spurs liquidity excess on the upside, creating vulnerability for illiquidity in the event of downside sell programs and speculative deleveraging.

It is surely No Coincidence that this week’s “repo” ructions followed last week’s spike in yields and resulting deleveraging. Is it a Coincidence that the marketplace experienced a powerful “rotation” that saw the favorite stocks and sectors dramatically underperform the least favored? Is it a Coincidence that hedge fund long/short strategies have been clobbered, in what evolved into a powerful short squeeze and dislocation? Surely, it’s No Coincidence the so-called “quant quake” foresaw this week’s quake in the repo market.

Let’s expand this inquiry. Is it a Coincidence that this week’s money market upheaval followed by a few months dislocation in the Chinese money market? And is it mere Coincidence that U.S. money market instability erupted on the heels of the ECB’s decision to restart QE?

There are No Coincidences. Chinese money market issues and currency weakness were fundamental to the global yield collapse. Trade war escalation risked pushing China’s vulnerable Credit system and economy over the edge. Global central bankers responded to sinking bond yields with dovish talk and monetary stimulus, feeding the unfolding bond market dislocation. Collapsing market yields and dovish central banks stoked melt-up dynamics in stocks and sectors seen benefiting from a lower rate environment. Growth stocks were caught up in speculative melt-up dynamics, while short positions in underperforming financials and small caps were popular hedging targets. Both momentum longs and shorts became Crowded Trades

Meanwhile, booming markets and the resulting loosening of financial conditions quietly bolstered flagging growth dynamics – from China to the U.S. to Europe. The prospect of constructive U.S./China trade talks risked catching the manic bond market out over its skis. Some stronger U.S. data then sparked a sharp bond market reversal, with rising yields spurring a reversal of Crowded equities trades. Losing on both sides, the long/short players suffered painful losses. De-risking of long/short strategies incited a powerful short squeeze, a dynamic that gained momentum into expiration week.

The S&P500 is only about 1% from all-time highs. Yet there’s been some real damage below the markets' surfaces. The leveraged speculating community, in particular, has been shaken. There were losses in Argentina and EM currencies more generally. Bond markets have turned unstable – on both the up- and downside. Long/short strategies have been bludgeoned. Short positions have turned highly erratic. And this week instability engulfed the overnight funding markets, with contagion effects for other short-term funding vehicles at home and abroad. Trouble brewing.

The leveraged speculating community is the marginal source of liquidity throughout U.S. and global markets. Not only have they faced heightened risk across the spectrum of their holdings, they now confront funding market uncertainty into year-end. This doesn’t necessarily indicate imminent market weakness. But it does signal vulnerability. Many players are afflicted with increasingly “weak hands.” They’ll exhibit less tolerance for pain. This dynamic increases the likelihood that market weakness will spur self-reinforcing de-risking and deleveraging.

There was considerable market vulnerability this time last year – even with equities at all-time highs. Global markets, economies, trade relationships and geopolitics are all more troubling today. Central bankers have burned through precious ammunition, in the process spurring problematic late-cycle excess. Understandably, there is dissention within the ranks – from the Fed to the ECB to the BOJ. Is monetary stimulus the solution or the problem?

Autumn is set up for some serious instability. There’s all this talk of the need for the Fed to create additional bank reserves. The issue is not a shortage of reserves but a gross excess of speculative leverage. It started this week. The Fed’s balance sheet will be getting much bigger. The Fed and the markets were blindsided by this week’s repo market instability. The surprises will keep coming.

For the Week:

The S&P500 dipped 0.5% (up 19.4% y-t-d), and the Dow fell 1.0% (up 15.5%). The Utilities jumped 2.2% (up 21.5%). The Banks retreated 1.0% (up 17.6%), and the Broker/Dealers dropped 1.5% (up 15.3%). The Transports sank 3.3% (up 14.0%). The S&P 400 Midcaps declined 0.9% (up 16.9%), and the small cap Russell 2000 fell 1.2% (up 15.7%). The Nasdaq100 lost 0.9% (up 23.6%). The Semiconductors dropped 2.7% (up 35.3%). The Biotechs advanced 1.0% (up 6.0%). With bullion jumping $28, the HUI gold index surged 6.9% (up 35.9%).

Three-month Treasury bill rates ended the week at 1.86%. Two-year government yields dropped 12 bps to 1.69% (down 80bps y-t-d). Five-year T-note yields fell 15 bps to 1.72% (down 96bps). Ten-year Treasury yields dropped 18 bps to 1.72% (down 96bps). Long bond yields sank 21 bps to 2.16% (down 85bps). Benchmark Fannie Mae MBS yields dropped 19 bps to 2.64% (down 85bps).

Greek 10-year yields dropped 23 bps to 1.33% (down 307bps y-t-d). Ten-year Portuguese yields declined seven bps to 0.25% (down 147bps). Italian 10-year yields gained four bps to 0.92% (down 182bps). Spain's 10-year yields fell seven bps to 0.24% (down 118bps). German bund yields dropped seven bps to negative 0.52% (down 76bps). French yields declined five bps to negative 0.22% (down 93bps). The French to German 10-year bond spread widened two to 30 bps. U.K. 10-year gilt yields sank 13 bps to 0.63% (down 65bps). U.K.'s FTSE equities index slipped 0.3% (up 9.2% y-t-d).

Japan's Nikkei Equities Index added 0.4% (up 10.3% y-t-d). Japanese 10-year "JGB" yields fell five bps to negative 0.21% (down 21bps y-t-d). France's CAC40 increased 0.6% (up 20.3%). The German DAX equities index was unchanged (up 18.1%). Spain's IBEX 35 equities index increased 0.4% (up 7.5%). Italy's FTSE MIB index dipped 0.3% (up 20.7%). EM equities were mostly higher. Brazil's Bovespa index gained 1.3% (up 15.2%), and Mexico's Bolsa jumped 1.7% (up 4.6%). South Korea's Kospi index rose 2.1% (up 2.5%). India's Sensex equities index gained 1.7% (up 5.4%). China's Shanghai Exchange declined 0.8% (up 20.6%). Turkey's Borsa Istanbul National 100 index dropped 3.2% (up 9.8%). Russia's MICEX equities index added 0.2% (up 18.0%).

Investment-grade bond funds saw inflows of $2.831 billion, and junk bond funds posted inflows of $3.292 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates jumped 17 bps to 3.73% (down 92bps y-o-y). Fifteen-year rates rose 12 bps to 3.21% (down 90bps). Five-year hybrid ARM rates gained 13 bps to 3.49% (down 43bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-year fixed rates down 16 bps to 4.16% (down 69bps).

Federal Reserve Credit last week jumped $23.4bn to $3.750 TN. Over the past year, Fed Credit contracted $423bn, or 10.1%. Fed Credit inflated $939 billion, or 33%, over the past 358 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $13.8bn last week to $3.467 TN. "Custody holdings" gained $40.8bn y-o-y, or 1.2%.

M2 (narrow) "money" supply jumped $12.3bn last week to a record $15.011 TN. "Narrow money" gained $791bn, or 5.6%, over the past year. For the week, Currency increased $5.8bn. Total Checkable Deposits rose $12.6bn, while Savings Deposits declined $14.0bn. Small Time Deposits were little changed. Retail Money Funds gained $8.6bn.

Total money market fund assets gained $4.9bn to $3.402 TN. Money Funds gained $519bn y-o-y, or 18.0%.

Total Commercial Paper dropped $22.2bn to $1.094 TN. CP was up $19bn y-o-y, or 1.8%.

Currency Watch:

The U.S. dollar index added 0.3% to 98.513 (up 2.4% y-t-d). For the week on the upside, the Japanese yen increased 0.3%, the South Korean won 0.2% and the Canadian dollar 0.2%. On the downside, the South African rand declined 2.4%, the New Zealand dollar 1.9%, the Australian dollar 1.6%, the Brazilian real 1.4%, the Swedish krona 1.1%, the Norwegian krone 0.8%, the euro 0.5%, the Singapore dollar 0.3%, the Mexican peso 0.2%, the British pound 0.2% and the Swiss franc 0.1%. The Chinese renminbi declined 0.17% versus the dollar this week (down 3.0% y-t-d).

Commodities Watch:

September 17 – Bloomberg (Javier Blas and Catherine Ngai): “The Sunday opening of the oil market is traditionally a sedate affair: volumes are minimal and only a few traders in Asia, where it’s already early Monday, are in front of their screens. Last Sunday was different. Order volumes were sky high and hedge funds, refiners and oil trading houses had their top traders staffing operations, according to interviews with multiple market participants. Brokers put special teams in place to beef up skeleton weekend crews. ‘It wasn’t just profit and loss,’ said Richard Fullarton, the founder of… oil hedge fund Matilda Capital Management. ‘People’s careers and livelihoods changed on Sunday night.’ Those who put in the extra hours were confronted with the kind of market that few if any traders ever experienced before with positions that were previously profitable potentially deeply loss-making, and vice versa. Within 24 hours, the world’s two main exchange-traded futures had their busiest trading day ever. Even diesel transactions hit an all-time high as turmoil spread beyond the crude market.”

September 16 – Bloomberg (Tom Schoenberg and David Voreacos): “U.S. prosecutors took an unusually aggressive turn in their investigation of price fixing at JPMorgan…, describing its precious metals trading desk as a criminal enterprise operating inside the bank for nearly a decade. The prosecutors charged the head of JPMorgan’s global precious metals trading operation and two others…, accusing them of ‘conspiracy to conduct the affairs of an enterprise involved in interstate or foreign commerce through a pattern of racketeering activity.’”

The Bloomberg Commodities Index increased 0.6% this week (up 2.9% y-t-d). Spot Gold jumped 1.9% to $1,517 (up 18.3%). Silver rose 1.6% to $17.849 (up 14.9%). WTI crude surged $3.24 to $58.09 (up 28%). Gasoline jumped 8.1% (up 27%), while Natural Gas fell 3.1% (down 14%). Copper dropped 3.4% (down 1%). Wheat increased 0.2% (down 4%). Corn gained 0.5% (down 1%).

Market Instability Watch:

September 17 – Wall Street Journal (Nick Timiraos and Daniel Kruger): “For the first time in more than a decade, the Federal Reserve injected cash into money markets Tuesday to pull down interest rates and said it would do so again Wednesday after technical factors led to a sudden shortfall of cash. The pressures relate to shortages of funds banks face resulting from an increase in federal borrowing and the central bank’s decision to shrink the size of its securities holdings in recent years. It reduced these holdings by not buying new ones when they matured, effectively taking money out of the financial system.”

September 20 – Bloomberg (Liz Capo McCormick and Alexandra Harris): “Signs that stress in U.S. funding markets is rebuilding ramped up pressure on the Federal Reserve to permanently increase reserves by boosting Treasury holdings, even as it was preparing a temporary liquidity injection for a fourth straight day. The New York Fed plans to do another $75 billion overnight repo operation on Friday. It follows liquidity doses of the same size Thursday and Wednesday, and $53.2 billion on Tuesday. The central bank is deploying this remedy for the first time in a decade. This week’s actions have helped calm the funding market, with repo rates declining to more normal levels after soaring to 10% Tuesday… However, swap spreads tumbled to record lows Thursday amid concern Fed policy makers haven’t announced more aggressive steps. Swaps are signaling less appetite for Treasuries, driven by concern traders won’t be able to fund purchases through the repo market. ‘The Fed needs to do at least double what they offered now and maybe even be more vigilant and do something even more significant,” said Thomas Simons, senior economist at Jefferies LLC. ‘This attitude of trying to kind-of fix the problem is not great.’”

September 18 – CNBC (Patti Domm): “As the Fed was meeting to consider cutting interest rates, it lost control of the very benchmark rate that it manages. It’s been a rough week in the overnight funding market, where interest rates temporarily spiked to as high as 10% for some transactions Monday and Tuesday. The market is considered the basic plumbing for financial markets, where banks who have a short-term need for cash come to fund themselves. The odd spike in rates forced the Fed to jump in with money market operations aimed at reining them in, and after the second operation Wednesday morning, it seemed to have calmed the market. The Fed announced a third operation for Thursday morning. In a rare move, the Fed’s own benchmark fed funds target rate rose to 2.3% on Tuesday, above the target range set when it cut rates at its last meeting in July… ‘This just doesn’t look good. You set your target. You’re the all-powerful Fed. You’re supposed to control it and you can’t on Fed day. It looks bad. This has been a tough run for Powell,’ said Michael Schumacher, director, rate strategy, at Wells Fargo.”

September 16 – Bloomberg (Alex Harris): “One of the key U.S. borrowing markets saw a massive surge Monday, a sign the Federal Reserve is having trouble controlling short-term interest rates. Amid the settlement of Treasury coupon auctions and the influx of quarterly corporate tax payments, the rate on overnight repurchase agreements soared by as much as 248 basis points to 4.75%, the highest level since December, according to ICAP pricing. It came back down to 2.50%, still up 23 bps for the day. Curvature Securities spotted a different peak: 8%. While the spike doesn’t necessarily mean credit markets are seizing up or a financial calamity is imminent, it could hamper the Fed’s ability to steer the economy… ‘The Fed has lost control of funding,’ said Mark Cabana, head of U.S. interest rates at Bank of America Corp.”

September 16 – Bloomberg (Christopher Maloney): “The swift move higher in Treasury rates sent mortgage duration, a measure of a bond’s sensitivity to changes in interest rates, to its biggest weekly increase in almost nine years. The Bloomberg Barclays U.S. MBS index duration rose to 3.11 years from 2.45 years last week, a 27% increase. This was the most violent swing higher in percentage terms since the 47% increase seen during the week ending Sept. 24, 2010…”

September 16 – Bloomberg (Alexandra Harris): “Costs in one of the key U.S. borrowing markets surged Monday amid the settlement of Treasury coupon auctions and the influx of quarterly corporate tax payments. The rate on overnight repurchase agreements soared by more than 140 bps to 3.68%, the largest daily increase since December, based on ICAP pricing. ‘Secured funding markets are clearly not functioning well,’ said Jon Hill, a rates strategist at BMO Capital Markets. A jump like this, especially since it’s not happening at the end of a quarter, is ‘bordering on chaos,’ he added.”

September 19 – Bloomberg (Liz McCormick and Alex Harris): “When plumbing works well, you don’t need to think about it. That’s usually the case with a vital but obscure part of the financial system known as the repo market, where vast amounts of cash and collateral are swapped every day. But when it springs a leak, as it did this week, it rivets the attention of the U.S. Federal Reserve, the nation’s largest banks, money-market funds, corporations and other big investors. The Fed calmed things down by pumping in billions of dollars, but it may have a lot more work to do on the pipes.”

Trump Administration Watch:

September 16 – Bloomberg (Josh Wingrove and Daniel Flatley): “Donald Trump risks a political backlash if he retaliates against Iran over a weekend strike on Saudi Arabian oil facilities after campaigning on promises to withdraw the U.S. from foreign wars. Trump tweeted Sunday that the U.S. is ‘locked and loaded,’ raising bipartisan alarm after the weekend attack that halved Saudi oil production. Speaking on Monday to reporters in the Oval Office, Trump said: ‘It’s certainly looking that way at this moment,’ and ‘we pretty much already know’ who did it. Secretary of State Mike Pompeo has blamed Iran, though Riyadh is stopping short of directly doing so.”

September 19 – Reuters (Tuqa Khalid and Aziz El Yaakoubi): “The United States said… it was building a coalition to deter Iranian threats following a weekend attack on Saudi Arabian oil facilities. Iran has warned U.S. President Donald Trump against being dragged into a war in the Middle East and said it would meet any offensive action with a crushing response. U.S. Secretary of State Mike Pompeo said that Trump, who has ordered more sanctions on Iran, wants a peaceful solution to the crisis.”

September 18 – Reuters (Jeff Mason and Stephen Kalin): “U.S. President Donald Trump said… there were many options short of war with Iran after U.S. ally Saudi Arabia displayed remnants of drones and missiles it said were used in a crippling attack on its oil sites that was ‘unquestionably sponsored’ by Tehran. ‘There are many options. There’s the ultimate option and there are options that are a lot less than that. And we’ll see,’ Trump told reporters… ‘I’m saying the ultimate option meaning go in — war.’ The president struck a cautious note as his Secretary of State Mike Pompeo, during a visit to Saudi Arabia, described the attacks as ‘an act of war’ on the kingdom, the world’s largest oil exporter.”

September 20 – Bloomberg (Mike Dorning, Jordan Fabian, and Mario Parker): “A Chinese trade delegation canceled a planned visit to farms in the U.S. heartland, driving down stock indexes as investors turned pessimistic on progress toward resolving the two nations’ trade war. The cancellation came only about an hour after President Donald Trump said he wasn’t interested in ‘a partial deal’ with China based on Beijing increasing its purchases of U.S. agricultural products. U.S. and Chinese officials held negotiations this week and are aiming for a high-level meeting around Oct. 10.”

September 16 – Reuters (Michael Martina and Andrea Shalal): “U.S. and Chinese officials will restart trade talks at the end of this week, but any agreement the world’s largest economies carve out is expected to be a superficial fix. The trade war has hardened into a political and ideological battle that runs far deeper than tariffs, trade experts, executives, and officials in both countries say. China’s Communist Party is unlikely to budge on U.S. demands to fundamentally change the way it runs the economy, while the U.S. won’t backtrack on labeling Chinese companies national security threats. The conflict between the two countries could take a decade to resolve, White House economic advisor Larry Kudlow warned on Sept. 6. Yu Yongding, an influential former policy adviser to China’s central bank, told Reuters that China was in no rush to make a deal.”

September 18 – Reuters (David Lawder): “U.S. and Chinese deputy trade negotiators resumed face-to-face talks for the first time in nearly two months on Thursday, as the world’s two largest economies try to bridge deep policy differences and find a way out of their protracted trade war. The negotiations, which will extend into Friday, are aimed at laying the groundwork for high-level talks in early October that will determine whether the two countries are working toward a solution or headed for new and higher tariffs on each other’s goods.”

September 17 – Reuters (Roberta Rampton): “U.S. Vice President Mike Pence has canceled plans to meet with the leader of the Solomon Islands to discuss development partnerships after the Pacific island cut ties with Taiwan in favor of China this week, a senior U.S. official said… The Solomon Islands was the sixth country to switch allegiance to China since 2016. Self-ruled Taiwan has accused China - which claims Taiwan as its territory - of trying to meddle in its upcoming elections.”

September 16 – Wall Street Journal (Rebecca Ballhaus): “President Trump repeated his sharp criticism of the Federal Reserve after an attack in Saudi Arabia over the weekend led to a major crude oil disruption. In a pair of tweets Monday, the president questioned whether the Fed would ‘ever get into the game’ and said the central bank and its chairman, Jerome Powell, ‘don’t have a clue.’ He again badgered the Fed to lower the interest rate, citing a strong dollar’s harmful effect on U.S. exporters. ‘And now, on top of it all, the Oil hit,’ he wrote. ‘Big Interest Rate Drop, Stimulus!’”

Federal Reserve Watch:

September 18 – Associated Press (Martin Crutsinger): “A sharply divided Federal Reserve cut its benchmark interest rate… for a second time this year but declined to signal that further rate cuts are likely this year. The Fed’s move reduced its key short-term rate… by an additional quarter-point to a range of 1.75% to 2%. The action was approved 7-3, with two officials preferring to keep rates unchanged and one arguing for a bigger half-point cut. The divisions on the policy committee underscored the challenges for Chairman Jerome Powell in guiding the Fed at a time of high economic uncertainty. The Fed did leave the door open to additional rate cuts — if… the economy weakens. For now, he suggested, the economic expansion appears durable in its 11th year, with a still-solid job market and steady consumer spending.”

September 18 – Bloomberg (Alexandra Harris): “The Federal Reserve on Wednesday made an adjustment to its tools used to control key benchmark rate in conjunction with its decision to ease overall policy. Fed officials decided to lower the interest paid on excess reserves by 30 bps to 1.8%, effective Sept. 19, while lowering its target range by 25 bps to 1.75% to 2%. It also lowered the rate on its overnight facility for repurchase agreements by 30 bps to 1.70%. The central bank’s shift follows three days of volatility in the market for repurchase agreements.”

September 18 – Reuters (Jonnelle Marte, Ann Saphir and Megan Davies): “Wild swings this week in U.S. money markets have raised fresh concerns about whether the New York Federal Reserve under John Williams has lost its deft touch with markets. The New York Fed had to intervene in cash markets this week when the repo rate, a key measure of liquidity in the global banking system, sky-rocketed, forcing the Fed to make an emergency injection of more than $125 billion on Tuesday and Wednesday. A key interest rate the Fed aims to influence also broke above the central bank’s target range on Tuesday for the first time since the financial crisis. ‘What has happened in the repo market is far from a minor problem,’ said Ward McCarthy, chief financial economist for Jefferies. ‘That’s a financial crisis waiting to happen if they don’t get that under control.’”

September 20 – Bloomberg (Matthew Boesler): “The market apparently believes the economy needs added stimulus to continue the expansion. My own view is different,’ Boston Fed President Eric Rosengren says. ‘The data we have in hand suggest instead that the recovery would continue apace even with little monetary policy accommodation,’ Rosengren says… ‘So far the economy seems to have weathered the impact of trade disruptions and slowing foreign growth.’ ‘While risks clearly exist related to trade and geopolitical concerns, lowering rates to address uncertainty is not costless.’ ‘In my view, there are clearly risks of headwinds hitting the economy, but the stance of monetary policy is already accommodative. There are also risks of tailwinds and costs to monetary policy being too accommodative”

September 18 – Bloomberg (Annie Massa and John Gittelsohn): “Mark Wiedman, head of international and corporate strategy at BlackRock Inc., sounded an alarm about negative interest rates… ‘We’re slouching toward the U.S. moving into negative rate territory,’ Wiedman said... ‘Negative rates are corroding and poisoning financial systems.’ Wiedman joined Steve Schwarzman and Jeffrey Gundlach in stressing the harm of negative rates to banks and the economy… ‘My strong view is I don’t think it makes any sense whatsoever,’ Schwarzman, the founder of Blackstone Group Inc., said… ‘Why would I take my money and pay somebody to take it? It’s hard enough to make it. I really just don’t understand the theory behind negative interest rates.’”

September 17 – Bloomberg (John Gittelsohn and Katherine Greifeld): “The spike in overnight repurchase agreements may prompt the Federal Reserve to expand its balance sheet, according to Jeffrey Gundlach… ‘Is it an imminent disaster? No. The Fed is going to use this warning sign to go back to some balance sheet expansion,’ Gundlach said… during a webcast for his $54 billion DoubleLine Total Return Bond Fund. It’s a way of ‘baby stepping’ to more quantitative easing, he added.”

U.S. Bubble Watch:

September 18 – Reuters (Lucia Mutikani): “U.S. homebuilding surged to more than a 12-year high in August as both single- and multi-family housing construction increased, suggesting that lower mortgage rates were finally providing a boost to the struggling housing market. Housing starts jumped 12.3% to a seasonally adjusted annual rate of 1.364 million units last month, the highest level since June 2007…”

September 18 – CNBC (Diana Olick): “Homebuyers seemed undeterred by last week’s turnaround in interest rates, or perhaps they were spooked into action. Strong demand from buyers easily offset the drop in demand from those wishing to refinance… Mortgage applications to purchase a home increased 6% for the week and were a strong 15% higher annually.”

September 18 – Wall Street Journal (Dawn Lim): “Money managers that mimic the stock market just became the new titans of the fund-management world. Funds that track broad U.S. equity indexes hit $4.27 trillion in assets as of Aug. 31, according to… Morningstar… Funds that try to beat the market had $4.25 trillion as of that date. The passing of the asset crown is the latest chapter in one of the most dramatic transformations in the history of financial markets. In the past decade, nearly $1.36 trillion in net flows were added to U.S. equity mutual funds and exchange-traded funds that mimic market indexes while some $1.32 trillion fled higher-costing actively managed counterparts.”

September 17 – Wall Street Journal (Joe Flint and David Marcelis): “Entertainment heavyweights have spent more than $2 billion on classic television shows in recent weeks while signing talent for new programming, in an effort to win over streaming customers who soon will have many more options to choose from. This week, AT&T Inc. ’s WarnerMedia struck a deal for ‘The Big Bang Theory,’ while Netflix Inc. acquired ‘Seinfeld’ and Comcast Corp. ’s NBCUniversal said it would have exclusive streaming rights to ‘Parks and Recreation.’ Two other shows, ‘Friends’ and ‘The Office,’ changed homes earlier this summer. The commitments total over $2 billion… ‘You will see more of this,’ said industry analyst Hal Vogel of Vogel Capital Management… The spending frenzy comes as four high-profile services—from Apple Inc., Walt Disney Co. , Comcast and WarnerMedia—are to launch between November and the spring…”

China Watch:

September 19 – Fox Business (Brittany De Lea): “As mid-level discussions take place this week between China and the U.S. amid an ongoing trade war, new reports indicate that President Trump might be prepared to escalate the situation should an agreement not be reached in the near future. According to… Michael Pillsbury, who President Trump has referred to as a leading authority on China, the president believes he has so far exercised restraint with regard to tariff rates. ‘Does the president have options to escalate the trade war? Yes, the tariffs can be raised higher. These are low-level tariffs that could go to 50% or 100%,’ he said, as reported by the South China Morning Post.”

September 16 – Reuters (Kevin Yao and Stella Qiu): “The slowdown in China’s economy deepened in August, with growth in industrial production at its weakest 17-1/2 years amid spreading pain from a trade war with the United States and softening domestic demand… Industrial output growth unexpectedly weakened to 4.4% in August from the same period a year earlier, the slowest pace since February 2002 and receding from 4.8% in July.”

September 15 – Reuters: “Chinese Premier Li Keqiang said it is ‘very difficult’ for China’s economy to grow at a rate of 6% or more because of the high base from which it was starting and the complicated international backdrop. The world’s No.2 economy faced ‘certain downward pressure’ due to slowing global growth as well as the rise of protectionism and unilateralism, Li said…”

September 15 – Bloomberg: “China’s slowdown is deepening just as risks for the global economy mount, piling pressure on the authorities to do more to support growth. Industrial output rose 4.4% from a year earlier in August, the lowest for a single month since 2002, while retail sales came in below expectations. Fixed-asset investment slowed to 5.5% in the first eight months, with the private sector lagging state investment for the 6th month.”

September 16 – Reuters (Yawen Chen and Ryan Woo): “China’s new home prices grew at their weakest pace in nearly a year in August as a cooling economy and existing curbs on speculative buying put a dent on overall demand. Wary of property bubbles, Chinese regulators have vowed to refrain from stimulating the real estate sector as they roll out measures to boost the broader economy hit by the Sino-U.S. trade war and slowing consumer demand. Average new home prices in China’s 70 major cities rose 8.8% in August from a year earlier, compared with a 9.7% gain in July and the weakest pace since October 2018…”

September 15 – Reuters (Yawen Chen, Kevin Yao and Roxanne Liu): “China’s property investment grew at its fastest pace in four months in August, a boon for the economy as other sectors weaken from the Sino-U.S. trade war and consumer demand slows… Property investment in August rose 10.5% from year earlier, quickening from July’s 8.5% pace…”

September 19 – Financial Times (Don Weinland): “When lossmaking Chinese iron ore miner Shandong Hongda scooped up a UK game developer in 2016, it also had grand plans to diversify into energy and healthcare businesses around the globe and move away from its low-growth mining past. In the end, it held on to Jagex, the creator of the world’s largest online role-playing game for just short of two years and its other plans have since fallen away too. The trajectory of Shandong Hongda, with its brief stint as a game developer and ambitions to expand elsewhere, has been followed by a number of Chinese companies, which have attempted to make debt-fuelled leaps into countries and industries far from their areas of expertise. But as credit conditions have tightened and authorities have taken a much more active interest in how much debt companies hold and the risks they are taking, businesses have drawn in their horns. Since the start of the year, there has been a record sell-off of global assets by Chinese companies totalling about $40bn… At the same time, the pace of acquisitions has slowed to just $35bn, as businesses worry about being labelled speculative buyers. It is the first time in a decade that Chinese companies are net sellers of global assets.”

September 19 – Wall Street Journal (Mike Bird): “China’s property giants are notorious for their rapacious issuance of debt. But a more politically sensitive liability has risen even faster, posing a less well known risk to the country’s housing market. Unearned revenue—the line on developers’ balance sheets that accounts for presales or contracted sales—now makes up a greater share of the 10 largest property developers’ liabilities than total debt. Their combined unearned revenue rose to just over $400 billion in June… The practice of selling homes once construction has started—but often years before completion—now makes up more than 85% of total sales in China. Yields of above 10% aren’t uncommon on Chinese property bonds, making presales an attractive source of financing.”

September 16 – Reuters (Clare Jim and Noah Sin): “Credit rating agency Moody’s changed its outlook on Hong Kong’s rating to negative from stable on Monday, reflecting what it called the rising risk of ‘an erosion in the strength of Hong Kong’s institutions’ amid the city’s ongoing protests… ‘The decision to change Hong Kong’s outlook to negative signals rising concern that this shift is happening, notwithstanding recent moves by Hong Kong’s government to accommodate some of the demonstrators’ demands.’”

September 15 – Reuters (Jessie Pang): “Hong Kong’s businesses and metro stations reopened as usual on Monday after a chaotic Sunday when police fired water cannon, tear gas and rubber bullets at protesters who blocked roads and threw petrol bombs outside government headquarters. On Sunday what began as a mostly peaceful protest earlier in the day spiraled into violence in some of the Chinese territory’s busiest shopping and tourist districts.”

Central Banking Watch:

September 17 – Financial Times (Stephen Morris, Olaf Storbeck and Martin Arnold): “European lenders are bracing for deeper cost cuts and consolidation after the European Central Bank extended a punishing five-year stretch of negative interest rates. The region’s banks were left disappointed by Mario Draghi’s last major act as ECB president, in which he last week cut its key deposit rate to minus 0.5%, while also unveiling a new tiering system designed to shield a portion of the deposits lenders keep at the ECB from negative rates. However, the relief provided by tiering will barely offset the lost earnings from lower base rates, according to analysts and executives…, piling pressure on a sector already struggling to generate acceptable returns. The ECB is expected to cut its deposit rate again by next year, which could lower even further the Euribor rate on which many loans are priced. ‘Deposit tiers . . . [are] a drop in the ocean,’ said Morgan Stanley analyst Magdalena Stoklosa. ‘Profitability uplifts could be minimal for most banks… as sensitivity to Euribor is multiple times greater versus savings on cash reserves parked at the ECB.’”

Brexit Watch:

September 14 – Reuters (David Milliken and William James): “British Prime Minister Boris Johnson likened himself to the comic book character The Incredible Hulk in a newspaper interview where he stressed his determination to take Britain out of the European Union on Oct. 31… ‘The madder Hulk gets, the stronger Hulk gets,’ Johnson was quoted as saying. ‘Hulk always escaped, no matter how tightly bound in he seemed to be - and that is the case for this country. We will come out on October 31.’”

September 16 – Associated Press (Lorne Cook and Jill Lawless): “Boris Johnson was booed by protesters and berated by Luxembourg’s leader on a visit to the tiny nation… for his first face-to-face talks with the European Union chief about securing an elusive Brexit deal. On a day of commotion and conflicting signals, Johnson pulled out of a news conference because of noisy anti-Brexit demonstrators, leaving Luxembourg’s prime minister standing alone next to an empty lectern as he addressed the media.”

Europe Watch:

September 17 – Reuters (Michael Nienaber and Christian Kraemer): “German Finance Minister Olaf Scholz said… policymakers could not accept the emergence of parallel currencies such as Facebook’s planned Libra, adding that Berlin would reject any such plans… ‘We cannot accept a parallel currency,’ Scholz said... ‘You have to reject that clearly.’”

Asia Watch:

September 18 – Associated Press (Kim Tong-Hyung): “South Korea… dropped Japan from a list of countries receiving fast-track approvals in trade, a reaction to Tokyo’s decision to downgrade Seoul’s trade status amid a tense diplomatic dispute. South Korea’ trade ministry said Japan’s removal from a 29-member ‘white list’ of nations enjoying minimum trade restrictions went into effect as Seoul rearranged its export control system covering hundreds of sensitive materials that can be used for both civilian and military purposes. The change comes a week after South Korea initiated a complaint to the World Trade Organization over a separate Japanese move to tighten export controls on key chemicals…”

EM Watch:

September 15 – Financial Times (Steve Johnson): “Emerging market central banks have turned more dovish than at any point since at least the global financial crisis, according to analysis of the language in 4,000 monetary policy publications. The extreme pro-easing bias is remarkable given that banks, including those of Brazil, Russia, India, China, South Africa and Turkey, have already cut rates this year… Bank of America Merrill Lynch’s Emerging Monetary Mood Indicator, based on robotic scanning of keywords used in the publications of 11 big EM central banks, is at its more dovish extreme since the height of the crisis in 2009… Based on single-month figures, the August reading — the latest available — was the most extreme since the depths of the dotcom crash in 2000.”

September 16 – Associated Press (Sheikh Saaliq): “Anuj Kapoor took over his father’s booming auto parts business in 2012, hoping to elevate the company from selling to suppliers to selling directly to carmakers. Seven years later, he’s had to lay off half his workers as drooping sales caused his profit to plummet by at least 80%. Confidence in the Indian economy is giving way to uncertainty as growth in the labor-intensive manufacturing sector has come to a near standstill, braking to 0.6% in the last quarter from 12.1% in the same period a year earlier. The economy grew at its slowest annual pace in six years in April-June, 5%.”

Japan Watch:

September 18 – Reuters (Leika Kihara and Daniel Leussink): “The Bank of Japan kept monetary policy steady on Thursday but signaled the chance of expanding stimulus as early as its next policy meeting in October… BOJ Governor Haruhiko Kuroda said the central bank has edged closer toward loosening policy than when its board last met in July, as the U.S.-China trade war and slowing overseas demand dampen prospects for achieving its elusive 2% inflation target. ‘We are more eager to act given heightening global risks. We will scrutinise economic and price developments thoroughly at next month’s meeting to decide whether to ease,’ Kuroda told a news conference…”

Global Bubble Watch:

September 16 – Bloomberg (Anooja Debnath and Susanne Barton): “Trading in the global foreign-exchange market has jumped to the highest-ever level at $6.6 trillion, according to the Bank for International Settlements. The average daily trading in April was up 29% from $5.1 trillion in the same month in 2016, the BIS reported… The growth of FX derivatives trading, primarily swaps, outpaced the spot market and now accounts for almost half of global FX turnover… Trading of outright forwards also increased, with a large part of the rise due to non-deliverable forwards. That reflected strong activity in NDF markets for the Korean won, Indian rupee and Brazilian real, the BIS said. ‘While we’ve seen growth across all forms of FX trading, swaps and forwards have seen particular growth,’ said Matthew Hodgson, CEO and founder of Mosaic Smart Data… ‘The FX market has woken up.’”

Fixed-Income Bubble Watch:

September 16 – Financial Times (Laurence Fletcher): “Parts of Wall Street’s debt securitisation engine are back running at levels not seen since the pre-financial crisis boom. …Dealogic’s indices of US securitisation activity show that issuance of collateralised debt obligations — structured products made up of bundles of bonds and loans — rose above its pre-crisis peak late last year and is currently back close to those levels this year. The market for commercial mortgage-backed securities has also rebounded strongly since late 2008 and early 2009, when issuance completely seized up in the aftermath of the financial crisis. Activity in the asset class is now some way above its 2007 high.”

Geopolitical Watch:

September 18 – Reuters (Phil Stewart and Parisa Hafezi): “The United States believes the attacks that crippled Saudi Arabian oil facilities last weekend originated in southwestern Iran, a U.S. official told Reuters, an assessment that further increases tension in the Middle East. Three officials… said the attacks involved cruise missiles and drones, indicating that they involved a higher degree of complexity and sophistication than initially thought.”

September 15 – Bloomberg (Anthony Dipaola and Verity Ratcliffe): “The latest and most destructive attacks on Saudi oil facilities provide stark evidence of the vulnerability of global crude supply in an age of disruptive technologies that can bring a century-old industry to its knees -- at least temporarily. From remote-controlled drones to anti-ship mines and computer worms, hostile parties have employed an unpredictable array of asymmetric weaponry to confound one of the best-equipped militaries in the Middle East. Saudi Arabia blames many of the attacks against its oil assets on Houthi rebels in impoverished Yemen, where Saudi forces have been fighting since 2015 in a civil war that’s spilling across their shared border.”

September 17 – Reuters (Tuqa Khalid): “Saudi King Salman said… that Riyadh was capable of dealing with the consequences of attacks on its installations. A statement issued after a meeting of Saudi Arabia’s council of ministers said the cabinet had reviewed the damage caused by the attacks on Aramco installations, and it called on world governments to confront them ‘regardless of their origin’.”

September 17 – Reuters (Stephen Kalin, Sylvia Westall): “Billions of dollars spent by Saudi Arabia on cutting edge Western military hardware mainly designed to deter high altitude attacks has proved no match for low-cost drones and cruise missiles used in a strike that crippled its giant oil industry. Saturday’s assault on Saudi oil facilities that halved production has exposed how ill-prepared the Gulf state is to defend itself despite repeated attacks on vital assets during its four-and-a-half year foray into the war in neighboring Yemen.”

September 16 – CNBC (Natasha Turak): “Satellite photos released by the U.S. government and DigitalGlobe reveal the surgical precision with which Saudi Aramco’s oil facilities were struck in attacks early Saturday. The strikes, which unidentified U.S. officials have said involved at least 20 drones and several cruise missiles, forced Saudi Arabia to shut down half its oil production capacity, or 5.7 million barrels per day of crude — 5% of the world’s global daily oil production.”

Friday Evening Links

[Reuters] Wall Street drops after China cancels trip to Montana farmland

[Reuters] Oil slips on trade fears but soars in week after Saudi production attacked

[CNBC] Chinese trade negotiators cancel US farm visit, cut trip short

[CNBC] China delegation’s sudden departure highlights trade and tariffs as main movers of markets

[Reuters] Hopes for trade breakthrough fade as China cancels U.S. farm visits

[AP] Trump says he doesn’t need China trade deal before election

[AP] 2 Federal Reserve officials highlight deep divisions

[Reuters] Fed's Rosengren flags risks to economy in WeWork-style model

[CNBC] Goldman Sachs says the market is about to get wild in October

[Bloomberg] Fed Tackles End-of-Quarter Funding Angst by Extending Repo Plan

[Bloomberg] U.S. Household Net Worth Increases $1.8 Trillion

[FT] Week of repo turmoil puts Wall Street traders in a spin